The Effectiveness of Financing Real Estate Development Through Off-plan Sales: Case Study of Selected Residential Developments Within Nairobi County

Abstract

Developing real estate is a high risk activity which requires commitment of large sums of capital. Unfortunately, most investors and developers do not have such funds and would therefore resort to borrowing, whereby they would pay interest to financial institutions thereby increasing the cost of real estate development. Off-plan property sales emerges as an alternative source of finance, presenting developers with a chance to obtain funds from would-be buyers of the units in their proposed development. In spite of the huge significance of off-plan property sales and its growing popularity in the global platform, there is limited knowledge in this strategy as a financing option. The study sought to determine the effectiveness of off-plan property sales, as a financing strategy to the developers and as an investment to the property buyers; its challenges; and recommending appropriate mechanisms of enhancing it. The researcher identified five case study areas (Loresho Ridge; Ramata Greens Apartments; Kings Millennium Estate; Muthaiga Valley Apartments; and Pearl Heights Apartments) within Nairobi City County, which are recent real estate developments that incorporated off-plan sales as a financing strategy. Key-informant interviews were conducted on developers and estate agents in the case study areas while questionnaires were administered to randomly sampled real estate developers and estate agents. The study established off-plan sales is an effective mode of financing real estate development since it generates significant savings on the cost of development, mainly through savings on interest, to the tune of between 4% - 8.5% of the total cost of development. It is also beneficial to buyers since off-plan units are sold at lower prices compared to completed developments. The challenges faced by developers in using off-plan sales as a strategy of financing real estate development include: difficulty in achieving the target amount through off plan sales; penalties due to project delays; failure by off-plan property buyers to complete payment of the purchase price; and lower prices of the off-plan sales relative to sale prices of the units upon completion of the developments. Challenges faced by buyers of off-plan property include potential fraud by unscrupulous developers; probability of distressed sale due to inability to complete purchase price; poor quality of construction; and delays in project delivery. The study recommends that developers need to establish an optimum mix in their financing options; careful time planning for real estate development; early and vigorous marketing of the development; pre-qualification of potential off-plan buyers; the need for due diligence by buyers prior to purchase of the off-plan units; and the need for legal framework regulating off-plan sales.