Alternatives to a build-and-sell concept
05/10/2005 www. theedge.daily Question Time: By P Gunasegaram

One thing is certain. Right now, the buyer of a house from a plan takes all the risk which includes the real risk that the developer will not complete the house as contracted.

But will the build-and-sell method help to solve this without bringing the industry to a standstill? And if it does not, are there alternatives which will give sufficient protection to the developer?

My colleague has argued convincingly that the adoption of a forced build-and-sell concept for all new developments is not the right way to go.

If build-and-sell is not enforced because of economic and other exigencies, it is still vital to ensure that the buyer is protected. What is untenable is the low degree of protection given to the house buyer.
Let us not underestimate the seriousness of the problem of abandonment of housing schemes and the lax enforcement which leaves the buyer holding the baby of an incomplete house and all its costs while letting the developer get off scot-free.

According to the Ministry of Housing and Local Government, there were 227 abandoned housing projects involving over 75,000 houses, over 50,000 buyers and a value of over RM7 billion as at the end of last year.

Right now, under the buy-then-build plan, the buyer bears enormous risk when he makes the decision to buy. The system favours most the developer, followed by the financier, with the house buyer left largely at the mercy of the developer who undertakes, but sometimes does not build the house as agreed and within the required time period.

The presence of the so-called housing developer's account, required in the early 1990s, into which a buyer's money is supposed to be deposited, has not had any impact on those developers absconding with buyers' money as the abandoned projects escalated in the aftermath of the Asian financial crisis in 1997.

Currently, buyers pay a deposit, typically 10%, on signing of the sale and purchase agreement. Then, they either arrange with a bank or make their own arrangement to pay to the developer into an account, which it appears the developer can easily draw down from, according to the percentage of completion determined by an architect appointed by the housing developer.

Thus, you have a situation where a buyer may have paid for 90% of the cost of the house in a scheme where infrastructure, ancillary facilities and the certificate of fitness are still not ready. If at this point the developer, which has already collected and in some cases used the 90%, absconds, the buyer is stuck.
Not only does he not have a house to move in to, he has to pay the bank interest, a double whammy that has been the ruination of many a house buyer.

Rules remove this risk to the buyer by requiring that all the money that he pays be put into a trustee account which cannot be touched by the developer until everything is completed according to agreement.
This gives a developer every incentive to complete the project — otherwise, it will get no money at all. At the same time, the money in the trustee account will ensure that the developer gets his money when he completes the project according to agreement.

In this way, the buyer is protected from taking on the risk which should rightly be the developer's, while the developer is ensured of getting its money once it completes its project according to agreement.
Developers will argue that it will be difficult for them to obtain bridging finance in the interim and that the houses would cost more. However, if sales are encouraging, and the developer has a good reputation, there should be no problem. It will also weed out weak and incompetent developers that really should not be in the business anyway.

Costs of the houses should not increase too much. The money in the trustee account will earn interest, which will accrue to the developer.

To take an example, assume a house costs RM100,000 and will take two years to complete. Assume also the developer's construction cost is RM50,000, which it finances 100% from the banks at 8% (low since the loan is secured against payments advanced to the trustee account).

Since the developer draws down the RM50,000 over two years, its interest cost will progressively increase and will be around 4% (half of 8%) a year on RM50,000 — equivalent to 2% a year on RM100,000. Meantime, the trustee account will earn a deposit rate of, say, 3% a year on a sum that progressively increases to RM100,000 over two years or roughly 1.5% a year on RM100,000 over two years.

Offsetting the income from the trustee income against the expense on the bridging finance results in 0.5% a year on RM100,000 or 1% over the two-year construction. In other words, the house costs 1% or RM1,000 more. Build this into a 20-year repayment period and it amounts to under RM10 a month — a small price to pay for iron-clad protection. (Please note that these are only rough calculations.)
This is something that housing developers should have no objection to.

Finally, a couple more things will make the protection better. First, developers must be required to already have the infrastructure in place before selling units, especially for mega projects.

Why ever should a single house buyer be burdened with the risk that infrastructure to the area would not be completed? I should be able to at least have road access to and stand on the spot where my house is going to be built instead of being shown a huge expanse of rubber and oil palm trees or ex-tin-mining land.

And two, the completion period should be dropped to one year. If you can't build a house in one, you should not be selling it. With infrastructure in place, there is no reason a house can't be built in just six months.

That would considerably reduce the waiting period, interest payments and risk for the would-be house buyer. All of which would be a good thing for the industry that should see an uptake in demand from such responsible development.