How developers should exit real estate projects

The real estate sector has been the key to creation of wealth for some of the world’s tycoons. It therefore comes as no surprise that Kenya too has been, more so in the last decade, experiencing massive investments due to the perceived high return.

Kenya is also estimated to have an annual housing deficit of approximately two million residential houses, which arguably makes a case for the large-scale residential developments as a lucrative sector for investors looking for high returns.

However, like any other good investment, careful planning of a developer’s exit is essential to navigate the significant legal and management issues that could potentially dilute a developer’s return, more so, in large scale and phased residential developments.

The core aim of most development projects (especially those that are ear-marked for sale), is to maximise returns on capital through a clean and quick exit. However, for most developers, the reality is that there is usually a mismatch between the project completion and sale of all the units in the development.

As a result of this mismatch, developers are usually ‘forced’ to retain ownership of the common areas and control of management of the development until the last unit is sold. At this point, the homeowners are not involved in the decision making on how service charge is levied or utilised and the general management of the estate.

As a result, mismanagement of service charge and poor management of development has become a major source of friction between developers and homeowners.

This practice by developers of maintaining control of the management of a development is expected to change once the new Sectional Properties Act, 2020 (Act) gains full traction.

Where a development is not exempt from the Act, a they are required to appoint a board of the Corporation within 90 days from the date 50 percent of the units are sold or within 180 days from the date the first unit is sold, whichever happens earlier.

However, before the tide fully shifts in favour of homeowners taking responsibility of the property owners management company (MC), a developer should take it upon themselves to ensure that they are ready to handover when that day finally comes.

How then can a developer prepare for such a handover and mitigate against liability?

As a starting point, the developer should formally create the MC and become the "initial board" . At this point, the developer will be playing a dual role of first, operating the MC and second, developing and marketing of the project.

This dual role creates a conflict of interest considering that the developer bears all the associated responsibility and potential liability of a director of the MC for acts done or omitted.

It is therefore advisable, from the onset, that a developer creates a clear separation of roles by ensuring that all contracts with third parties relating to management of the development are entered into by the MC, not the developer and preferably, all operations are done by a third party management company, with the oversight of the developer.

It is also expected that once the last unit is sold, the developer should handover the management of the MC to the homeowners.

Often the separate homeowners will own their individual units and manage the common areas (such as gardens, lifts, clubhouses, lifts etc) jointly through the MC. The first step should be onboarding all the homeowners as member of the MC either by transfer or allotment of shares.

Once the homeowners become members of the MC, form a unit-owners-controlled board of directors, which can take over the management duties from the developer.

On the other hand, the new homeowner-controlled board, should, before taking over its duties in the MC, independently or through its lawyer retain the services of an independent auditor to review the books and records of the MC while it was in the control of the developer. This would assure the new home-owners board that the developer acted properly while they were in control of the MC.

It is also expected that for proper operation of a development, each homeowner within a development is required to pay service charge, which is utilised to fund the running of the MC and maintenance of the common areas. To achieve proper accountability and avoid service charge related disputes, segregation of service charge funds from the developer’s other funds is a crucial step in preparation of the handover by a developer.

During handover, the developer is expected to account for service charge paid and transfer any unspent and advance service charge to the homeowners. The reconciliation can be complex especially for large developments and a developer should therefore ensure that the MC’s service charge and service charge deposit bank accounts are set up from the onset.

Over and above the measures highlighted, developers should consider taking out an adequate directors and officers liability insurance cover to hedge against any director or officer liability that may be brought against them for acts done or omitted during their tenor as directors and officers of the MC.

Amrit is a partner in the real estate and finance practice at DLA Piper Africa, IKM Advocates Maureen is a senior associate in the same practice

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