Centum Real Estate...of the property/project, much like the current legal landscape in Kenya. The...

Centum Real EstateResearch Report Vol 01

June 2019

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Centum Real Estate Research Report-June 2019Centum Real Estate Research Report-June 2019 21

Earlier development projects in real estate were built and financed on the speculation that “if we build it, they will come.” These projects were financed and built using ‘pro-forma’ financial modeling after extensive market research to determine demand and pricing.

The developments principally bet on the future and as such carried significant risk. The concept of preselling is premised in market validation; which is the process of determining whether a product is of interest to a given target market.

Pre-sales allow a property developer to be market led as opposed to being product led. Therefore, a presale agreement is employed when the purchaser agrees to buy the property according to specifications outlined on the builder’s plans.

In some cases, the prospective purchaser previews a similarly constructed demonstration model dwelling. In other cases, the buyer will view multimedia presentations

or print literature in order to make a presale purchase decision.

Over the past five decades, presales have become a popular practice for property transactions. The sustainability of pre-sales model is hinged on building trust and market confidence by delivery of projects.

Presales, in principle, work like partnerships, and as such it is also a game of integrity, which means building and maintaining relationships is a core part of the process.

Developers who have relied been on, by buyers, to deliver off-plan projects within budget and on time are most likely to make the cut when pitching for investor’s money a second or third time.

The purpose of this article is to highlight the following:•Benefits and Pitfalls of the presales model•the current regulatory landscape of Presales in the Kenyan real estate sector •Case study of the Presales regulation that came into effect in Abu Dhabi and China, which increased the barriers to the presales model.

Are pre-sales the “Holy Grail “of real estate funding?Presales present an avenue for developers to market validate real estate products as well as optimize the funding mix.

CONTENTS01

04

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03INTRODUCTIONON PRESALES

CASE STUDIESCHINA & ABU DHABI

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PAGE 07

PAGE 03

PAGE 09

PAGE 05

BENEFITS &PITFALLS

CENTUM RE IMPLICATIONS

REGULATORYIMPLICATIONS

“Presales, in principle, work like partnerships, and as such it is also a game of integrity”


Pitfalls of presales to developersKey benefits of presales to developers

Key benefits of presales to customers/investors

Recent market developments have exposed the pitfalls of the presales model mainly driven by lack of project completion.

These developments have made headlines and are leading to the erosion of trust between investors and developers, which is a fundamental fabric of real estate investments.

The potential threat this poses to Centum RE is the contagion effect it could potenitally have on off-plan sales for future projects

Failure to deliver projects on time has cast doubts on the presales model in the real estate sector, with home buyers, bearing the brunt. The lack of delivery by one sector player is likely to cause a contagion of mistrust in the entire real estate sector.

The anchor benefit is in helping developers unload construction inventory in a speculative market with a more flexible system of financing; in essence sharing the risk with the buyers.

Buying off plan allows investors to acquire a future asset at today’s price and hence allow the buyer to achieve capital gains during construction and on completion. For instance, 1255 palm ridge has had a 15% price appreciation 4-months into construction.

Presales serve as a vehicle for price discovery for to-be-built dwellings since the presale price contains information, among other things, about expectations of future real estate prices and inflation.

To purchase a property off plan all one needs is a deposit, which is usually 10% to 20% of the purchase price, and the rest of the amount is either paid on completion, or in flexible periodic installments. This allows individuals without the financial muscle to purchase houses immediately.

Pre-selling can also significantly reduce the cost of financing for real estate developers due to its equity-like characteristics.

The buyer is able to select the best location for their house and can also get to pick the finishes of the house and hence get a house that is in line with their preference

The table below summarizes the key risk that parties face during in the presales approach to construction;

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Pitfalls of Presales

The table below summarizes the key risk that parties face during in the presales approach to construction

Pre-sale Risks Manifestation Risk Stems From

Deposit Release/Settlement Settlement Delay Customer

Buyers Cannot be Located No Settlement Customer

Deposit Mismanagement Construction Delay Developer

Design Changes Change Requests and Construction Delays

Developer

Delay in Final Product Delivery Construction Delay Developer

Final Product Misrepresentation Final Product Developer

Final Product valuation below sales price Final Product Independent Valuation of Final Product

Failure to deliver projects on time has cast doubts to the presales model in the real estate sector, with home buyers, bearing the brunt. The lack of delivery by one sector player is likely to cause a contagion of mistrust in the entire real estate sector.

Pitfalls of Presales

The table below summarizes the key risk that parties face during in the presales approach to construction

Pre-sale Risks Manifestation Risk Stems From

Deposit Release/Settlement Settlement Delay Customer

Buyers Cannot be Located No Settlement Customer

Deposit Mismanagement Construction Delay Developer

Design Changes Change Requests and Construction Delays

Developer

Delay in Final Product Delivery Construction Delay Developer

Final Product Misrepresentation Final Product Developer

Final Product valuation below sales price Final Product Independent Valuation of Final Product

Failure to deliver projects on time has cast doubts to the presales model in the real estate sector, with home buyers, bearing the brunt. The lack of delivery by one sector player is likely to cause a contagion of mistrust in the entire real estate sector.

presale businessTradeoffs of presale model

Market Validation

Capital gains

Price Discovery

Flexible Payment Plan

Cost of Financing

Preference


Summary of laws governing real estate

regulatory implications

Below is a summary of the main laws governing the real estate sector in Kenya include: (key is to note that the Current Legal Institutional Framework in Kenya does not specifically address presales regulation):

The Constitution of Kenya, 2010 which under Chapter Five provides a legal framework for transactions in land and the environment.Statutes:•National Land Commission Act, 2012 (NLC Act) which provides for functions and powers of the National Land Commission (NLC) and its internal procedures;

•Land Registration Act, 2012 (LRA) which governs the registration of dispositions in land;•Land Act, 2012 which consolidates all the different land laws in Kenya and provides for sustainable administration and management of land and land-based resources;•Land Control Act (Cap.302) (LCA) which establishes the Land Control Board (LCB) to regulatetransactions affecting agricultural land; •Landlord and Tenant (Hotels, Shops and Catering Establishments) Act (Cap.301) which provides for protection of commercial tenants from eviction or exploitation;•Sectional Properties Act, 1987 which provides for the division of buildings into units, ownership of common property of buildings and for the use and management of units and common property;•Distress for Rent Act (Cap.293) which provides for procedures for levying distress for rent in lease transactions;

•The National Construction Authority Act, 2011 which establishes the National Construction Authority and its powers and functions;•Environment and Land Court Act, 2011 (ELC Act) which establishes the Environment and Land Court (ELC) and its powers and functions;•Environmental Management and Co-ordination Act, 1999 (EMCA) which establishes the National•Environment Management Authority (NEMA); and•Physical Planning Act (Cap. 286) (PPA) which provides the procedures for the preparation and implementation of physical development plans.real estate market conditions and can be utilized to identify real estate cycles

Proposed laws which will affect the real estate sector if enacted are:•The Land Laws (Amendment) Bill, 2015 which seeks to amend the land laws to align them with the Constitution, to provide for procedures on evictions from land and for connected purposes.•The Community Land Bill, 2015 which seeks to regulate the use of community land and its registration.•The Physical Planning Bill, 2015 which seeks to amend the PPA to align physical planning laws with the Constitution.

“Currently there is no regulation that specifically governs presale contracts in real estate transctions in Kenya”

“Presales Legislation- Future Regulation that could come into play given the sub-par delivery of presales models by developers in the Kenyan Real Estate”

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case studiesDepartment of Municipality, Abu dhabi Guangzhou Municipality, China

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Due to perennial litigative challenges arising between customers and real estate developers, the Guangzhou Municipality in China promulgated pre-sales regulations to tighten control of the presale model. Some of the preventive measures contained in the legislation are highlighted below:

•Prior to presales commencing, projects involving commodity premises of four stories or more must complete (i) the foundations and the structural work of the first floor if there is a basement or (ii) the foundations and the structural work of the first four floors if there is no basement

•The property developer may not change the design of the premises which have been pre-sold without the consent of the purchaser concerned.

If the purchasers do not agree to the changes, they may request a refund of the purchase price already paid with interest and claim liquidated damages from the developers

•If the real estate property developer transfers the project which has been pre-sold to another developer, it must obtain consent from purchases who have purchased two thirds or more of the gross floor area already pre-sold

•The developer is prohibited from making any advertisements which may misrepresent themselves or mislead potential purchases

•The property developers must regularly inform the purchaser of the construction progress once the premises under construction are presold

•The property developer must issue a quality guarantee and brochure for use upon delivery of the completed residential premises which have been sold.

Other regulation detailed in the following link:https://books.google.co.ke/books?id=MthIFA

If3BUC&pg=PT3512&lpg=PT3512&dq=Guangz

hou+municipality+issued+similar+pre-sale+rul

es+in+December+1998&source=bl&ots=brkU

xD6Iq1&sig=ACfU3U1nTz394GswvGaTd6D_90T

K3kZWFw&hl=en&sa=X&ved=2ahUKEwj59IL89-

PiAhUQtRoKHQ5EAC4Q6AEwAHoECAkQAQ

The Emirate of Abu Dhabi enacted Law Number (3) of 2015 Concerning the Regulation of the Real Estate Sector to increase the precision guidance of off plan developments and confidence of investors due to the fast pace of development and launching of several new real estate projects from 2010.

Prior to the Law, Abu Dhabi had no protection regarding any delay, non-completion, or defects of the property/project, much like the current legal landscape in Kenya. The regulatory framework establishes the Department of Municipality Affairs (the DMA), which is responsible for maintaining the real estate records that have similar functions as those of Real Estate Regulatory Authority (the RERA) in Dubai. The summary of the provisions pertaining to presales are highlighted below. These are potential provisions that could be implemented in Kenya.

Developers are not allowed to sell any unit unless they fulfill the conditions as stated:•Obtain a license from Department of Economic Development to qualify that they are eligible to undertake the development of such real estate project to reduce the risk of (i) any mismanagement of the real estate project where the interest of the public is involved at large; and (ii) the developer breaches its obligations and misuses its position and entitlements.

•Developers who plan to sell off-plan property units of the project should open an escrow account after submitting an application and necessary documents to the DMA. The developer should also appoint an account trustee and all the funds paid by the customers of the off-plan property units should be deposited into this escrow account.

•The developer should open a separate escrow account for each project and the amounts deposited in this escrow should be solely used for construction and settlement of financing payments under the provisions of the escrow account agreement. Additionally, the law has laid down a separate provision for escrow accounts and the developers’ obligations for managing the funds for the construction. •The developer has to self-fund or obtain finance for the first twenty percent (20%) of construction works.

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The current presales regulatory framework in Kenya has allowed real estate developers to undertake presales with minimal regulatory scrutiny.

This has reduced the barrier to product testing for market players in the developer space and allowed several developers to roll out a myriad of developments with minimal capital commitments to the projects. If the regulations that have been adopted in China were to be imposed in the Kenyan real estate market, the costs of market validation would significantly increase.

This would create significant barriers to the presales model and push the approach to real estate developments to product led market.

Our role as Centum Real Estate is to deliver to promise on the projects that have been market validated for the sustenance and trust of the presales model to continue with the current regulatory flexibility.

In our current portfolio, a total of 1,188 units have met the threshold of market validation and are in the process of pre-construction or construction.

The specific units that are in the construction phase with a delivery target of FY21 have a dividend potential of KES 1billion and impact potential of 664 customers. The delivery of these units will create a focal impetus for the roll out future units under the presales model.

IMPLICATION TO CENTUM REAL ESTATE

The current presales regulatory framework in Kenya has allowed real estate developers to undertake presales with minimal regulatory scrutiny. This has reduced the barrier to product testing for market players in the developer space and allowed several developers to roll out a myriad of developments with minimal capital commitments to the projects.

If the regulations that have been adopted in China were to be imposed in the Kenyan real estate market, the costs of market validation would significantly increase. This would create significant barriers to the presales model and push the approach to real estate developments to product led market.

Our role as Centum Real Estate is to deliver to promise on the projects that have been market validated for the sustenance and trust of the presales model to continue with the current regulatory flexibility.

In our current portfolio, the following developments have met the threshold of market validation and are in the process of pre-construction or construction. The specific units that are in the construction phase with a delivery target of FY21 have a dividend potential of KES 1billion and impact potential of 664 customers. The delivery of these units will create a focal impetus for the roll out future units under the presales model.

Entity Project Status No. of Units

Phase 1 Presales (KES ‘000)

Potential Revenue

(KES ‘000)

Potential Net profit

(KES ‘000) Deposits

Collected

CDL Riverbank Under Construction

160 80 15 4,020,000

474,266

114,750

Cascadia Market validation

430 430 50 5,233,690

1,202,666

82,289

590 510 65 9,253,690

1,676,932

197,039

VDL Awali Estate Under construction

152 72 26 2,224,000

483,068

65,081

1255 Ridge Homes

Under construction

1,255 330 311 4,015,000

296,416

164,956

1,407 402 337 6,239,000

779,484

230,037

PMEL Mirabella Under construction

22 22 12 747,780

116,091

96,032

Bella Vista Under construction

750 240 186 5,310,993

733,869

240,778

Riviera Market validation

53 10 6 1,009,915

142,683

13,900

Signature villas

Post construction

4 4 - 404,000

50,500

-

829 276 204 7,472,688

1,043,143

350,710

2,826 1,188 606 22,965,378

3,499,599

777,786

Expected to be finished by FY 2021 No. of Units Revenue Profit Awali Estate – Phase 1 72 2,224,000 483,068

1255 Ridge Homes – Phase 1 330 4,015,000 296,416 Mirabella 22 747,780 116,091

Bella Vista – Phase 1 240 1,496,054 206,724 Total 664 8,482,834 1,102,298

1,007,957

2,622,197

5,516,856

6,910,282

- 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000

FY21 FY22 FY23 FY24

Centum 4.0 Real Estate Expected Dividend Pay-out (KES’000)

Expected to be finished by FY 2021 No. of Units Revenue Profit Awali Estate – Phase 1 72 2,224,000 483,068

1255 Ridge Homes – Phase 1 330 4,015,000 296,416 Mirabella 22 747,780 116,091

Bella Vista – Phase 1 240 1,496,054 206,724 Total 664 8,482,834 1,102,298

1,007,957

2,622,197

5,516,856

6,910,282

- 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000 8,000,000

FY21 FY22 FY23 FY24

Centum 4.0 Real Estate Expected Dividend Pay-out (KES’000)

Report by Centum RE Research DepartmentDocument design by Flora Aluoch.

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