Purchasing Groups – Pros and Cons

In the past few years we have been witness to a new trend in Israeli Real Estate projects – purchasing groups. It is estimated that about a third of the apartments currently being constructed in central Israel are being constructed by purchasing groups. The current economic crisis has brought in its wake stricter bank controls over construction companies with respect to the financing of projects. This in turn has caused many a construction company to delay or even abandon planned projects. In addition, the much publicized demise of the Israeli construction company, “Hefziba”, has deterred many purchasers from purchasing apartments from construction companies while still at the construction stage.

All of this has lead to a search for new ways to purchase apartments that are still being constructed, without doing so directly from a construction company. This is where purchasing groups enter center stage. Until the issues of financial backing and general insecurity with construction companies are resolved, experts predict that purchasing groups will become increasingly popular.

What is a purchasing group? How is it different from purchasing an apartment from a construction company at the preconstruction or construction stages? Do purchasing groups really save the purchasers money? What are the dangers, if any, of purchasing groups?

What is a purchasing group?

A purchasing group is an organized group formed to purchase land for the purposes of constructing on the land one or more buildings for residential or commercial purposes. At the conclusion of the construction, units are allotted to the purchasers.

The group’s organizers locate the land, find the potential purchasers, organize the group, choose the professionals who are to construct the project and manage the construction of the project by those professionals. The legal work, which includes the purchase of the land, contracts with group members or purchasers, contracts with various professionals involved in the construction, dealings with the bank that is financing the project, collection of money from the purchasers and disbursement of funds to the various suppliers and professionals and the registration of title, are all performed by a lawyer who acts as a trustee (Hebrew, “ne’eman”) for the group.

How does a purchasing group work?

The purchasing group is usually initially organized by a small group of people who find the land and recruit a group of purchasers. This group customarily gets a fee in the form of a certain percentage of the money paid by the purchasers. A lawyer is retained who acts a trustee for the group and performs all necessary legal work (as described above).

As the construction proceeds and money needs to be allocated, the lawyer sends notices to purchasers with a request for payment. The amount each individual purchaser pays is in proportion to his part in the project (i.e. the size of his apartment). These expenses include all the costs related to the construction project. Examples of such costs include purchase of the land, costs of building permits, planning, supplies, materials and labor.

As a prerequisite for joining the project, the purchaser must open a line of credit with the bank that is financing the project. Should the purchaser default on any payment, the group’s lawyer may withdraw the required amount of money from the purchaser’s line of credit.

In contrast, when purchasing an apartment directly from a construction company, the final price is set out in the contract, though usually linked to one of the indexes. The company is responsible for all aspects of construction work and the registration of title. A payment schedule is set out in the contract.

When purchasing an apartment from a construction company, the purchaser is given plans to the apartment with the internal structure already in place. Should the purchaser wish to implement changes, he will often have to pay for these changes, though this may depend on which stage the construction is at. The purchaser is given standard specifications for the apartment, which he can then upgrade at his own expense.

Purchasing groups usually allow for much more flexibility of internal design of apartments. Purchasers are given a hollow shell of an apartment and they can plan the internal structure and layout without additional expense. There is usually a basic standard of finish that is offered to the purchasers with regards to most of the products involved in the apartment (such as kitchen cabinets, ceramics, doors, bathroom fittings etc) but the purchaser can upgrade at his expense.

When purchasing from a construction company, the purchaser does not pay in accordance with the building stages and prices are linked to an index. For example, many construction companies link their prices to the building index (Hebrew, “madad habeniya”) which usually rises sharply during the summer months. In order to avoid this increase in the price, purchasers usually try to pay as much as they can afford to, before the summer months. By law, the purchaser must be given a bank guarantee for all monies paid in and this protects their investment in the event of the construction company going bankrupt before the project is completed. With purchasing groups the payments are paid in accordance with the progress of the construction and a bank guarantee is usually not given (although in some project a bank guarantee is offered).

When purchasing an apartment directly from a construction company, the purchaser is protected by the relevant law requiring the company to give them either a bank guarantee or an insurance policy. When buying within the framework of the purchasing group, the purchaser does not necessarily need these protections because the land already belongs to him and he is paying for each construction stage as it takes place and not in advance.

When purchasing an apartment from a construction company, the purchaser is protected by the laws concerning warranties and responsibility for quality of construction. This is not so when purchasing within the framework of a purchasing group. It is therefore important to make sure that the proper warranties are given by the various professionals involved in the construction of the project. Monies can be set aside to provide a form of warranty by another construction company not involved in the project. This company will then provide any repairs needed after the completion of the project.

Do purchasing groups save money?

The main selling point for purchasing groups is that this form of construction project saves money for the purchasers. Value Added Tax (V.A.T., which is currently 16.5% of the price of the land) is not paid if the land is purchased from private individuals (who do not have to pay V.A.T.), but if the seller is not a private individual who is required to pay V.A.T. (which he will incorporate into the price of the land) then nothing is saved here.

While many claims are made about saving other costs that a construction company would have incurred, in many cases these costs are in fact not avoided. Examples of costs the purchaser incurs directly or indirectly when purchasing from a construction company include:

  • Bank guarantees and financial backing – BUT as seen above the purchaser usually needs to open a line of credit, which costs money and in many purchasing group projects bank guarantees are offered.
  • Advertising and marketing the project – BUT when forming the group it is necessary to advertise as well and this is passed on in some form to the purchaser.
  • Purchase tax is much lower, as you pay purchase tax on the land only and not on the whole apartment – BUT purchase tax levels have dropped steeply in the past year (see our Purchase Tax page) so the savings here are not significant.
  • The construction company’s profits – BUT, as mentioned above, a percentage is often paid to the organizers of the group and again this cost will be passed on to the purchasers.

What are the pitfalls?

As with anything that proves profitable, many people who are not experienced and well versed in the management of a project of this type have gotten into the game. Before joining a group, check to see the track record of the organizers and try to talk to purchasers of their previous projects to see if things went smoothly and professionally and if they really saved money.

How do the organizers keep the different purchasers in line? What happens if the group fails to reach a consensus as to how things should be done? Remember, if there is dissent in the group it can cause the construction to ground to a halt. How is dissent in the group handled? What happens if purchasers try to withhold money in order to influence the decisions being made? The answer is simple; the lawyer can simply withdraw money from the purchaser’s line of credit.

Most organizers will ensure that they have a majority within the group who support them. In this case an individual purchaser who complains is generally answered with “the majority does not agree with you”. Find out who the other purchasers are and their reasons for purchasing the apartment. Make sure you are aware of the underlying group dynamics in order to ensure that your opinions will be heard.

What happens if one of the professionals working on the project gets into financial difficulty and cannot fulfill his obligations? Again, the answer is simple – the purchasers will have to add in money to finish the construction. In cases like this, the great savings that purchasing groups promise may become insignificant. When purchasing directly from a construction company, the company has to cover unexpected additional costs. The price written in the contract is final and cannot be changed.

In Conclusion

Despite all of the above, purchasing groups are fast becoming a force to be reckoned with as more and more projects of this type are appearing on the market. Many projects have been completed successfully and their purchasers happy with the results. However, when joining a purchasing group, one should do so with his or her eyes wide open, giving serious thought to the old adage “Caveat Emptor – Let the Buyer Beware”.