How safe are off-plan deals?

Buyers who pay for a property long before the foundations are done seek to get bargain deals. But with most developers shunning escrow accounts, what is the guarantee that buyers would not lose their hard-earned money should something go wrong? KEVIN OGUOKO reports

The legal dictionary describes an escrow as something of value such as a deed, stock, money or written instrument put in the custody of a third person by its owner or a grantor.

According to Faith Waigwa of Nungo, Oduor and Waigwa Advocates, the term escrow initially applied solely to the deposit of a formal instrument or document, although it is popularly used to describe a deposit of money.

“In Kenya, escrow accounts are normally used where conveyancing lawyers wish to jointly operate an account when dealing with complex transfer of legal title of a property such as sale of a large commercial property with many tenants or owners,” says Waigwa, a city lawyer specialising in property law.

Conventionally, in the case of selling of a residential property where escrow is involved, a buyer, after identifying a property, is presented with a letter of offer, after which they are required to pay a deposit of between ten per cent and 30 per cent to show their seriousness in buying the property. The payment schedule is then agreed on until the final instalment, which is to be made when the building is complete.

In the escrow scenario, instead of the deposit payments being given to the developer directly, the lawyers of both the purchaser and the seller put the money in a joint account.

How it works

“What happens in escrow account transactions is that the seller’s lawyers open a joint bank account with the purchaser’s lawyers for purposes of having the purchase price deposited into such an account (which mostly is an interest-earning account) until the transaction is finalised. The purchase money is then released to the seller together with the interest that will have accrued,” says Waigwa.

When the funding is complete and the deed is clear, the escrow agent will then record the deed to the buyer and deliver funds to the seller. The escrow agent or officer is an independent holder and agent for both parties and receives a fee for his or her services.

“Sometimes, the interest that accrues in the escrow account may be shared between the seller and the buyer,” she adds.

Escrow provides a simple and amicable platform to carry out complex business transactions that carry risk of loss of millions of money.

But Home and Away has established that many Kenyans do not use escrow accounts as is the practice in developed countries. The developers do not prefer it either. Instead, escrow accounts have been left for use only for large cash transactions.

“Escrow accounts are normally used in the transactions of hundreds of millions of shillings. Transactions involving relatively ‘smaller’ amounts such as when buying apartments are normally carried out in cash,” says Waigwa.

This means the money paid by the buyer normally goes directly into financing the construction of the property in question.

Marketing

“The offer price is normally used to entice potential homeowners to invest in housing units way before ground breaking. The offer price is normally way below the market price of a similar completed unit and is used to initiate sale so that the developer does not fund the project 100 per cent,” says Abdullahi Dahir, Director of Imara Gardens, a development on Mombasa Road.

When Imara Gardens was launched early last year, an apartment unit was going for Sh6.8 million. That has since increased to Sh7.8 million currently.

“No bank will fund a project 100 per cent. Part of the money got from the off-plan sales in used to develop the project while the rest is used to service the loan. The concept is that the less you borrow or owe, the more free you are,” says Dahir.

He adds: “Reducing your loan amount with lump sum payments way before maturity, puts you in a good stead with the bank. You can easily go back and ask them to help you finance a totally different project.”

According to Dahir, if a developer does not sell a number of housing units off-plan within the first six months of a project’s launch, then there is a cause to worry.

The project would be faced with financial constraints, as there would be the loan to service. This explains why most developers engage in aggressive marketing campaigns to sell off apartments and other residential developments long before ground-breaking.

Power of off-plan sales

“When people start buying into the project, they influence others to do the same. That is how powerful off-plan sales are,” says Dahir, who reveals that 20 per cent to 30 per cent of their clients come through referrals.

His sentiments are echoed by Dr Ojiambo Oundo, a director at Roack Consult Ltd, a Nairobi-based real estate firm

“Many off-plan buyers are speculators who want to take advantage of the fact that the prices would have increased by the time of completion,” says Dr Oundo.

In Kenya, escrow accounts are usually used between developers and suppliers of building materials and the contractors. But in the United States, escrow accounts are extensively in use.

In mortgage transactions, an escrow deposit account is maintained by the lender (banks and financial institutions) and funded by the borrower (home owner), from which the lender makes tax and insurance payments for the borrower as they come due. In mortgage transactions in Kenya, banks generally require borrowers to use escrow accounts.

The rationale behind this is that it prevents a weakening in the protection provided to the lender by the property.

If the taxes are not paid, the tax authority could place a lien on the property that would have a higher priority than the lender’s lien. Similarly, if the house burns down or is flooded, the lender’s protection goes with it if the insurance premiums had not been paid.

According to various Internet sources, to assure themselves that there will always be enough money in the account, lenders ask for more than they actually need as a “cushion.” In years past, many of them maintained unreasonably large cushions.

So what are the remedies for potential losses caused by failure to use escrow accounts? According to Waigwa, getting a lawyer involved in all your transactions is one of the surest ways to avoid unnecessary losses in property deals involving substantial amount of money.

“Get a lawyer to interpret the terms stipulated in the contract. The lawyer could help you negotiate with the vendors’ lawyers and make them favourable for you,” advises Waigwa.

One of the terms that are normally negotiated is the holding of the purchase price deposit money, which is usually ten per cent to 30 per cent of the selling price in the case of off-plan sales.

Instead of the money going directly to the developer, the money can be held by their lawyers who will in turn, release it to the developer once the conditions set are met.

The lawyer would also enable one to get the warranty clause on the contract to be in the buyer’s favour. Standard warranty clauses provide general representations and warranties for a commercial sale of goods or services. It includes a disclaimer of other representations and acknowledgement sub-section.

In Kenya’s case, the clause assures the buyer that the property being sold has been certified and proved to be legal.

“Someone can lie while in actual sense the property in question has been earmarked for demolition. After the contract with the warranty has been signed, we carry out a search to check on the legality of the property in documents like the Ndung’u Report and government agencies,” says Waigwa.

But what happens when the property is well past its due date or has been delivered in a poorer state than what was agreed.

According to Dr Oundo, one sure way to avoid this is to go for reputable developers with proven track records.

“In case of a dispute, parties involved can go through arbitration. In the case of legally binding disputes, one can move to the High Court,” says Oundo.

But Waigwa says few disputes involving off-plan sales have been taken to the High Court.  “Rarely do buyers demand a refund of the money when in dispute over one reason or the other, which can range from design to finishing issues,” says Waigwa.

She adds: “A major reason for this is that the offer price is usually lower and by the time of completion, the property price would have gone up. Therefore, demanding a refund is like forfeiting the property’s price appreciation.”