City&Country: The Edge Investment Forum on Real Estate 2011-- ‘Build- then-sell: The impact on property prices’

The government recently proposed new measures to tackle the issue of abandoned housing projects in the country. One proposal is to compel developers to implement the build-then-sell (BTS) concept in property development. Getting the property development fraternity to adopt the BTS concept is nothing new and it has been debated over and over again for years.

However, just recently, Housing and Local Government Minister Datuk Chor Chee Heung said BTS is expected to be made mandatory after 2015, and amendments to the Housing Development Act 1966 to facilitate the adoption of BTS are being made.

While efforts by the government to protect home buyers are welcome, there is always the bigger picture to consider.

Panellists taking part in the discussion on the topic “Build-then-sell: The impact on property prices”at The Edge Investment Forum on Real Estate 2011 provided some food for thought on how it will impact not just developers but house buyers as well, with the most immediate impact being on housing supply and prices.

The panel comprised Datuk Teo Chiang Kok, Bandar Utama developer See Hoy Chan Holdings Group director; Kevin Lam, managing director and country head of personal financial services at United Overseas Bank (Malaysia) Bhd; and Sam Tan, Real Estate and Housing Developers’ Association (Rehda) Youth member and executive director of Ken Holdings.

All three agree that homebuyers will have to pay significantly higher prices for a BTS property than buying off the plan.

As developers will have to fork out higher upfront costs under BTS, the number of developers, especially the smaller ones, will not be able to survive. Fewer developers means fewer houses.
“Demand will therefore exceed supply which will drive prices up,” says Teo.

Some phases of Bandar Utama were developed using BTS and Teo, speaking from experience, says a housing sector based on BTS across the board will not be sustainable in a growing economy like Malaysia where there is a huge demand for housing among its population.

Tan of Rehda Youth’s adds that BTS will also have a negative impact on the economy as the housing sector drives about RM20 billion of the country’s economic and business activity.

According to Tan other potential effects includes the loss of close to one million jobs in the industry, loss of economies of scale, the compromised delivery of affordable housing and banks losing substantial income from end-financing. Instead, there should be more stringent enforcement of the existing Housing Development (Control and Licensing) Act against errant developers to curb incidences of abandoned housing.

UOB’s Lam believes that the priority among stakeholders should be on the long-term sustainability of the property market.

Lam also put forward a few alternatives to the implementation of the BTS concept for policymakers, including a segmented approach in which homes are marketed after being 50% to 60% completed.
Summing up his presentation, Lam posed this question to the participants, “Considering the near-term impact of reduced supply and changes in property prices, who will this benefit?”
Find out each panelist’s take on the issue in the following reports.

The Bandar Utama experience

Build-then-sell (BTS) in theory seems ideal. But in practice, it is not so ideal,” says Datuk Teo Chiang Kok, See Hoy Chan Holdings Group director.

Teo was speaking during the panel discussion on “Build-then-sell: The impact on property prices” during The Edge Investment Forum on Real Estate held on April 9.

See Hoy Chan is the developer of the Bandar Utama township, where some phases were developed using the BTS method.

Teo says it was by accident that the developer undertook the BTS concept in developing Bandar Utama back in 1997. “It was during the 1997 recession. There were fire sales everywhere so we decided to withdraw from having new launches in a distressed market and to wait until the market stabilised.

“But we also wanted to keep the construction team intact so we decided to keep on building. That’s how we started. We continued with the BTS because we saw that our customers were happy with it.

“We had enough reserves in 1997 to self-finance the BTS development and were confident of our track record, our location, and of the demand for houses here so we went ahead. To be able to adopt BTS, we had to reduce by more than half the number of houses built per phase.
“Nevertheless, it was a high-risk undertaking and it was crucial to time the completion of the homes at the right time of the property cycle,” he adds.

Teo also stresses that upon completion, there is a lag period before homes can be handed over to buyers. For instance, upon completion, it takes at least three months to obtain certificates of fitness, compliance and completion (CF, CCC), while the sales and purchase process will take about one month. End-financing application, approval and documentation takes about two to three months, release of housing loans take two weeks and handover of possession takes two to four weeks. Teo says, all in all, it takes an average of six months after completion before a property can be handed over.

This means developers have to fork out money to maintain security and care of the completed houses. “We have to care for the product for another four to six months upon completion and we incur holding, security, and deterioration costs. It is a de facto extension of the warranty period,” he says. 

Teo notes that in order for BTS to work, all parties must deliver and perform effectively, with no withdrawals from house buyers as well.

“Time is of the essence when it comes to BTS, so every party including the approving authorities must ensure timely building approvals and issuances of certificates of fitness, for example.
“Utilities providers must also play their part to deliver in a timely manner. All end-financing and transfer documents as well as the land office must process and transfer the necessary documents on time,” Teo says.

“Now the government is pushing for strata titles to be delivered during vacant possession upon completion for condominiums. I think it is a very big step taken by the government.

“The respective parties must be prepared to pay liquidated and ascertained damages (LAD) if the delay is caused by their respective departments. If the land office fails to carry out the transfer on time, will they be ready to pay LAD? At the moment, LAD is shouldered solely by the developer.”

Current scenario
Teo says developers are called upon to carry many unfair burdens, costs and responsibilities, which rightfully should be shouldered by the government: ”This leads to a higher than normal expenditure which is probably more than any other businesses. Developers are expected to have to build infrastructure in time or ahead of completion of our buildings. More infrastructure is left to the developers to build, such as reservoirs, water reticulation, sub-stations and sewerage treatment plants and sewer lines, for example.

Developers, he says, also have to carry the burden of building low-cost houses and which are loss-making propositions. “We carry it out as a condition for approvals, but, at the end of the day, the cost is passed to the middle- and higher-income house buyers. There are no progress payments and cashflow to carry cross-subsidies with BTS. All this is additional cost that will translate into higher property prices,” he says.

“If BTS is enforced on all property developers, only those with deep pockets will survive and the number of developers will be reduced drastically. My estimate is that at least 70% of the current developers will drop out. The number of houses built will be reduced dramatically due to the financial burden to developers. In turn, demand will exceed supply and prices will go up. The market will ensure prices of houses will double or triple,” Teo says.

The price hike for properties is to account for factors such as the total cost of construction of houses, infrastructure, low-cost houses, other additional risk factors and the shortage of supply in houses, he says.

In terms of financing, Teo says banks must be prepared to provide loans based on project feasibility rather than sales and collateral.

Enhancing BTS
To make the BTS method easier for developers to adopt, Teo suggests allowing sales to be conducted upon practical completion and to allow processes such as loan applications as well as legal documentation for property purchases to run parallel with the CF/CCC certification process.
He proposes a collection of 10% upon practical completion and the other 90% upon the issuance of the CF. “This poses no risk for buyers or bankers as the value of completed houses as collateral is covered at least nine times.”

Of the current 10:90 BTS variant where purchasers pay 10% before completion and the remainder upon completion, Teo says, “The developer is contract-bound with no escape clause compared to house buyers who have many escape clauses. House buyers stand to lose a maximum of 10%, which is worthwhile for speculative punting, and they can walk away if the market drops while developers may have to take legal recourse while reselling takes time too,” he explains. Specific performance requirements for both parties are necessary and the penalties must be commensurate with the stages of completion and not limited to 10%, he adds.

According to Teo, BTS should be seen as another option for development while buyers should have the freedom to choose whether they want to buy off-the-plan or completed projects.

He believes that BTS is practised in developed countries because there is no backlog of homes to be built. “They are building for a marginal increase of the population and they do not need to carry subsidies such as social housing and bumiputera quotas and discounts,”he adds.

“However, in a developing country like ours, a big proportion of our population is young and we are building to fulfill this need for homes and not just for incremental needs,” he explains.

Teo concludes that the BTS concept can only be sensibly adopted with the cooperation of all parties. Approving authorities, service providers, lawyers, bankers and land offices must agree to specific performance targets and be responsible for LAD where delays are caused by the offending party, he stresses.

Housing supply greatly impacted if BTS enforced

The compulsory adoption of the build-then-sell (BTS) concept may possibly lead to “super developers” forming an oligopoly to control the property development sector, says Real Estate and Housing Developers’ Association Malaysia (Rehda) Youth member and KEN Holdings Bhd executive director Sam Tan at the panel discussion on “Build-then-sell: The impact on property prices” at The Edge Investment Forum on Real Estate held on April 9.

Concurring with fellow panellist Datuk Teo Chiang Kok, director of See Hoy Chan Holdings Group, that around 70% of the developers in the country will be affected, Tan says a significant number of small and medium-sized developers will be pushed out of business and “it will possibly create a new breed of super developers”.

He cites Hong Kong as an example, with super developers the likes of Li Ka Shing, Thomas Kwok Ping-Kwong of Sun Hung Kai & Co Ltd and Lee Shau-Kee of Henderson Land Group. “It is not easy to get into the Hong Kong market as land prices there are very high,” he says.

“BTS is very capital intensive and land costs are getting higher. Try buying land nowadays when every landowner wants to sell to you at a price higher than their neighbour’s land. So, for developers, it is getting harder to purchase affordable land.

“Besides land costs, developers also have to spend on professional fees and marketing and infrastructure costs. If BTS is made mandatory, developers will have to swallow the construction cost as well, and it is a huge cost.”

“Will build-then-sell impact our property market? Absolutely. It will have a big impact on a market based on demand and supply,” he says.

“A developer who was able to build 300 houses under the sell-then-build would now only be able to build about one-third under the BTS. Therefore, the number of units launched will inevitably be reduced.”

About 150,000 new homes are built each year, while there were 4.43 million completed homes at end-2010. Housing needs continue to be on an uptrend.

“We have a huge young population and you can see parents looking to buy properties for their children,” says Tan, who believes the adoption of the BTS will have a big impact on the economy.
The sales of the top 10 developers ranked in The Edge Property Excellence Awards 2010 have estimated sales of RM7 billion per year, he says. “If the BTS concept is enforced, supply of new housing and sales will shrink as a result,” he points out.

Furthermore, the housing sector generates about RM20 billion in economic and business activity, and includes 78,000 professionals, contracting firms, building material suppliers, manufacturers and service providers. If BTS is enforced, it could potentially affect close to one million people working in the industry, compromise the delivery of affordable housing and wipe out a portion of the country’s GDP, says Tan.

He adds that bankers will lose substantial income from end-financing and the income for state governments derived from land conversions and quit rents/assessments will be reduced.

“I always say that developers only play the role of the conductor, while the orchestra is made up of so many stakeholders in the industry — banks, purchasers, local governments, contractors, marketing agents, suppliers and so on. It is an industry where everything needs to grow in balance.
“No move is a bad move; you just have to think of the pros and cons over the long and short term,” he says.

Among the positives of the BTS concept are that buyers will get to see what they buy. However, new super developers will have almost no competition. Tan believes the downside for consumers outnumber the upside. For one, house buyers will be denied freedom of choice and no longer enjoy capital appreciation from a very valuable investment tool.

“I am sure some of you have bought a property and experienced capital gains from the transaction of properties after holding them for a period of time. With the BTS, you lose the capital appreciation which you can tap into during the construction period.

“As a result of low supply, house prices will soar. As it is, the huge outcry in the industry is about the stratospheric rise in house prices. There is still strong demand for housing and as our country grows, this demand will only increase,” he says.

Supply of houses in rural areas and suburbs may also be compromised. “There are many small developers in rural areas and they build small projects, but they may not be able to do so with the BTS. You will immediately see a shortage of new houses there within the next three to four years. Even super developers will not be able to deliver such units in the suburbs as they may prefer to focus on the inner city areas where values are higher,” says Tan.

BTS already exists in the form of the secondary market, stresses Tan. “In 2009, the secondary market covered 88% of the property transactions based on government figures. Full mandatory BTS will hamper the growth of the property industry,” he says.

Are we ready for BTS? Tan compares our average national income per capita with those of Brunei and Singapore: “Singapore’s is US$20,066 while Brunei’s is US$20,823.10. Our average national income per capita is US$3,311.76. Our unemployment rate is not zero; it is not high but it is not zero. If the unemployment rates increases, what will happen to our economy?” he asks.


Hope for sustainable growth

Stating from the onset that he wants to take a neutral stance on the panel discussion topic of “Buildthen-sell: The impact on property prices”, panellist Kevin Lam, United Overseas Bank (Malaysia) Bhd’s managing director and country head of personal fi nancial services, says his hope is to see sustainable growth for the property sector for the long term.

“I hope all stakeholders will work together to support the long-term sustainable growth of the property market in Malaysia,” he says.

Lam says that, while the intention of the build-then-sell (BTS) system to protect homebuyers is good, there are implications and considerations that must be made before making the BTS compulsory in Malaysia.

During the panel discussion at The Edge Investment Forum on Real Estate 2011 on April 9, Lam acknowledged that the BTS system is being mulled by the government because of concerns over the number of abandoned projects. Figures from the Housing and Local Government Ministry show that as at Dec 31, 2010, there are 271 “ill and late” projects in the country. Lam estimates that there are about 2,000 projects under construction nationwide and based on the Ministry’s fi gures, puts the number of abandoned projects in the country at an estimated 13.5%.

“At face value, 13.5% is quite substantial but are the numbers really that high?” asks Lam.

“I spoke to several developers and was told that even phases in a big project are categorised as “ill and late”. Perhaps there should be more public information that gives a clearer picture as to exactly what kind of projects get abandoned, in what areas, and at what price points. Should we then consider if BTS should apply to only segmented markets or should it be a onesize-fi ts-all solution?”

Lam off ers an alternative to BTS — a segmented approach where homes are marketed after completion of at least 50% to 60%, a system that has been adopted by China.

This will apply to homes for the “heartlanders” of the core population segment, defi ned by income or house value. Heart-landers are genuine buyers buying a home for own stay, he says.

Adopting the BTS system in the Malaysian housing sector also means shifting the cost of fi nancing and warehousing of the completion risk to developers and bankers.

Developers will be required to have deep pockets and the borrowing margin will have to increase, says Lam. With the current borrowing margin of developers at about 50% to 70%, Lam says developers will face a longer gestation period, which increases risk-based capital under new global banking standards.

He notes that, currently, it takes about three years for a development to be completed and, in some cases, up to another year for the handover.

“That is about a four-year holding period. When the exposure is open for a duration period that is much more than what it is now, it’s likely that the cost of financing to developers will go up and developers will only be able to focus on one project at a time,” adds Lam.

When that happens, he foresees a reduction in supply and changes in property prices in the near term. “Considering the near-term impact of reduced supply and changes in property prices, who will this benefit?” he asks.

Developers and bankers will also have to be much better at development cost projection. This will include land cost, material cost, labour cost and interest cost, which involves financing cost, credit, liquidity, capital and operational cost.

Taking oil prices, which has surpassed US$100 a barrel in the face of political instability in the Middle East, as an example, Lam questions whether it is possible to correctly project its future price due to its volatile nature. He cautions that it is dangerous to attempt a development cost projection based on future prices. In view of the difficulties that will be faced by developers, particularly in cash flow and financing, only the fittest and financially sound developers will survive.
Prudent banks will have to practice risk-based pricing and Lam cannot rule out aggressive pricing due to stiff competition.

He cautions that the market may see a higher rate of abandoned projects due to higher cost of financing, a longer gestation period and variability in construction and bankruptcy due to insufficient cash flow and high gearing.

Lam also suggests Malaysian developers to redevelop older existing properties, a practice termed as “en bloc” development in Singapore, which is widely practised by developers there due to scarcity of land.

“Will en bloc happen in Malaysia soon? If I were a developer or a banker financing a developer, I would consider alternatives to buying a piece of land and building from scratch. I would opt for something with an existing structure and a proven location with fewer approvals to obtain and lower cost,” says Lam.

Concluding his presentation, Lam says considerations should be made regarding implications of the BTS implementation, economics of demand and supply, and other alternatives before going through with the implementation.

This article appeared in City & Country, the property pullout of The Edge Malaysia, Issue 854, Apr 18-24, 2011

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