For residents of, and investors in, the United Arab Emirates, off-plan sales have become a standard way to purchase residential real estate. Basically, customers interested in buying villas and apartments engage with the real estate developer before construction even begins. The customer first pays a deposit to secure the real estate asset. Then, as progress on the real estate asset is completed the customer continues to pay, in advance, for the next phase of construction. The developer doesn’t have to borrow funds to develop assets and are assured a seller in advance, while the customer doesn’t have to borrow to buy the asset and saves themselves the risk of market fluctuations during the construction phase.
This means both sides save on bank fees and interest, and both parties have future clarity on prices. If the contracts are fair, then both developer and customer will enjoy the savings of disintermediating the banks.
For the customer, this can mean a significant saving. To get a feeling of how big, consider a customer who buys a completed apartment for one million UAE dirhams ($272,250), and gets a 15-year mortgage of 700,000 dirhams at 8%, payable annually. The total payments on the mortgage would be about 1.23 million dirhams. So the mortgage costs an extra 530,000 dirhams over its lifespan.
I’m ignoring the time value of money here because it applies to both the off-plan and mortgage scenarios, complicating the mathematics without really affecting the conclusions.
The disadvantage of an off-plan sale is that the customer is paying cash upfront without enjoying the use of the asset. How big this disadvantage really is can be partially measured by the difference in customer pre-payments versus the actual progress achieved by the developer. If the customers is pre-paying far more than progress has been achieved then they are in effect lending to the developer at zero interest. If, on the other hand, the difference between prepayments and progress achieved is small, then this would be a much fairer situation.
A note of caution: The cost-benefit analysis of off-plan sales versus a mortgage for a final product is unique to each customer’s preferences. The question being addressed here is how efficiently are off-plan sales programmes?
Time is money
If you read the notes of the 2018 financial statements for Emaar Properties and Aldar Properties, you will see that the basis for their revenue recognition is exactly the same. In summary, pre-payments by customers do not form part of the recognised revenue but are instead classified as a liability - advances from customers. The revenue is only recognised as progress on construction takes place, with clear audit guidelines on how progress is measured.
The central question of this article is: are off-plan sales programmes being applied efficiently? In other words, if prepayments by customers are quickly put to use for progress on the development of their assets, then this would be considered efficient. On the other hand, if customers are asked to prepay but these prepayments are not quickly used by the developer, then it is not so efficient. Inefficient off-plan programs are unfair to customers as it locks their money in without using it productively, giving the developer a low cost source of funds it can invest and make a return on without passing on benefits to the customer.
Measuring the off-plan sales efficiency requires far more information than provided by published financials. However, we can estimate the relative efficiency of Emaar to Aldar.
The first estimate is to look at the ratio of advances from customers as a percentage of the average balance of development properties. For Emaar, advances from customers as of year- end 2018 is 13.6 billion dirhams versus 38.4 billion dirhams in development properties for a ratio of 35%. Aldar has advances from customers at 362 million dirhams, versus 2.5 billion dirhams in development for a ratio of 15%. This clearly shows that Emaar is locking up far more unemployed customer funds than Aldar. By this measure, Aldar is 57% more efficient - a benefit to customers.
A different estimate is advances from customers to total revenue. For Emaar, this is 53% and for Aldar it is a mere 6%. Aldar is clearly more efficient by this measure as well.
To see the effect of Emaar collecting so much customer money in advance we can look at its finance income as a percentage of net profit, relative to Aldar’s. For Emaar, finance income is 9% of net profit while for Aldar it is 4%.
Customer benefits come from efficiency
Clearly, Aldar is managing its customers’ money far more efficiently than Emaar is. Last year, Aldar and Emaar announced a strategic partnership. Perhaps Emaar can learn from Aldar how to more efficiently manage its customers’ money to further enhance its offering.
* Any opinions expressed in this article are the author’s own
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© Opinion 2019