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Procurement options for the delivery of low cost housing

Following on from our previous article in relation to the region's low cost housing needs, this article considers some of the procurement options available to developers for the delivery of low cost housing developments in the Middle East, with a particular focus on the Kingdom of Bahrain.

The options considered in this article are not exhaustive and professional advice should always be sought when considering which options are the most appropriate in relation to a particular low cost housing scheme.

Freehold structures

A land owner can seek to develop its property directly or it may appoint a developer to do so on its behalf. This could relate to a single site development or a master planned development. Where a land owner appoints a developer to undertake the development on its behalf, the appointment may be made under a development management agreement. (We will examine some of the key terms of a development management agreement in our next Arabian Homes article).

In a master planned development, the land owner will develop and seek approval of the master plan and be responsible for the development of the community infrastructure. The master developer will then sell plots to sub-developers who are responsible for the development of those plots.

The development of plots by sub-developers needs to be controlled by the master developer. This is usually done under what is known as the 'Master Community Declaration', which also sets out responsibilities for shared facilities and for the recovery of service charges for maintenance of infrastructure and common areas.

As an alternative to carrying out / managing the master planned development, a land owner could transfer its freehold interest in order to facilitate development and generate capital receipts.

As legal ownership of property in Bahrain is on a freehold basis, a transfer of the freehold title will usually be required by developers / sub-developers / investors where the project is to be developed and sub-sold to end users. A developer may also require the transfer of a freehold title in order to obtain development finance to fund a project.

Leasehold structures

A leasehold structure allows the land owner to retain the long term ownership of the development property. A land owner can proceed to develop the property and grant leases to end users. Such a structure could also be considered by foreign owned developers / investors in areas where foreign ownership is not permitted.

In addition, the land owner could grant a lease to a developer to undertake the development and to sublease to end users. The payment to the land owner could be on a premium basis (lump sum), a rack rent basis (market value), a turnover rent based on a percentage of the yearly turnover of the development or such other terms as may be agreed.

The lease to a developer would need to be for a sufficiently long period of time so as to give the developer time to undertake its development and to grant subleases in order to give it a return on its investment.

It is worth noting that, the Bahrain Civil Code does not impose a maximum length of term for a lease. However, a lease should not create a permanent right. Any provision in a lease which seeks to 'convert' a lease to a permanent right (for example, a perpetual renewal right) may be void. A Bahrain Court may also consider a lease to be void where an excessively long term is granted.

A development lease / musataha structure is similar to a leasehold right but contemplates the development and on-sale of the freehold titles. It is a useful structure where foreign ownership restrictions apply and an owner wishes to procure development by a foreign developer for on-sale to Bahrain / GCC nationals.

Under the development lease / musataha structure, the land owner grants a development lease to a foreign developer for a lump sum. The developer undertakes the development on the basis that the developed units are intended for sale to Bahrain / GCC nationals.

For this structure to work effectively, the development lease must be long enough to ensure that the development can take place. In addition, the land owner should enter into a power of attorney permitting the developer to enter into sale agreements with end purchasers on its behalf. Typically the revenue from such sales will belong to the developer. However, an alternative to this could be a profit share in the future sale proceeds or a compensation payment for unsold units at the expiry of the development lease / musataha.

A leasehold structure may not be the most appropriate structure where the developer requires development finance as the financier’s ability to take security is restricted as leases are not capable of registration at the Survey and Land Registration Bureau. In addition, and because leases do not give rise to a proprietary interest, there is also likely to be less demand for leases in Bahrain. 

Public Private Partnerships (PPP) structures 

PPPs can encompass a variety of structures comprising freehold ownership, leasehold ownership, a combination of the two or an alternative. 

There is no widely agreed, single definition or model of a PPP. However, PPP arrangements typically involve joint-working between the public and private sectors.

PPPs are accepted as an alternative to the traditional forms of procurement. Traditional procurement characteristics might include the Government procuring assets (not services) from the private sector or the private sector being responsible for delivering the asset but not its long-term performance. With PPPs, the private sector returns are linked to service outcomes and performance. The private sector is responsible not just for asset delivery, but for overall project management, implementation and operation.

PPP structures remove the up-front capital costs from the public sector’s balance sheet and, as a result, may allow for the delivery of an asset which the Government may have been unable to finance directly. 

In addition to giving the Government access to private capital and removing the need for up-front Government capital expenditure, some of the main potential benefits of PPPs include:

  • Access to private sector know how;
  • Value for money may be achieved through cost certainty and efficiencies; and
  • Potential for the fairer allocation of risks to those most able to manage them.

The most common form of long term PPP model is the concession arrangement. These are long term agreements which can be used by the public sector as a means of procuring infrastructure assets, including their ongoing maintenance, by the private sector. Such assets can be as diverse as roads, schools, hospitals and wastewater treatment plants.

Concession arrangements can be categorised depending on how revenue will be derived. Essentially, there are two models: the tariff model and the availability model.

Tariff based models are used where the private sector is able to obtain revenues directly from the end user. A good example is a toll road. In this scenario, the private sector will take demand and collection risk in relation to the revenues from the end users.

Under a Tariff based model, the private sector will need to undertake due diligence to ensure that there is likely to be sufficient demand for the product or service it is procuring.

Availability based models are used where it is not possible to obtain revenues from end users but where there is a need to make the relevant infrastructure asset ‘available’. The procurement of schools, hospitals and other social infrastructure projects are likely to fall within this type of model.

The key characteristic of the availability based model is that the public sector will make payments to the private sector on the basis that the asset is made available and removes demand and collection risk from the private sector as payments are made irrespective of usage.

A variety of contracts can be used for concession agreements. The two most common forms of contract are known as build-own-operate (BOO) and build-own-operate-transfer (BOOT).

The main difference between a BOO and a BOOT is that a BOO provides for a transfer of legal title from the public sector to the private sector.

If an availability based model is being considered, the public sector is likely to incur significantly more costs in relation to a BOOT than an BOO. The reason being that under a BOOT, the public sector will also be paying for the capital expenditure in relation to the asset.

Whilst there are a number of benefits associated with PPP structures, they also have some potential disadvantages, including:

  • The public sector bearing the costs associated with the transfer of risk to the private sector despite the public sector ultimately retaining the risk; and
  • Affordability issues can still occur despite the up-front costs of procuring the asset being removed from the public sector's balance sheet, especially in relation to large value projects which require the Government to make payments over long concession terms (for example, 25 to 30 years).

Invariably a PPP will be more expensive than direct procurement as the procurement, maintenance and operational costs are usually placed on the private sector. The payments from the public sector will therefore need to reflect the cost of borrowing to fund construction, the costs of maintaining and operating the asset as well as an agreed return.

This makes affordability a particularly relevant consideration and, as result of this, more advanced PPP structures have been developed where the public sector grants the private sector rights over additional land. The idea being that the capital receipts generated by the private sector from the development of the additional land can be used to ‘subsidise’ the cost to the public sector in relation to the public asset. In some cases, the capital receipts from the private development of the additional land may be significant and therefore cover the cost of or even provide a profit to the public sector. This is known as a Hybrid PPP.

This article has identified some of the main procurement options for the delivery of low cost housing. The most efficient structure will reflect the circumstances of the project (which are often complex). Identifying the best procurement option is very important and will require professional guidance and expertise to ensure that the relevant developer meets its core objectives of cost management, profit realisation and the delivery of an affordable product.

This article was written by Simon Green.

For more information please contact Simon on +974 40 316610 or simon.green@crsblaw.com.