Off-Plan Property Investment Schemes: When a guaranteed return is too good to be true
Off-Plan Property Investment Schemes ("OPPISs") are well established way for investors to acquire UK real estate and are often seen as an attractive investment opportunity, particularly for international investors who would otherwise find it difficult to purchase UK properties.
However, OPPISs around the UK have been collapsing in recent years and investors in the schemes often have very little control before it is too late.
Trowers & Hamlins have a wealth of experience of advising investors regarding OPPISs and the steps that can be taken to protect investors' interests. This article examines why OPPISs may fail and what investors can do to protect themselves.
What are off-plan property investment schemes?
OPPISs are schemes used to fund substantial property developments, such as care homes, student accommodation, residential flats, multi-storey car parks, storage facilities and hotels. These large developments are divided into individual spaces which can be sold to an investor (a "Unit"), such as a hotel room.
The structure of the scheme allows developers to obtain funding without borrowing heavily (or at all) from commercial banks. The schemes typically structured in the following way:
- A development company (the "Developer") buys a plot of land and the proposed development is planned. The building to be constructed is apportioned into Units which can be sold to investors one-by-one.
- To finance the construction, the Developer instructs a marketing agent to promote the scheme and sell Units to investors on the following terms (or similar).
- In return for a deposit and subsequent staggered payments from investors, the Developer will grant the investor a lease of a Unit, once built, typically for a term of 100-250 years.
- Once the Unit is completed the Developer enters into the lease with the investor, whereby the investor must pay ground rent, maintenance charges, insurance and other costs.
- At the same time, the investor and the Developer / its nominee enter into another lease or contract (the "Management Contract"), which provides that:
- Although the investor has taken a lease of the Unit, the Developer or its nominee will be given the rights and responsibility for managing and letting the Unit.
- Whatever rents and other costs the investor must pay to the Developer, the investor is entitled to receive an equivalent amount from the Developer / its nominee under the Management Contract.
- The investor shall also receive another payment, often described as the "Assured / Guaranteed" Rent. This represents the investment return, typically 6-10% p.a. of the Unit's purchase price.
- The company named in the Management Contract then lets out the Unit to occupiers for a rent. The investor is not involved in this at all.
- The documents provided by the marketing agent will typically give the impression that:
- Investors' income from the Unit will be "guaranteed" or "assured" and
- therefore there is no risk to the investor.
- The Unit is a "hands-off" asset, with no ongoing costs such as service charges or ground rent.
- In our experience, investors agree to take a lease of the Unit under the impression that they will receive a reliable rental income, even if their Unit is not occupied, and they will not be directly responsible for maintaining the Unit or dealing with any occupier.
- Once the contracts are entered into, the participating investors collectively fund the development. Once built, the investor expects to leave the Developer to run the building and let their Unit. The investor expects to simply collect the investment returns without any further involvement.
What are the risks?
These schemes can seem risk free, but in reality OPPISs are often extremely risky investments with hidden issues that are not obvious at the outset. For example:
- As the Developer or its nominee deals with the occupier, collects rent, and pays operational costs without investors' involvement, investors often have no oversight of whether their Unit/building is managed competently and cost-effectively.
- If the Developer controls the rents received from occupiers and the funds received from investors, investors may not know whether their income ultimately came from an occupier of their Unit or from another investor. If funds from new investors to buy Units are used to pay the existing investors, the OPPIS may be a pyramid scheme which will collapse when no more Units can be sold.
- The Company required to pay investors under the Management Contract may not be an substantial company. Developers often nominate special-purpose-vehicle companies as investors' tenants rather than the Developer itself. This means that if the companies fail to pay investors the "Guaranteed Rent", they may not have sufficient assets to be worth suing.
- If a bank was financing the development rather than investors, it would carry out extensive due diligence on the property, market and Developer and secure its loan against the Developer's assets. If the Developer defaulted on its agreement, the bank could call on its security. Investors cannot carry out equivalent due diligence and may have no/weak security in place. If the developer becomes insolvent, it is much less likely that investors will recover their capital.
How do I know whether my investment is failing?
It can be difficult to understand how your Developer is performing and whether there are unseen problems in the OPPIS. The following questions will help investors assess whether their investment is riskier than it seems.
- When are you required to advance funding for this development? If you are being asked to provide substantial funding before entering into the lease, your payments are likely to be the development finance.
- When exactly will the unit be deemed "complete" under the contract? Does complete mean 100% ready for letting and occupation?
- Is the development on schedule? This is particularly important if your developer has agreed to make any payments to any investors before all units are completed.
- Have your solicitors registered a form UN1 against the Developer's title, to give notice of your interest in the Unit whilst it is being built?
- Are there any banks or institutional lenders also financing the development? If so, would they be entitled to payment in priority to you in the event of the Developer's insolvency?
- Which company pays you income for your Unit? If not the Developer, why not?
- Is the rent paid by the occupier more than the amount that you are entitled to plus the operating costs?
- Do you pay the service charges and ground rents directly or is this process entirely out of your control?
- Is your Unit occupied? If not, can the Developer or their agent supply you with the material being used to market the property?
- Are you being provided with a full service charge budget each year which itemises the costs of maintaining/operating the building and the Units?
- If you wanted to, could you assume day-to-day control of your Unit and management of your tenant?
- Is the Developer engaged in any other developments? How is the funding for these sites kept separate from your own?
What can I do to protect my investment?
- Ask your Developer to answer the above questions if you don't know the answers.
- Work with other investors. There is strength in numbers and, whilst the Developer may be able to ignore the requests of 1 investor, it is much harder to ignore 100 organised and well-advised investors.
- Review the statutory accounts of the companies named in the Lease and the Management Agreement. Check whether they have charges registered at Companies House.
- If you can, inspect your Unit or the site. Whilst this may not be practical for all investors, there is no substitute for seeing the position on the ground. If travel is impracticable, consider instructing a local independent property agent to visit for you.
- If you have concerns regarding your investment in a OPPISs, take legal advice from UK solicitors with expertise in dealing with failed property investment schemes. These solicitors should be different to the solicitors who acted on your behalf in relation to acquiring the Unit.
We regularly act for investors around the world and insolvency practitioners regarding OPPISs. This has included a number of high profile schemes operated by Alpha Student Homes and the Elliot Group. We are well placed to advise investors on potential issues in investors' schemes, including developer/tenant insolvency, director conduct, fraud, right to manage, landlord/tenant disputes, restructuring and professional negligence.
We routinely work with developers, lenders, property and insolvency professionals to achieve the best outcome possible for investors and we are used to advising investors collectively or individually. We understand that the collapse of these schemes can impact a significant portion of investors' savings and we are here to support investors in turning the situation around.