The Dangers of Buying a House Before it is Built

The Dangers of Buying a House Before it is Built

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A model of a house.Image Source: Daily Nation

When Elizabeth Lwali decided to buy a house, she looked for a bargain and found one that she has never regretted. Located in Embakasi, Nairobi, Ms Lwali’s house is a three-bedroom apartment with an en suite master bedroom.

Unlike many people who go for a completed house, Ms Lwali, an investment officer with a Nairobi-based pan-African housing finance and development institution, bought hers even before the foundation was laid. She was asked to pay a 20 per cent deposit when the construction started in October 2007. The amount also acted as the booking fees. She cleared the balance when the project was completed last year.

As the project was nearing completion, she arranged for finances to settle the balance. Her husband and she raised over 50 per cent of the money from their own sources. Ms Lwali paid the balance (30 per cent) through an employer mortgage scheme. There is already a tenant in the house. For Ms Lwali, the wait was worth it.

“It is always cheaper to buy at the beginning. I bought my unit for Sh3.5 million, but those who are buying similar units in the same project are paying almost double, at Sh6.5 million. I have made capital gains while doing nothing, literally.”

The process she followed in acquiring the house is called a pre-sale or buying on paper or buying on the plan — or simply buying off-plan.

Strictly speaking, a pre-sale refers to anything (a house in this case) sold before completion — whether half-way, quarter-way, or 90 per cent complete. This arrangement has become common in Kenya since the rebound of the real estate sector in Kenya over eight years ago. Experts estimate that about 60 per cent of new housing projects in the country are sold under pre-sale arrangement.

People go for this kind of arrangement because they are looking for a bargain as pre-sale houses are substantially cheaper than similar ones by the time the construction is completed.

As a buyer, it also gives you some “breathing space” to arrange for the financing. Pre-sales come with sweeteners — buyers are even allowed to pay the deposit in instalments. During the construction period, you can move from one bank to another, seeking mortgage financing.

Or if you are a business person, you can stagger your payments to your comfort. Off-plan selling also enables developers not to pump in their own money, relying on deposit instead. All in all, it is a risk management tool for both the developer and the buyer.

And as Ms Lwali attests, pre-sales can be gratifying. “My experience was good. I was not required to put in any additional money. “There were no ugly experiences. I did not have to insure anything. All I had to do was to make the necessary extra payments — including stamp duty, legal fees, and three-month service charge deposit, — when required.”

However, despite success stories like Ms Lwali’s, property experts are warning that pre-sale arrangements are not 100 per cent safe for buyers. Although they have obvious advantages they transfer an “excessive” level of construction risks to the buyers, most of who are looking for bargains.

“Pre-sales are not safe for buyers, especially at this time when the cost of building materials is on the increase, sometimes to a level that makes it not practically feasible to deliver the project at the proposed deadline and price,” says Mr Wilberforce Oundo, a director with Roack Consult.

Mr Oundo has witnessed many cases where, towards the end of a project’s completion, the developer asks buyers to top up their payments to match the prevailing market prices, in total disregard of the pre-sale contract signed, which clearly states the price.

“It is not unusual for developers to change prices at the end of construction. I have seen cases where a developer goes back to those who had booked and asks them to top up and refunds the money of those who are unable to increase their payments.

“Sometimes the depositors are also asked to pay any penalties or costs incurred. There are quite a number of such cases that have happened towards the end of the project,” he says.

Whereas some developers are forced by circumstances like unexpected jumps in the cost of building materials to renege on pre-sale agreements, most do it out of greed.

This has been so, especially given the rapid rise in property prices in major cities like Nairobi. According to Mr Oundo, most developers would rather return the deposit for units booked earlier, then sell them at a higher price.

“The developer’s argument is very simple: ‘I am in business and I want make more money. So, if you can’t give me the money then I would rather break the contract and sell this property at a higher price’,” he says.

Developers forced to increase prices because of higher cost of construction materials find comfort in the law.

The Architectural Association of Kenya contracts allow the contractor to vary the contract terms if the prices of some specified and principal materials increase beyond 15 per cent.

The contractor is not obliged to seek approval to vary the contract. Kenya’s property experts are not the only ones urging buyers to exercise caution with pre-sales.

In its new book, Housing Finance Policy in Emerging Markets, the World Bank says pre-sales can be risky for the consumer.

“Problems occur when there is no construction lending but large advances paid by the consumers, and the developer fails to deliver the expected housing product — in terms of quality, time, and price — leaving households to take the whole risk and face dire legal straits in trying to recover their advances (deposits),” says the book.

According to the publication, consumers, especially those who earn low or moderate incomes, frequently commit all their savings to make a down payment. Should the project or developer fail, individual consumers rarely have the resources to pursue a case in court to recover their deposits, which is unlikely when the developer is bankrupt or has been left with insufficient assets.

“If the unit that is delivered does not meet promised standards, a consumer who pre-purchased it with a mortgage has little recourse except to default on the mortgage and pass the problem on to his or her lender,” it says, noting that this is the main cause of the few non-performing mortgage loans in China.

In particular, it notes, consumers are usually ill-equipped to judge progress or quality of construction of a large development project. “Several scandals of this nature have been made public,” says the report.

Another disadvantage of pre-sales is that they presume that one’s (financial) circumstances will remain the same or improve for the entire construction period.

Usually, one is given 14 or 30 days to complete the payment upon issuance of the certificate of occupation. But sometimes your circumstances have since changed and you may no longer qualify for a mortgage and are unable to get alternative funding.

Sometimes people lose jobs before completion of the construction. Mr Oundo says the most heart-rending case of a pre-sale gone sour was that of a friend who paid a 30 per cent deposit, then lost his job towards the end of the project last year.

“He was buying a Sh15 million house on Kiambu Road and signed the contract, confident that nothing would happen to his job,” he says.

Things were made worse by the fact that the sale contract was lopsided. It said that in the event of default, he had to pay interest on the outstanding balance.

He ended up losing the 30 per cent deposit (Sh5 million) and another Sh3 million in penalties, forfeitures, and interest.

The contract did not have a provision for varying the price, but it clearly stated that in the event of default, the purchaser would forfeit 20 per cent of the deposit paid as well as pay interest at the prevailing bank interest rates on a monthly basis in the event he was unable to complete the payment.

“The developer’s argument was, if he had not booked the property, someone else would have bought it.

“He was supposed to pay the remaining 70 per cent within 30 days after practical completion. Unfortunately, he lost his job about a month to the completion date,” says ms Oundo.

Lesson: Buyers need to ensure that the pre-sale contract they sign is foolproof and does not leave room for any changes/amendments instigated by the developer.

The recourse, Mr Oundo notes, lies in ensuring that the sale agreement is so tight that it has no provision for varying the price or refunding the deposit.

If that is included in the contract, he says, then the only recourse you have is to go to court and seek specific-performance — that the developer is obligated to deliver to you the product/property instead of giving you the money.

Source: Daily Nation

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