Most developers need financing to commence and complete development projects. As at June 2011, the top 10 public listed developers had a combined market capitalisation of RM17.81 billion and borrowings of RM11.46 billion.

The majority of new properties are sold under the Sell-Then-Build (STB) system whereby developers sell them without having to construct them first. Buyers have to pay 10% of the purchase price as down payment on signing the Sale and Purchase Agreement (SPA) and the balance progressively based on the property’s stages of completion.

Developers are able to immediately access buyers’ monies and, together with their own internal funds and/or bank borrowings, fund the project’s construction costs. Buyers thus share a substantial burden of the project’s financing and business risks. 

Statistics from the Ministry of Housing and Local Government (Monitoring and Enforcement Division) at its’ highest peak ie. end-2005, classified 261 housing projects as abandoned (88,410 units with an estimated value of RM8.04 billion).

Recognising STB’s inherent weaknesses, the 10:90 system was introduced to run concurrently alongside STB for two years. The new variant of STB still allows developers to sell without first having to construct the properties and buyers still have to pay 10% down payment upon signing. But the balance is only payable upon the property’s full completion with electricity and water ready for connection and together with relevant title. Hence, the Buyers’ exposure to the Project’s financing and business risk is limited to only the 10% down payment paid.

Financing under STB

Developers use a combination of internal funds, bank borrowings and buyers’ progress billings to fund construction costs. As more properties are sold, progress billings increase. Developers then need to use less internal funds and/or bank borrowings and the project becomes “self-financing”. However as stated above, buyers will be exposed to the Project’s financing and business risks.

Financing scenario under 10:90

Since developers will not be able to access progress billings, they need to have more internal funds and/or bank borrowings which will be a hybrid between project financing and bridging financing.  The project’s financing and business risks are shared between the developer and the developer’s financier (DF).

Project financing is “the financing by a bank for the construction of a specific project where repayment will commence upon the completion or commissioning of the specific project”, the “specific project” being the proposed housing development works.

Bridging financing is “a short-term advance made by a bank to a customer pending the receipt by the customer of funds from some other sources”, “some other sources” being the balance purchase price to be collected upon completion of the property.

The DF will have to take a more proactive role with the removal of the end-financier’s (EF) role until the property is completed as the risk is no longer shared with buyers.

Roles of DF

1. Pre-construction stage

When a developer applies for bank borrowings, the bank has to conduct stringent checks to ensure it has a proven track record and financial resources, technical and management ability to complete the proposed development. 

Standard documentations required for Project Financing are, inter-alia, feasibility studies on the proposed development’s viability and written undertakings from the developer’s shareholders to “top-up” in the event of cost overrun. Similar criteria should apply under the 10:90 system.

This does not mean small developers will not have access to financing. They, or niche developers, normally undertake smaller developments or stagger the developments over different phases to minimise their risk. There should be no reason for them to be denied financing.

Under the 10:90 system, it is important for the DF to “know their customer” and understand not only their business but also the associated risks and mitigate them. Once the developer has satisfied all of the bank’s criteria, the bank borrowings can be approved.

2. Construction stage

It is crucial for banks to effectively monitor the proposed development by requesting for regular progress reports/sales reports and comparing them against the original budgets/plans. This will help banks ascertain that the project is on schedule and on budget. At the first sign of trouble, banks can take the necessary preventive action.

Banks should also conduct periodic site visits to monitor physical status of the development works as is normally done under project financing. However, most banks don’t do so before releasing progress billings to developers under STB.

3. Completion stage

Once the development is certified completed, buyers or their EF will pay the balance 90% purchase price to the developer. The standard SPA under STB allows buyers and/or the EF to pay direct to the DF. This position is carried to the 10:90 system, thus safeguarding the DF’s position. The DF should continue monitoring the project’s sales progress until it is completely sold.

Role of EF

Under the 10:90 system, their role remains the same – to provide financing to the buyers to enable them to acquire their property, although the EF will only come in when the property has been completed. Here, the EF’s position is more secure as the property has been completed and the risk of abandoned housing projects is non-existent. 

Impact on banking industry

The 10:90 system should not have a major impact on the banking industry since banks have been providing bridging financing and project financing in some form in the past and will continue to do so.

However under STB, as a large part of the risk is being borne by buyers, banks have become complacent and may not have done a very extensive “risk management process” and/ or “monitoring process”. They must take a more proactive role.

Benefits of 10:90 system to banking industry

Risk is considerably lower to DF because: