Build & sell concept the only solution?

The Star 14/08/2004 BY RATING AGENCY MALAYSIA BHD

MANY prospective home-buyers and perhaps even developers, would laud this concept mooted by our Prime Minister. The proposal is aimed at protecting homebuyers' interests while promoting more efficient use of resources.

The residential property market has long grappled with a huge stock of unsold real estate or property overhang, as it is commonly known. A large chunk of the oversupply has been contributed by projects in less-than-prime locations, and that is just referring to completed units. Government-backed Syarikat Perumahan Negara Bhd is reportedly attempting to revive as many as 97 abandoned housing schemes, affecting more than 30,000 buyers. Some of these projects are believed to have been stalled for over 10 years.

The recent redefinition of stock overhang has painted a much prettier picture by “reducing” the volume of unsold residential stock by as much as 53,000 units. Of course, there is no assurance that the numbers would not creep up again. Besides, the relevant authorities obviously believe that the root of the problem has not been addressed. The powers that recognise that a revamp has to be carried out beyond mere reclassification.

There is, however, much less doubt that property development is indeed a lucrative business. Most of the RAM-rated property companies enjoy strong double-digit profit margins for their developments, even after taking into account the requirement to build low-cost units.

Such good returns, coupled with stronger demand in line with the improving economy and market sentiments, have prompted a fair number of non-traditional players to jump on the bandwagon lately. A similar (and worrying) trend had been observed prior to the regional economic crisis in 1997.

Certainly, implementing the build-and-sell system could curb this; increased working capital requirements and heightened market risk will render even the established players more cautious about launches, what more the greenhorns.

In fact, even the property development fraternity has voiced its resistance against adopting such a practice, with many claiming to lack the financial capacity.

At the other end of the spectrum, however, homebuyers have lauded the build-and-sell proposal – especially those that have been hard done by in one way or another.

Location alone no longer the key to success

Even under the present sell-and-build system, most participants would agree that the Malaysian market has become more discerning, demanding lifestyle concepts, better landscaping and quality finishings. Location alone no longer guarantees success. Comprehensive market surveys and pre-launch registration drives to gauge the demand for and viability of projects have fast become crucial determinants.

Although many players are already rising to meet the more sophisticated demands, errant developers are still being accommodated as homebuyers nonetheless shoulder most of the risks. The current modus operandi does not require developers to have substantial cash at hand before embarking on a project, particularly if no land-holding cost is involved.

Under the Housing Development Act (HDA), homebuyers are required to pay 10% of the purchase price upon signing their sale and purchase agreements (SPAs). The balance must be settled progressively, in accordance with a schedule of completion. With purchasers funding a significant portion of the construction cost, we estimate that most developers would only need 20% - 25% of the estimated amount to commence work.

Although the HDA has been in place for some years, there have still been cases of incomplete housing schemes being abandoned. Besides, there are also many reports about shoddy workmanship and delayed home deliveries. There have even been instances where owners rudely discover that their abodes are not fit for occupation – after taking delivery of their homes.

Nevertheless, the recent amendments to the HDA have been designed to better protect homebuyers' rights. They now have more avenues to seek redress with the setting up of the Housing Tribunal; the lead-time to case hearings has been shortened and developers are not allowed to counter-sue purchasers. Even so, one can only resort to so much legal action before hitting a brick wall, so to speak, and the tribunal’s decision is final – there is no room for appeal.

If implemented, the build-and-sell regime would force industry players to place even greater emphasis on purchasers’ requirements, thereby putting an end to sub-standard quality. Within the broader scheme of things, it would also curb over-zealous building and reduce the overhang. On the other hand, such benefits do not come without costs.

Bitter-sweet consequences for buyers?

While buyers can now be certain about the quality of their properties, it is almost certain that developers’ additional working capital will bump up price tags. We estimate that prices could go up by at least 7.5%, even after assuming that financial institutions would not raise their rates despite the heightened risks. Most of the property companies rated by RAM are currently paying between 5% and 10% per annum for their bridging loans. The estimated price hike is illustrated in the simple example below:

Main assumptions:

Construction period – 2 years; 50% completed in Year 1 and 100% in Year 2;

Construction cost for a standard 2-storey terrace house – RM120,000;

Financing – 100% for the cost of the house. The developer will fund the land cost and infrastructure work;

Drawdown of loan – RM60,000 in Year 1; RM120,000 in Year 2, and

Interest expense – RM3,000 in Year 1; RM6,000 in Year 2
Based on the above scenario, the developer’s cost per unit would increase by RM9,000 or 7.5% i.e. (RM9,000 / RM120,000) x 100%. Assuming the developer is not willing to sacrifice its margins, the entire RM9,000 would be passed on to the buyer.

Those who have fairly strong purchasing power may not be too perturbed by such price hikes, but potential homebuyers in the low- to medium-income brackets could feel a much sharper pinch. The rivalry among developers has actually benefited purchasers from the perspective of more innovative housing schemes and the introduction of lifestyle concepts. Will the new system now weed out the smaller “niche” players, thereby reducing competition and leading to just a few property giants?

Hurdles for property developers

Presently, only a handful of developers are practising the build-and-sell concept. Furthermore, it is usually carried out on a small scale and for well-established developments. Adequate funding, or rather the lack of it, would be the main hurdle for many developers before they can adopt the build-and-sell concept. For those without deep pockets, they would have to rely much more on the good graces of the banks for their financing needs before a housing project can materialise. As it is, banks are already shying away from this sector; what more when market risks are heightened?

Spillover effects on other sectors ?

When the property boom slows down, construction employment will follow suit. A similar trend will also be experienced by the building materials industry, be it manufacturers or traders, not forgetting the professional consultants – lawyers and other numerous service providers to these industries. Ultimately, the social and economic implications need to be seriously assessed before implementing the build-and-sell concept.

Alternatives worth considering?

Our research shows that the sell-and-build concept is, by and large, only practised in this region. Besides Malaysia, Indonesia and Vietnam are the other countries adopting the same system. China, Hong Kong, Singapore and Australia adopt something “in between”.

In China, properties can be offered for sale prior to completion, but only after two-thirds of the structural work has been completed. However, a relatively recent report by Standard & Poor’s (issued in November 2003) pointed out that there are no regulation pertaining to purchasers’ payments vis-à-vis pre-completion sales.

In Hong Kong, developers are allowed to commence sales 20 months from the date of expected completion (based on the architect’s certification of the estimated completion date). Similar to China, there is also no ordinance that govern the use of such sale proceeds prior to handing over the properties. Nonetheless, the report also noted that the financing banks would normally impose restrictions on the use of those proceeds.

Both the above arrangements would probably reduce the completion risk borne by purchasers to some degree. However, an even more prudent system is practised in Singapore and Australia, where homebuyers pay 10% upon signing their SPAs, after which the developers’ solicitors will hold the money in trust. Not only must the developers deliver the completed units before receiving the remaining 90%, they will also need to hand them over complete with titles and certificates of fitness for occupation. The 10:90 system appears to be one that the Malaysian market can emulate; it appears viable from the angle of most, if not all, market participants.

Buyers’ interests would certainly be better protected compared to our present sell-and-build regime. Not only will they own completed homes, but they can also be certain that the authorities have certified these safe for occupation. From the developers’ perspective, unnecessary wastage of resources can be avoided; they would have a better gauge of the demand before starting construction; financing for working capital would also be more readily available; lenders would be more comfortable parting with their funds when developers can prove the existence of demand for their products.

Nonetheless, some may opine that the 10:90 system would not address the overhang problem given that buyers could still walk out on the SPAs and forgo their 10% deposit. However, we are of the view that rescission risk is a not serious concern, especially if the project is in a choice location. Furthermore, we believe that our local property market is still dominated by genuine buyers and not speculators who are in for quick returns.

Conclusion

Inevitably, the current system has to change if the local market is to continue its evolution. The pitfalls faced by the average consumer when purchasing an unfinished property have long been acknowledged. Nevertheless, we believe that the alternative concept eventually implemented must also be able to strike a delicate balance between the buyers’ and developers’ interests. A lopsided system that favours one party would not augur well for the development of the housing industry in particular, or the economy in general. After all, the industry is indubitably an important pillar of the national economy.