Hey presto! Now you see it, now you don't

Buyers of off-plan properties during the boom years adopted, unwittingly, the role of private equity investors and banks, and many saw their investments disappear.

In the good times: buyer cash supplanted that of private equity investors and banks in the early stages of off-plan property development.

I watched the children's faces light up as the magician made one ball into two. He doubled it. Then with a sleight of hand he made the two balls go back into one. Ooh, said the children. Wow, said I. That is what it must have felt like if you had purchased an off-plan property recently. Before you could say "expelliarmus!" the value of your property was blown away and you were back to or below the original price.

How did this feat of economic wizardry happen? To save you from having to reach out and grab the nearest Harry Potter book on the dark arts, let us shed some light on the subject. In mature property markets a developer typically brings 20 per cent of the financing for a project to the table. The other 80 per cent comes from a bank. However, of the developer's 20 per cent contribution, he may put in only 2 per cent. The other 18 per cent comes from a private equity property investor, sometimes directly, other times through a fund. So the developer is totally reliant on the bank and the private equity investor, who are taking all the risk.

The private equity investor must have deep pockets because, let's face it, investing in off-plan property other than starting up your own business is arguably the second most risky form of investment you can find on the planet. It is not to be taken lightly and that is why the private equity investor is normally someone who has a sophisticated history of investment and a track record to go with it. Also, they know that five times out of 10 they will lose all their money. But they will make enough on the other five transactions to have made it worthwhile. The private equity investor will also know from experience that his 18 per cent will be used by the developer to pay for consultants' fees - architecture, project management, quantity surveying and so on - approvals from authorities and the start of sub-structure works (enabling and piling).

"Before building work even starts, to achieve planning and detailed design approval from the authorities, the developer in the UK model would incur circa 15 per cent of the construction cost," says Garrie Renucci, a partner at Gardiner and Theobald, a construction consultant. The bank will thereafter step in and finance the rest of the project development cost. All three parties know they cannot sell any units in the project until it is near completion.

"Taking the UK and US development models as examples, the end user does not appear in the equation till very near completion of the building," said Mr Renucci. "Thus both the developer, and more importantly the equity investor and/or the bank, are too heavily exposed to do anything other than build the project and hope to recover some, if not all, of any potential losses they may incur. "This formula ensures very few developments are ever stopped once physical work has commenced, even in a recession. This does not, however, curtail the developer and financiers from looking at slowing down delivery by re-phasing and re-programming."

But as we know today, the property market in the UAE ballooned up exponentially without the input of private equity investors. So how did the whole thing take off? This is where the extremely willing but utterly ill-informed buyer comes in, after saving up for a piece of the action. They took the place of the private equity investor. And in many cases they also took the place of the bank, because there was no bank financing for construction.

Did unit buyers know their cash was being used to pay for design? No. Did they know that their funds were being pumped into infrastructure? No. Did they know that off-plan property is the world's second-riskiest form of investment? Are you kidding me! Sorry, but in the words of Del Boy from the UK sitcom Only Fools and Horses, the only reply you'll get, governor, is "no income tax, no VAT, no money back and no guarantee".

So it wasn't in any of the glossy brochures? Correct. It wasn't in the sales and purchase agreement that unit buyers signed? Correct. The suave sales person didn't explain any of this? Correct once again. But then, they didn't have to. Sajjad Hoque, the director of the brokerage firm Live Dubai, takes up the story. "My training taught me to always read the contract. Most people don't, and even if they did it was probably a waste of time," he says. "Once demand caught on, contracts became totally biased towards developers, and from a developer's point of view it was take it or leave it."

It was certainly a seller's market. Units and floors in projects were being sold on the back of crumpled A4 sheets of paper listing price per square foot. Once a buyer got their receipt, which in some cases they didn't, they were ecstatic, as if they had just won the golden ticket to visit Willy Wonka's chocolate factory. However, it was and will always be the responsibility of the buyers in a transaction to do their own due diligence and make an informed buying decision. After all, no one was holding a gun to their head. In fact, customers were fighting with each other to get to the front of the queue.

The experience has left many with a bitter aftertaste. As a remedy, Mr Hoque suggests giving investors greater rights and protection. Rehan Khan is the former chief operating officer of a Dubai-based property developer