The economics of residential projects should to be reworked as the market finds its way out of the recession.
New construction finance models needed
Construction financing for residential projects may need to be reworked as the market finds its way out of the recession, experts say. While the escrow account model, which links payments from buyers to construction and so instills confidence among investors, it does not guarantee a project will be built. Developers therefore need to be less dependent on their customers for money and find ways of securing the full construction costs before work begins.
Current market uncertainty is also encouraging investors to default if they are not confident their homes will be built, according to Andrew Charlesworth, head of corporate finance advisory, Jones Lang LaSalle. "The whole financing model needs to be looked at again," he said. "There's a reliance on off-plan sales and we need to look at how to be less reliant on consumers going forward." Mr Charlesworth said developers may need to look towards the project financing schemes used in mature property markets like the UK, whereby construction is usually financed by banks or other financial institutions.
"The developer may also have an agreement with the banks that they will provide mortgage financing to its qualified buyers, which would take away a lot of the uncertainty that the buyer won't have the cash available," he said. "The developer can then get on and build the building without worrying about the financing, while the contractor knows it will get paid because everything is kind of pre-built around it."
Mr Charlesworth added that the escrow system could still play a role in such a model. "It could possibly be the deposit that's made, but then the buyer would have a bullet-proof mortgage in place before they finally complete on their purchase," he said. "A lot of banks might be quite hesitant about it right now but I think that's a target we should aim for as and when the market starts to stabilise. Now is a great opportunity for everyone to take a step back and start looking to see what we could do better for the next cycle."
While Dubai has had an escrow law in place for almost two years, it is still in the pipeline for Abu Dhabi. Still, because of the flaws in the system that have been exposed due to the slowdown, experts question whether it would be the right option for Abu Dhabi. "I think we need to think about whether escrow will be the best way," said Scott Aitken, a legal consultant at Clyde and Co, a law firm.
However, the escrow system needs to be implemented in the capital as soon as possible to give greater confidence buyers, said Gurjit Singh, chief property development officer at Sorouh Real Estate. "What a consumer wants from a product now is to pay as they see progress," he said. "And that may need to be dove-tailed very accurately with how banks are going to package their loans to individuals. So banks would release payments based on construction progress."