PX: certainty in every deal

Copyright © PSL Homes Ltd 2014
Permission granted to reproduce for personal and educational use only. Commercial copying, hiring, lending is prohibited
Residential
Property
Part-‐Exchange

Certainty in Every Transaction

2
Introduction
Eleven out of eleven of the UK’s biggest housebuilders use part-
exchange as an effective sales and marketing tool. In a recent
study, we found that UK housebuilders consider part-exchange to
be the second most effective tool in driving reservations after Help
to Buy. While large companies have strong enough cash flow and
big enough balance sheets to buy and hold used stock, the
situation isn’t so straightforward for regional and local
housebuilders.
We’ve engaged with around 200
housebuilders of all sizes over the last 10
months. We see a playing field that isn’t level
because the bigger companies are able to
use size to their advantage. Smaller
companies might offer part-exchange, but
they rarely aggressively promote it to drive
conversions. Are they missing a trick?
This white paper explores using part-
exchange as an effective tool to promote
sales and suggests ways of mitigating the
risk that buying used stock creates.
There’s
a
reason
that

11/11
of
the
country’s

most
successful

housebuilders
put
PX
on

their
homepage.

It
works.

Dom Hawes-Fairley, PSL Homes

3
Table of Contents
Introduction
...........................................................................................................
2

Table
of
Contents
...................................................................................................
3

Executive
Summary
...............................................................................................
4

Why
is
Part-‐Exchange
Important?
..........................................................................
5

What
does
PX
success
look
like?
............................................................................
7

Establishing
a
Valuation
Framework
......................................................................
8

Current
Valuation
Strategies
..................................................................................
9

Introducing
a
New
Valuation
Strategy
..................................................................
11

Introducing
the
Saleability
Index
..........................................................................
13

Certainty
on
every
transaction
.............................................................................
14

Part-‐exchange
&
Help
to
Buy
...............................................................................
17

It
doesn’t
have
to
be
all
or
nothing
......................................................................
18

About
PSL
Homes
.................................................................................................
19

4
Executive Summary
Part-exchange is an important marketing tool for housebuilders of
all sizes because it increases reservation rates, makes customers
chain-free and allows the housebuilder to retain control of
completion. Importantly, accepting a part-exchange allows builders
to negotiate on the price of the inbound property, rather than they
one they’re selling, maintaining price list integrity.
But, property part-exchange is a risky business and measuring the success of
the PX programme is only possible if one measures all of the costs associated
accurately. Ideally, costs are allocated on a transaction-by-transaction basis, but
in the real world this rarely happens because many companies don’t account for
fixed costs in their PX transactions. Success in part-exchange is deal-by-deal.
Establishing a fair PX purchase value is important to homeowners and that
inevitably means using independent valuations. The established route for
achieving this is through local agent valuations, but in most market conditions
this only works in the interest of homeowners. We present a new framework for
valuations that takes market conditions into account delivering better value for
housebuilders.
Resaleability is critically important to successful PX transactions and it’s not
being considered in a meaningful way. A structured and impartial approach to
forecasting the resaleability of a property may be more useful than just
considering mortgageability or value on its own.
The key to a successful PX programme is being able to achieve margin
transparency on each and every transaction. Outsourcing might seem like an
expensive option, but that is not always the case. Ideally, a PX programme
offers housebuilders the option to buy direct where they are certain of the
business case, or outsourcing where they are not. In each and every case a
structured approach is needed in order to make risk-managed decisions.
Help to Buy rules out PX transactions but only where housebuilders are running
their own PX programmes. An outsourced PX programme offers the ability to
combine both.
The strategy we recommend to our clients is this: If you’ve got ready
funds and a very high degree of certainty that you can go under offer on a PX
property within 21 days of going on market, buy it with company funds. In every
other case outsource the PX purchase.

5
Why is Part-Exchange Important?
As the property market recovers, housebuilders across the country have
reported impressive reservation rates. Help to Buy has undoubtedly been the
major catalyst in the housing market recovery outside the capital. It’s got
homebuyers out viewing again and it’s helping them to stretch their budgets
further. But, Government initiatives can only help housebuilders sell faster if
their customers are chain free or have already sold.
To solve this problem, many housebuilders offer assisted sale programmes that
allow reservations to be made with exchange contingent on a timely sale of the
used stock. Assisted sale programmes work best in buoyant markets, with very
saleable properties or where the homeowner is modest in his or her price
expectations. The problem with assisted sale is that it doesn’t offer certainty and
that means it’s only a partial solution.
Certainty

Part-exchange offers total certainty once a deal is
agreed. Because it removes the need for
homeowners to market their own properties,
the deal’s progress is fast, efficient and
predictable.
To the customer, certainty is about more than
knowing their old home is sold without hassle
or estate agents traipsing through the house. It’s also about certainty of timing,
moving and getting on with their lives. That’s a powerful sales tool. But, if
development schedules should slip a little “chain free” also means that
customers complete at the convenience of the housebuilder, not the other way
round.
“Chain
free”
means
that

customers
complete
at
the

convenience
of
the

housebuilder,
not
the
other

way
around

6

Price
control

A customer with no property to sell is in a strong position to negotiate because
they are immediately proceedable, but housebuilders don’t like discounting
because they know it can set a precedent for future sales.
Part-exchange customers are also immediately proceedable, but instead of
negotiating on the price of the property they’re selling, housebuilders can
negotiate exclusively on the price of the property they’re buying. This allows
them to maintain the integrity of their price list and still give the customer a good
deal.
Increased
reservation
rates

There’s a very good reason that 11/11 of the biggest housebuilders in the UK
promote PX so aggressively. It works. Barratt Homes reported a 42 per cent rise
in PX reservations in a six-month period in 2012.

7
What does PX success look like?
It seems simple to buy a used house, but it’s very hard to do it in a way that
manages risk in a consistent way, delivering measurable and transparent
profit every time. There are just too many variables at play.
Some companies choose to define success by the number of part-exchange
deals they execute and they measure PX performance purely as an aid to
reservations. Put another way, they don’t measure the profit and loss on each
deal and, in our opinion, leak profit as a result.
In fact, our experience is that the great
majority of companies don’t get too
deeply involved in the financial efficacy of
their PX programme. They see part-
exchange as a necessary evil to be
competitive and, because the true costs
of running a part-exchange programme are spread across the P&L sheet, they
don’t measure them.
We may look at PX on the P&L in a future white paper as it’s a highly specialized
subject. In summary, we believe that PX costs should appear “above the line”
not below it. That’s to say PX is a cost of sale, not an overhead.
• If you have a full-time part-exchange manager, how do you allocate that
overhead to individual deals? You probably don’t. You probably mark it
down to fixed overhead and get on with building. But that doesn’t mean
it’s not a real cost.
• If you buy a property and have to hold it for a year before completing on
its resale, how are you accounting for that?
Our model for PX success is about transparency and certainty; knowing exactly
what each PX will cost you and managing risk so that you profit from the better
deals and offload risk on the rest.
Success in part-exchange is deal-by-deal. Because no two properties are the
same and local markets operate differently we don’t think the old approach
works effectively. Ideally housebuilders should be working a PX programme that
offers flexibility, minimal risk and maximum effectiveness.
The starting point to effective PX is effective valuations.
PX
is
a
cost
of
sale,
not
an

overhead…
Success
in

part-‐exchange
is
deal-‐by-‐
deal

8
Establishing a Valuation Framework
PX must offer customers a “fair” price for their old home to be a successful
sales and marketing tool. “Fairness” is an important concept to homeowners
because when it comes to one’s own home, decisions are often more
emotional than rational. Fair matters.
The PX price of a property is almost never going to be
as much as the property could sell for on the open
market. Vendors choose to part-exchange their
properties for a number of reasons, but generally
accept that they will achieve a lower price in PX than
they could on-market. Thus, demonstrating fairness is
an important part of gaining trust and achieving
reservations.
The starting point for establishing a PX price is identifying a realistic open market
valuation (OMV). As we all know, the OMV of a property is simply what someone
will actually pay for it, but how accurately can the established industry predict
that in advance? Not very accurately at all and here’s the rub. People think of
open market value as a price point, but in reality, it’s a price range.
Estate agents tend towards the optimistic to win listings. It’s their valuations that
fuel your customers’ expectations and if you buy at their price, you’ll almost
certainly lose out. RICS surveyors’ red book valuations are often seen as the
benchmark, but they can sometimes value down and sometimes value up. More
often than not, they value down to err on the prudent side.
Both the agent and
the RICS surveyor are
probably “right” in
their valuations. If
someone walks
through the door and
falls in love with the
property, it could well
sell at the agent’s
price. Equally, it could
sell at or below the
RICS valuation if it’s
been exposed to the market for too long. This is why open market value works
better as a range than a price point.
What’s key is that to be seen as fair, an independent reference point is needed
and there are a few ways to achieve that.
People
think
of

open
market

value
as
a
price

point,
but
in

reality,
it’s
a

price
range

Figure 1: Open market value

9
Current Valuation Strategies

Estate
agent
valuations

Housebuilders that operate their own PX programmes generally use the average
of two or three local agents’ valuations as their purchase price.
In our experience, most estate agents use “on market comparable pricing”. If all
of the properties on market were valued correctly, this would be a good
approach, but very few are. On market comparable pricing is an appropriate
methodology to use when prices are not appreciating and there’s palpable
under supply, because lack of supply will help to compensate for over-valuation.
But, it’s not a good approach to use in other market conditions if the objective is
to convert PX enquiries into profitable sales.
It is also commonly accepted that agents routinely over-value properties in order
to win instructions. We very strongly advise our clients not to rely solely on agent
valuations. Here’s a good example of how it can go wrong.

10
Case Study
In June 2013, we encountered a property that we valued at £65,000 in
Middlesborough. It had been valued by local agents at £89,850 (open market price)
with a fast sale price of £76,000. Over-valuing is bad if you’re a homeowner trying to
sell, but it’s disastrous if you’re a housebuilder trying to buy in a PX.
In this case, the housebuilder was faced with taking an immediate loss £11,000 or
hanging on and hoping. They hung on and hoped. The property finally sold for £64,000
in December 2013.
With council tax, cost of capital, salaries, legal and agent fees on the final sale, this a
case study for what PX success does NOT look like.
RICS
red
book
valuations

The RICS red book valuation is the ultimate independent reference for a
property’s value. But, as any professional involved in buying and selling property
knows, RICS valuations are also somewhat slanted because they’re designed to
manage risk for mortgagors not pinpoint value for other purposes.
RICS valuations perform best when used as part of a managed risk process
because they are often on the bearish side.
3rd

party
valuations

Housebuilders that outsource some or all of their PX programme will typically be
provided with a report offering more analytical and in-depth valuation
methodologies combining both on-market and sold comparables.
This is an improvement on the majority of agent-only valuations, but we believe
that over-analysis of comparables can produce bearish valuations in some
markets and bullish valuations in others.

11
Introducing a New Valuation Strategy
The right PX value is one that ensures the profit on your sales transaction
once all of the associated costs have been allocated and which leaves the
customer feeling they’ve been well and professionally treated.
We advocate identifying PX value by taking a structured approach to valuations
depending on market conditions as illustrated in figure X. Saleability plays an
important part in the offer price too and this is a factor that’s generally
overlooked in current valuation models. We’ll look at saleability next.

Figure 2: Valuation strategies

12
On
market
comparable
pricing

Where prices are stable but stock is selling through quickly (4-6 weeks), the best
strategy to use for valuations is on market comparables. This is the market
condition that we’re currently seeing in smaller market towns and villages in the
Midlands and parts of East Anglia. Prices aren’t genuinely rising because
demand isn’t increasing, but well priced stock is selling quickly. Selling quickly in
such markets means being better priced than nearest on market comparable
properties.
Vendor-‐led
pricing

Where prices are rising AND properties are moving quickly because of an
increase in demand but insufficient increase in supply, the best strategy to use
for valuations is vendor-led. This is the market condition found in prime markets
like London, Cambridge and Oxford.
Vendor-led pricing doesn’t mean always over paying to secure deals, but it does
mean that your ability to negotiate a purchase price will be reduced. In such
instances the best strategy may be to offer to underwrite the sale at sold
comparable prices, but advise the purchaser to sell on the open market to test
for a higher price.
Buyer-‐led
pricing

Where prices are either static or deflating and the market is slow, taking
properties in part-exchange is risky. While these market conditions are usually
associated with general downturns, they are still prevalent in certain areas of the
UK, even as we power out of the recession caused by the global credit crisis.
Buyer-led pricing will rarely offer vendors anything near market value, but when
nothing else is selling, it does allow a move to be made. We see these
conditions in parts of Wales, the North East of England and in certain parts of
the West Country.
Sold
comparable
pricing

Where asking prices are rising, but sales are slow the best gauge to use for
value is what has actually sold. These conditions are often prevalent where
agents are driving market values or in locations adjacent to more prime markets
where values are anticipated to rise, but they haven’t yet.
Sold comparable pricing offers vendors a very easy reference point for value.

13
Introducing the Saleability Index
Many housebuilders use mortgageability as their sole criteria for
purchasing part-exchange properties. While this certainly keeps
things simple, we don’t believe that mortgageability on its own is
an effective risk management strategy.
We believe that using mortgageability as sole criteria for PX appropriateness can
lead directly to very poor PX decisions. A better approach is to consider the
saleability of a property, of which mortgageability is a contributing factor. A
purchased PX property that is not saleable can rapidly reduce the margin made
on a new house sale and in extreme cases, eradicate all meaningful profit.
We maintain that saleability is the single most important factor in establishing the
true potential of a property for PX purposes. What happens when a property is
mortgageable but not saleable? Either the price has to be dropped in order to
secure a sale or the owner has to wait for the market to catch up. This can take
years in a static market and many smaller housebuilders need cash to build, not
to hold existing stock. On-market stock doesn’t get more valuable over time.
At the same time, one of the key reasons that homeowners seek PX deals is
that they can’t sell or can’t wait to sell on the open market. Thus, a house with
low saleability can’t be ignored for PX purposes, it just has to be factored in the
purchase price, resale price or both.
Most estate agents and surveyors factor in saleability to their valuations but their
assumptions are subjective, non-specific and un-measureable. We use
saleability scale that is objective, highly specific and measurable to validate the
valuations that we issue. We may address this in more detail in a future white
paper.
Figure 3: Saleability factors

14
Certainty on every transaction
Why
does
certainty
matter?

Certainty of sale is critical to customers buying a new house, just
as certainty of margin is to housebuilders when selling one. From
the customer’s point of view, certainty and simplicity make buying
a new home very attractive and a well-run PX programme can serve
as a very strong incentive to choose one housebuilder over
another.
From the builder’s point of view, certainty of margin enables commercially sound
decision-making. Some housebuilders see PX as either cost neutral or as a
potential profit centre in a rising market. In many cases, this is because the true
costs of the transaction are being obfuscated at the accounting stage.
We’ve already seen that valuations are subjective at best and an educated
guess at worst which makes managing risk and achieving certainty on a
transaction difficult if the risk is being taken by the housebuilder.
Outsource
purchasing
to
achieve
complete
certainty

One option to achieve certainty is to work with an outsourced PX specialist and
let them take the price risk by buying the property for you. In flat or recessive
markets, this is a popular option, but when the market turns, or perhaps more
realistically, is perceived to have turned, attitudes change.
Outsourcing the purchase of PX properties certainly reduces balance sheet risk,
but it doesn’t come for free. Existing providers offer to buy for a fee, at a
discount to the PX value or a combination of both. Many of the transactional
costs incurred by the outsourcing company are also incurred by housebuilders
who buy direct, so the full cost of outsourcing is less than it may at first seem.
Let’s look at an example.
A property has a PX value of £100,000 against a reservation of a new 3-bed
semi worth £179,995 with a GDV of £53,000.
A PX company offers £87,000 for the property meaning the housebuilder has to
contribute £13,000 to deliver full PX value to the customer. At first sight,
outsourcing looks like it will erode almost 25% of the margin, but PX doesn’t
come free even if you buy direct.
Please see Figure 4 on page 15.

15
Scenario
1:
Ideal
circumstances

The property sells for full asking price within six weeks of going on market and
completes six weeks later.
Transactional
costs
for
a
3
month
sale
at
£100,000

Purchase
Legal costs £800
Searches £300
Surveyors fees £175
Inventory costs
Finance or cost of capital at 75% LTV for 3 months 8% p.a. £1,500
Insurance £50/month £150
Council tax £150/month £450
Utilities £30/month £90
Sale
Legal costs £500
Agency fees (VAT inc) 1.5% £1,800
Total £5,765
Figure 4: 3 month sale
Note: no allowance has been made for the human capital cost of managing the
transaction or maintenance work that may be needed to the property such as
draining heating systems etc
Scenario
2:
Not
uncommon
circumstances

The property doesn’t sell quickly and after a price reduction sells for £95,000
after four months on market and completes after six months on finance.
Transactional
costs
for
a
6
month
sale
at
£95,000

Purchase
Legal costs £800
Searches £300
Surveyors fees £175
Inventory costs
Finance or cost of capital at 75% LTV for 6 months 8% p.a. £2,850
Insurance £50/month £300
Council tax £150/month £900
Utilities £30/month £180
Loss on sale £5,000
Sale
Legal costs £500
Agency fees (VAT inc) 1.5% £1,710
Total £12,715
Figure 5: 6 month sale

16
Certainty
of
risk

When a housebuilder buys a part-exchange property direct, they take on 100
percent of the risk. Many companies that we speak to focus purely on price risk
– the amount they can sell the property for after purchasing it, but there are
more risks than that in each deal.
Price
risk

Price risk is the most common risk used to measure and to manage PX
transactions by housebuilders. It works like this: if house bought for
£160,000 has buying and selling costs (SDLT, legal fees and agency
fees) of around £6,000, it must sell at £166,000 or more to break even.
This is a fairly simplistic approach to take because it doesn’t take
account of the cost of finance, internal salaries etc etc.
Managing price risk to deliver certainty is about being confident in the
property valuation. This subject has been covered in some detail earlier in
this paper. We maintain that the valuation methodology most companies
use it flawed and therefore, risk is not being managed effectively.
Property
risk

Property risk is the most overlooked of all risks in the PX process. Few
companies commission anything but valuation surveys prior to
completing on PX deals and, thus, expose themselves to something
being wrong with the structure of the building. The most common issues
we encounter are damp, electrical and heating issues.
Margin
risk

Margin risk is the risk that the PX transaction erodes the margin on the
new property sale.
The simplest way to manage all of these risks is to outsource the PX process to
a third party. While this will almost certainly reduce the margin slightly on each
deal, it avoids the penurious instance of getting either the price or the property
risk assessment wrong.
Risk Direct Purchase Outsourced purchase
Price risk Yes No
Property risk Yes No
Margin risk Yes No
Figure 6: PX risk management

17
Part-exchange & Help to Buy
If Help to Buy is the best marketing tool available to housebuilders
in the UK and part-exchange is the second best tool, what happens
when they’re combined? According to the regulations, Help to Buy
is not available on houses that are being part exchanged, but there
is a way of combining both to really superboost sales.
As a housebuilder, the Help to Buy rules prevent you from accepting a property
in part-exchange and approving a Help to Buy application. The rules don’t
prevent your customer from working with an independent part-exchange
company, however. You can even refer them, but the PX company will have to
pay SDLT on the transaction as the exemption
will no longer apply. Strictly speaking, such a
transaction is not a part-exchange, but it looks,
feels and works that way for a customer.
Using an independent PX partner is a totally legal
way of being able to offer Help to Buy to your
customers while giving them all the benefits of a
part-exchange. You will need to contribute financially to the deal, but you’ll
achieve certainty and guarantee your margin or be able to refuse the deal.
Strictly
speaking,
such

transactions
are
not
part-‐
exchange,
but
they
look,

feel
and
work
that
way

for
a
customer.

Figure 7: Help to buy

18
It doesn’t have to be all or nothing
If every property were to achieve a fast sale, outsourcing some or
all of the part-exchange process wouldn’t make sense. But, that’s
not the way the market works. Some properties sell very quickly at
the price you want and others don’t. Those that don’t linger and
end up getting discounted and discounted.
The optimal part-exchange strategy uses
both direct purchase and outsourced
part-exchange to manage risk and
maximize profitability across the phases
of a development.
As long as the property appraisal
methodology is consistently applied,
decisions about who actually buys the PX
property can be left until quite late in the
process.
The strategy we recommend to our clients is this: If you’ve
got ready funds and a very high degree of certainty that you can go
under offer on a PX property within 21 days of going on market, buy
it with own funds. In every other case outsource the PX purchase.
If
you’ve
got
ready
funds

and
a
very
high
degree
of

certainty
that
you
can
go

under
offer
on
a
PX

property
within
21
days

of
going
on
market,
buy
it

with
own
funds

19
About PSL Homes
PSL Homes is a privately funded property services company. We
work on both an ad-hoc and retained basis with national and
regional housebuilders, housing associations, property investors
and other professional property owners. We buy properties direct
to liquidate assets quickly and we operate part exchange
programmes for housebuilders under our PrepackPX brand.
PrepackPX offers a unique approach to PX that offers total risk management,
detailed analysis and insight, certainty of margin on every deal and multiple
funding options for purchased properties.
PSL Homes
2nd
Floor, King’s Hall
Parson’s Green
St Ives
Cambridgeshire
PE27 4WY
Tel: 01480 877 330
Web: www.pslhomes.co.uk
Web: www.prepackpx.co.uk
@pslhomesuk
@prepackpx

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