A friend recently wrote to me to ask me for advice on whether he should buy a house off-plan, with the intention of selling it once the development is complete. With his permission, I publish the advice I gave to him below.
Off-plan house sales (also called pre-sales) are where the developing company sells some units in advance, and uses the money raised from these sales towards construction of the housing project. In Kenya today, off-plan sales work in two ways:
- The simplest, where you buy a unit in the development, and once the development is complete you have your unit which you can either rent out, live in or sell. Sometimes in this model, the developer will even allow you to do your own finishes on the unit.
- Where you buy x shares in the development company, together with other individuals, and at the end of the period, you own x% of the entire project. On sale of the units, you make x% of the profits.
Both plans come with similar risks which I will outline below, but the second model has an extra layer of risk which a buyer should be discerning of. I write about that extra layer at the end of the post, so read on…
- The quality of finishes by the developer. This includes core things like plumbing and electricity. Some developers will use poor quality finish and cut corners on electrical works. This can cost you up to 5% of the purchase price in repairs, in the first 2-3 years, and it gets worse with time. In the house I have rented, the owner will need to replace the flooring soon, we’ve had to replace all locks, the developer installed a cheap Chinese Jacuzzi which looked great at the beginning, but has cost my landlady close to Kshs 50,000 in repairs.
- How well the developer is able to manage the property post-completion. Many developers are resorting to renting the units out because of slow sales. Unlike in the past where the developer would walk away and the owners come together and manage the facilities, if the developer has the largest stake, he could also be the person with the majority vote. This can be quite problematic. Again using our estate as an example, the facility has deteriorated because due to project losses, the developer couldn’t maintain HIS units, so they are not occupied, resulting to low service charge. The end result is that people who bought units are not able to fetch as high returns as they had projected.
The final risk that is unique to people who buy shares in development projects is:
4. Equity risk. By buying shares in the investment company, you are technically in business with other individuals who have bought the shares with you, and the development company. This means your risk exposure is significantly higher than the person who just bought a unit. If the development company takes a loan, your share is liable for that loan repayment, not to mention any other decisions the company makes.