Presales, Financing Constraints and Developers’ Production Decisions
 

Abstract:

This study explores the impacts a presale contract has on a developer’s pricing and production decisions in a game-theoretical framework. In an environment where developers have full capital market access, we find that both developers and buyers are indifferent between a presale and a spot sale method. This is true because a developer will adjust the presale price to compensate for the option value he gives to the buyer. However, in an environment with financing constraints, both developers and buyers are better off when a presale method is used. This is the case because the presale method solves the financing constraint by injecting equity into the development and, hence, reducing financing costs. The latter benefit can then be shared by both developers and buyers. Also, the additional equity the developers receive makes it more feasible for them to increase the size of their developments. This model prediction seems to describe well the real world situations seen in some of the property markets in Asia with nascent financial systems.