Finance Real Estate Investment by use of Forward Sales Agreement: a Review of the Impact on Rate of return in Kenya's Residential Real Estate Investment

For many years, real estate investment and development has been hampered by lack of financing, among other bottlenecks. Consequently, the supply of real estate products has remained low compared to demand. The housing shortage, for example, has remained high with very many households occupying housing units that are below their expectations. In the recent past, there have been continuous and incessant attempts to invent new and innovative ways of financing real estate investment and development in Kenya. The innovative financing tools have been developed in order to alleviate the problem of access, cost and risk, while achieving high returns on investment. One of the most innovative tools has been the forward or presales contracts. Invariably, the use of this tool has necessitated the sale of individual units at a price that was lower than the current market price or at a price that was lower than the projected sale price at the end of the project. This tool has been embraced by many developers because of the benefits it supposedly brings to the developer. Some of these benefits include low financial leverage, low cost of financing, reducing the amount of personal equity, enhancing market confidence in the project, improving rating of the investment by debt and equity financiers, transferring some risks to the buyers among others. The study reviewed ten medium-sized residential projects executed and completed between the year 2005 and 2010 in Nairobi and Mombasa. The project selected were those that had units ranging from 50 to 100 units targeting the middle-income groups. The focus of the review was to establish the key motive for use of the pre-sales agreement mode of financing, the number of units sold under pre-sales contracts, the number of units sold under other arrangements, the overall cost of the project (including the final cost of finance), total sales proceeds and net sale proceeds. Results reveal that the key motivating benefit to the developer has been the ability to reduce the financing costs, both from equity and debt. Developers expect that the forward sale contracts at a lower price will be compensated by lower financing costs and ultimately achieve the average market return on investment. However, results reveal that this benefit has not been achieved and projects financed using forward sales/pre-sales contracts recorded lower return on investment compared to market rate of return on similar investments. Finally, the study concluded that pre-sales contracts are not a return enhancing financing model for residential real estate investment in Kenya.