Letters of credit (L/Cs) are increasingly being used to finance property investments in the US housing market, particularly when it comes to purchases of beachfront condominiums and other holiday homes.

Property developers have worked out that they can ask buyers to put up L/Cs as partial deposits for properties before or under construction. This, they say, lowers the risks involved for the buyer who would normally have been expected to put up a deposit made up entirely of cash.

Under construction

Using L/Cs to finance property purchases is on the increase amongst buyers of beachfront condominiums and other holiday properties in Florida, Alabama and Texas.

Most of the properties are unfinished and in some cases building work has not even begun.

Benefits

By asking for a standby L/C, the developer aims to benefit from the ability to raise finance against the documents that guarantee payment for the property, provided, of course, that it is properly completed as specified in the documents. Sometimes advance finance is not available to developers until 60 per cent of condominiums are pre-sold.

Buyers meanwhile apparently benefit because they do not have to find cash up front with the consequent loss of interest that this normally involves. The standby L/C deposit, rather than cash deposit, also lowers the risk to the buyer of the property being unsatisfactorily completed.

Security

Some property developers are asking for L/Cs to be secured against buyers' assets while others are apparently not asking for this security.

The L/C-based option of not having to ask for and obtain cash deposits is apparently allowing developers to obtain advance finance quicker than ever before. This has led to concerns in some quarters that the market may overheat.

Overheating

Some experts say the L/C deposits make it too easy for speculators to buy. Around 20 per cent of residential property sales involve investors, not families or individuals who plan to live in the home.

Such purchasing could be artificially lifting prices and demand and could destabilise the market should speculators start dumping homes, the experts suggest.

Fees

In Alabama, buyers are allowed to use L/Cs for as much as 20 per cent of the down payment. In Florida, buyers can use L/Cs for half of a 20 per cent deposit but must find the balance in cash.

Banks say they are charging fees of between 1 to 3 per cent of L/C value per year.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.