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If you are missing the adrenaline rush of participating in the property market, now may be a good time to do so. The off-plan property segment, which was partially responsible for triggering the real estate crash several years ago, has re-emerged in a more disciplined format.
Banks are playing a vital role in stabilising the real estate market, snuffing out risky speculation and adding filters to safeguard investor interest when it comes to under-construction projects. An off-plan property is a cost-effective way of securing a home in expensive cities such as Dubai. More importantly, it can provide investors with superior capital gains, both in the short and long term.
The normal process is to buy property directly from a developer for a fixed price via a payment plan. By the time the property has been developed fully, its market value climbs due to the appeal of a finished project. If buyers decide to hold on to their properties for a number of years, they can get excellent rental income that can help cover their monthly instalments to the bank. On the other hand, investors with an appetite for smart and swift transactions can choose to sell their off-plan properties prior to project completion, cash in on capital growth and avoid the costs of owning a finished property.
Risk and regulation
There is, however, an inherent risk. Investors can be left in the lurch by developers who don't complete projects on time. Prior to 2008, an unregulated market and general euphoria over a booming economy enabled overambitious developers to attract funding from immature investors. Many failed to deliver projects on schedule, and sometimes not at all.
Flipping, or the practice of swiftly reselling off-plan property for profit before project completion, was another factor. In the pre-2009 years, investors were gripped by a flipping frenzy when a large number of people netted gains that went up to a whopping 200 per cent. The resulting turmoil generated by the off-plan sector is now the stuff of grim legend.
Fortunately, the unregulated phase is now in the past. The UAE government and Central Bank have taken strong regulatory steps to cool speculative instincts and prevent developers from abandoning projects and defaulting on financing.
Most developers no longer allow the resale of an off-plan property before completion, unless buyers pay at least 40 per cent of the price. Title transfer fees have also been hiked from 2 per cent to 4 per cent to prevent fly-by night investors from flipping units needlessly and registration fees have also increased.
Thus, since 2013 the offplan segment has gained momentum. Banks, which were hesitant to step into the under-construction financing space, have reworked their products. This time they are covering all risk areas and have controls in place that will protect not only the interests of banks but also the investors. Financing is now restricted to 50 per cent of finance-to-value (FTV).
Role of bank financing
Today, the real estate market has stabilised, the flipping practice has largely disappeared and the focus is back on end users and genuine investors.
Armed with several safeguards, UAE banks are cautiously venturing into the off-plan financing segment. Deterrents against exploitative developers include stringent escrow laws that have ensured disciplined financing among developers, enhanced investor confidence and led to a resurgence of off-plan property demand.
According to realty experts, there has been at least a 20 per cent surge in offplan resale offers in the past year. UAE banks have put in place safeguards that screen the credentials of developers. Unlike in the past, banks now deal only with reputable builders and have their own set of criteria to approve a developer or a project.
A real estate company's cash flows should be transparent, construction quality sound and the ability to meet contractual obligations strong. Banks also make a de tailed examination of whether relevant approvals from government authorities and regulators are in place. Based on these criteria and the developers' track records, institutions such as Noor Bank have drawn up their own list of recommended developers to aid customers who wish to purchase off-plan projects.
At the other end, banks have tightened off-plan financing rules to protect not only their own portfolios but also their customers' interests. Off-plan investment carries an element of risk, which the bank can help mitigate by putting adequate checks in place.
Up to 2008, most Islamic institutions offering finance on off-plan would accrue the profit until handover of the property, and the client would start paying rentals or equated monthly instalments post-handover. This allowed customers to adopt a casual attitude towards purchase and financing, resulting in large profits accrued in the bank's systems, so they either had to take a loss in the event of a default or the property handover had to be delayed.
In recent years, banks have revamped their strategy according to rules laid down by the Central Bank. Clients now have to make a mandatory 50 per cent down payment to the developer before a bank extends its finance, which is in tranches. The total amount of financing is capped at 50 per cent FTV to safeguard against unnecessary risks. Noor Bank has had the first-mover advantage in an innovative off-plan Islamic product structure, where customers make monthly payments based on the last tranche disbursements covering both fixed and variable rental portion. This reassures the bank the customer is committed throughout the construction period.
This structure works well for customers too, in that they do not get burdened with a lump sum rental (profit portion) payment upon handover. And since tranche payments are monitored and linked to strict construction milestones, the risk is lowered for all parties concerned.
By the time a bank OKs financing for a client, a developer would have completed almost half the construction work and it would be financially unfeasible to delay or halt the project.
Banks are now careful to release tranche payments based on independent evaluation of a developer's construction milestones. In the case of unforeseen delays, banks do consider factors such as a developer's buffer period for delivery.
After financial institutions were burned in the instability triggered by the off-plan sector, a note of caution has crept in and only a limited number of banks offer financing for off-plan projects now, including Noor Bank, which finances a maximum amount of Dh20 million for tenures of up to 25 years for both residents and non-residents, but only for end use. Documentation required for home financing include income assessment, documents pertaining to the off-plan property, along with proof of Oqood registration and relevant charges. For overseas buyers, the requirements are similar.
One of the biggest problems during the global recession was large-scale defaulting on payments. Banks are more sensitive and have adopted a solution-oriented approach. This includes finance restructuring, profit rate reduction or payment deferment, depending on the severity of individual cases. In instances of death, or permanent total disability, banks offer family takaful (Islamic insurance) that covers the clients in such eventualities.
Advantages of off-plan
To limit financial risk, developers start selling during the construction stage of a project. There are several advantages to buying off-plan:
• Asking prices are normally considerably lower than for completed properties, so off-plan can generate bigger returns.
• Prices do not remain low for long and as construction progresses they rise steadily — being an early bird can deliver higher profit margins.
• Early purchase allows you to choose the best positioned properties. The best units always offer higher capital appreciation and can command higher rental incomes.
Follow the law
Key points from three major regulations — Escrow Account Law (Dubai Law No. 8 of 2007), Interim Real Estate Register (Dubai Law No. 13 of 2008) and Regulation of the Interim Register (Executive Resolution No. 6 of 2010) — that protect investors.
• Developers must be registered with the Dubai Land Department (DLD).
• Developers must open an escrow account for each project, where all payments will be made.
• Payment plans have to be attested by the Real Estate Regulatory Agency; project progress is published on its website.
• Developers cannot sell units until they have possession and title deed of the relevant plot.
• Developers can market their projects only after getting DLD approval.
• Off-plan sales can begin only after approval from statutory authorities such as the Dubai Municipality.
• If a developer markets a project through a broker, a contract registered with the DLD is mandatory.
• All off-plan units sold should be registered with the DLD's Interim Real Estate Register.
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Source: Pawan Dhawan, Special to Property Weekly