Off plan investment refers to the purchase of property (home/house/office space) before construction works have commenced and the works are completed. The purchaser buys the property off the plan or at the design stage of the development. It is a concept that many prospective homeowners tend to shy away from as they find it a complicated process with high probability of risk that can end up frustrating one’s home ownership plans.
An off plan set up is however advantageous to the developer as it is seen as an alternative and cheaper source of finance. Developing real estate is a high-risk activity which requires commitment of large sums of capital. A developer may obtain financing from a bank, however a bank may be reluctant to cover the entire budget for the project. In addition, such borrowing increases the cost of the development as developers have to factor in additional costs such as bank fees and interest rates. An off plan arrangement therefore becomes a cheaper alternative to obtain the required funding.
Recently there has been an increase of fraud relating to purchasing of real estate the off plan way thus casting a dim light on what can be an attractive real estate investment venture. Projects fronted by real estate development companies such as Suraya Group and Banda Homes have been in the news for various reasons such as undue delay of development projects years after commencement dates due to lack of funds to either complete construction or complete the purchase of the land required for the development. It is however not all gloom as a properly packaged off plan investment can have various advantages.
- Fixed low purchase price – it is common place for real estate to appreciate in value. An off plan purchase allows for the purchaser to lock the price at an early stage before the appreciation of the value of the property. In addition, the price is likely to be lower than a completed unit.
- Potential high capital gains - buying off plan allows purchasers to acquire a future asset at today’s price and therefore it is seen as purchasing the property at a discount. Should the property values go up during construction one will still pay the discounted amount for the property. Depending on the prevailing market trends, the property bought off plan may increase in value thus enabling one to secure a high value asset for a low initial capital outlay.
- Flexible payment plans – for one to secure a property off plan, all one needs is a deposit which is usually 10% to 20% of the purchase price. The balance will be paid on completion or by flexible periodic installments. This allows individuals without the financial capability to acquire property they otherwise could not afford once complete.
- Preference on unit - the purchaser is able to select the best location for his or her unit, choose their preferred finishing and hence acquire a unit that is in line with their preference as opposed to buying a complete house where he/ she has to settle for whatever has been built by the developer and in locations left over. First time off plan purchasers have considerable pull with the developer and thus are more involved in the development as construction progresses.
As much as off plan investments have obvious advantages, they transfer an excessive level of risk to the purchaser.
- Project delays – there is a chance that the development project will extend beyond the estimated completion date. This can be as a result of various reasons ranging from an inability by the developer to acquire required finances, permits or approvals such as the final subdivision of the land or approval of the building plans. At times the delays or stalling is caused by factors beyond the developer’s control such as environment and physical factors. Regardless of whoever’s fault has caused the delay, the developer may have to pay penalties because of project delays or refund the purchase price due to non-completion or stopping the project all together.
- Probability of distressed sale – off plan purchases seem very lucrative at the onset as the purchaser see the purchase price as being very low and something they can manage to commit too. However by making these projection the purchaser can failure to properly budget for the purchase or circumstances can change where the funds projected are no longer available. The purchaser will then end up with inadequate funds and be unable to complete payment of the purchase price and risk losing their money and the unit. Failure by the purchaser to complete payment of the purchase price will also cause a problem to the developer who will be depending on the same amount to repay the loan amount or compete construction.
- Inflation – cost overrun is likely to occur as a result of under estimation of the cost of the project during budgeting and the developer will thus be unable to achieve the target amount through off-plan sales. This will cause delays in the completion of the development project and at times the developer can decide to return the deposit paid and sell the same unit at a higher price or opt to obtain further financing. In any event this will delay the completion of the development.
- Poor Quality/standards – developers use very attractive brochures/show houses to advertise but at times deliver substandard products. The results is that the purchaser does not get value for money unlike when buying a complete unit where one negotiates the purchase price based on tangible evidence. There is a risk that the quality and standards of fixtures of the unit will be different from those a purchaser had imagined or seen in the brochure or show house.
- Lower expected returns on the investment – there is no guarantee that the price of the property will appreciate with time. In some cases, market conditions may change, or the developer may over promise returns such as rental yields and capital appreciation and on completion the purchaser achieves lower than expected returns and hence doesn’t earn the projected gains.
- Fraud – there is a likelihood of potential loss of money due to fraud by unscrupulous developers who can disappear with the purchaser’s deposit without delivering the project. There have been numerous cases of fraudulent transactions where individuals were defrauded of their money because of simply failing to carry out a proper due diligence over the investment before paying the deposit.
When entering into an off plan purchase, it is vital that the purchaser undertakes a proper and detailed due diligence. It is no longer sufficient just to carry out a search on the land where the development will be erected but going further by understanding the historical ownership of the land both at the Lands Office and on the ground.
In addition to undertaking a due diligence the purchaser should ensure proper terms of the agreement are negotiated. This is best done by engaging a lawyer who is well versed with real estate matters. Some terms that can be negotiated with regards to the agreement are project completion dates, payment of the purchase price, a future date the purchaser can pull out of the project in the event the same is not complete. Failure to properly review the agreement can lead to allowing the developer to vary the price, refuse to refund the deposit or non-completion of the project without an option for the purchaser to pull out. In addition to a proper review of the agreement and due diligence on the land, the purchase should also look into the following:
- The developer/seller - is it a properly established company and duly registered, who are the directors and shareholders, what other projects have they undertaken and completed, what where the shortcomings of those projects if any, were completion dates met. The purchaser can also look at the team of consultants and confirm whether they have the required certification to practice in Kenya e.g. the main contractor should be registered with the National Construction Authority.
- Visiting the site of the project - the purchaser should also visit the site to know if it is a legitimate site for the project. This should be done prior to any investment and throughout the development period to ensure the project is running smoothly and that the purchaser is up to date with the progress of the development, so that if any issues arise, they can follow up with the developer or consider exit options before it is too late.
- Project approvals - the purchaser should also seek to know if the developer has obtained the necessary approvals for the development and hence has legal right to develop the property to prevent delays in the delivery of the project. some of the required approvals include: approvals from the county Government, National Construction Authority, National Environmental Management Authority, Water Resource Management Authority.
- Regular updates from the developer - the purchaser should get regular updates from the developer on the progress of the development to ensure that the development is ongoing and will be delivered on time.
- Expert advice on return of investment - if the purchase of the property is for investments purposes, the purchaser should obtain independent expert advice on the future marketability of the property and the return on investment. That is rent prices, yields, occupancy and uptake. This will help the purchaser know if the development is a worthy while investment. A good developer should be able to share at least a summary of their research findings with the purchaser.
An off plan real estate purchase is a good avenue of investment and people should not shy away from it. With a thorough due diligence prior to commencement of the development project up to completion and a properly negotiated agreement that protects the investment of the purchaser, an off plan purchase can help one obtain a home at a more considerate price.