Introduction
There are a number of structures available to those who intend to undertake developments in Bahrain. A prudent developer should always consider the most appropriate development structure before undertaking any development. As part of this, a developer will need to consider the current challenges facing the real estate market, the changing development trends, and how best to exploit development opportunities whilst maximising returns and managing risks.
This article will specifically examine some of the key considerations that will affect the most appropriate development structure as well as some of the most common forms of structures used in Bahrain and the wider region.
Key Considerations
In order to determine the best development structure the following should be taken into account:
Status of Ownership
The way in which a developer holds the property will determine what structure is available to a developer.
Foreign Ownership
Bahrain, as with other parts of the GCC, is subject to foreign ownership restrictions. Foreigners may only own property in certain areas, such as tourist and investment projects of a special nature.
Foreign ownership restrictions are likely to dictate the nature of the development and how the development is structured at both the corporate and project level.
Legislation
The Ministry of Industry & Commerce in Bahrain requires a company undertaking any form of activity in Bahrain to establish a presence here. The restrictions and licensing laws imposed in relation to particular activities are likely to impact on any chosen development structure.
In addition to the above, Bahrain law may also impact on the preferred development structure, for example leases may be restricted in terms of their length and this could severely impact a development structured on a leasehold basis.
Identity of Developer
The developer may be restricted from disposing of its freehold on the grounds of public policy or as a result of specific legislation. This is certainly an issue in relation to some government entities.
Nature of Development
The nature of the proposed development, and what the developer is seeking to achieve, are also key considerations. For example, investors are unlikely to want to acquire residential property on a leasehold basis. However, a leasehold structure may be appropriate for alternative developments.
Local Market
An awareness of what the market will accept is imperative. In certain jurisdictions within the GCC, the demand for freehold strata titles in relation to office space is low. To date, businesses have preferred to lease their space and, consequently, a developer may encounter difficulties if it constructs an office tower with the intention of disposing of floors on a strata freehold basis.
Structures
The options below are intentionally brief as a number of which are dealt with in more detail in one of our previous articles entitled "Procurement Options for the Delivery of Low Cost Housing".
1. Freehold
If a property is held on a freehold basis, an owner may appoint a developer to undertake the development on its behalf under a development management agreement. If so, the payment mechanism will need to be considered carefully so as to protect the owner and not reward inefficiency on the part of the developer.
In a master planned development, the owner will develop and seek approval of the master plan and be responsible for the development of the community infrastructure. A master developer will sell plots to sub-developers who are then responsible for the development of those plots in accordance with the master plan in addition to any rules and regulations imposed by the master developer.
The single site or master planned development gives an owner considerable control, although it does increase the owner's exposure to the risks of development.
Alternatively, a land owner could dispose of the freehold to facilitate development and generate capital receipts. A further payment could be structured to allow the owner to benefit from the increased value of the property following completion of the development.
2. Leasehold
A leasehold structure allows the owner to retain the long term ownership of its property by developing the property (or granting a lease to a developer to do this) and then granting leases/sub-leases to end users.
A lease structure could be available to foreign owned developers/investors in areas where foreign ownership is not permitted.
However, whether this is appropriate will depend on the local law of each jurisdiction. For example, the Bahrain Civil Code does not impose a maximum length of term for a lease. However, a lease in Bahrain should not create a permanent right and one needs to remain vigilant in this respect when drafting leases as any provision in a lease which seeks to 'convert' a lease to a permanent right may be void.
A further consideration in Bahrain is that a lease is not capable of being registered at the Survey and Land Registration Bureau in Bahrain. This means that there is a less of an appetite for leasehold property in certain sectors.
3. Mixture of Freehold & Leasehold
Where an owner is not concerned with transferring its freehold ownership but does want to remain in occupation, one option is to consider is a sale and leaseback structure.
Depending on the identity of the owner, a developer/investor is likely to be keen on this structure given that it will have the owner as a tenant. This 'added security' could be reflected in the sale price and/or the rent reserved under the lease.
4. Development Lease (Musataha)
The development lease structure is similar to the leasehold right but contemplates the development and on sale of freehold titles.
This structure is useful where foreign ownership restrictions apply and an owner wishes to procure development by a foreign developer for later sale to GCC nationals. 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.
5. Joint Venture (Musharaka)
The joint venture structure is a common form of development structure across the GCC. The development is procured through the establishment of a joint venture. The owner will usually contribute the land (or the right to reclaim land) to an SPV; the developer will contribute capital and the skills to undertake the development.
Issues, such has how the profits are shared, should be dealt with under a comprehensive Joint Venture Agreement. Any losses are usually shared in proportion to capital contributions and again, this should be clearly dealt with in the agreement.
This allows an owner to profit from the development of its land by contributing to the costs whilst allowing also allowing an element of control over the development to remain.
6. Concession Agreement
Another structure which an owner can consider, and which gives the owner more control over what is developed, is a concession arrangement.
Under a concession agreement, an owner will usually grant a developer/investor the right to build operate and maintain a ring fenced asset for a period of time in return for a fee or royalty payment.
A concession agreement and associated documents will not usually convey any legal interest in land in jurisdictions where leasehold rights or licences are not capable of registration. Concession arrangements are common for projects which are capable of being financially freestanding.
Concession agreements can be categorised depending on how revenue will be derived. There are essentially two models: (1) Tariff model or (2) Availability model. An in depth look at these models is outside the scope of this article, but is dealt with in more detail in our previous article entitled "Procurement Options for the Delivery of Low Cost Housing".
7. Public-Private Partnership (PPP)
Where an owner is a Government body, a public-private partnership structure may be considered. PPPs can encompass a variety of structures comprising freehold, leasehold, a combination of the two or an alternative (such as a licence). There are a number of different procurement models but the most common long term PPP model is the concession agreement.
8. Timeshare
Time-shares are where the property is used by multiple people who are allowed to use it during specified periods each year. The users do not own the underlying property and are most popular in areas where there are high levels of tourism.
9. Fractional Ownership
Fractional ownership is an arrangement where a group of people share the ownership of the property along with certain rights to use the property.
This can be done in a number of ways such as family or friends pooling their resources, or where investors are grouped by a developer and made shareholders of a company owning the asset.
Typically, the property is acquired and held by an SPV company on behalf of both the financier and the purchaser. Each time the purchaser makes a payment to the financier, the financier's share in the property decreases and the purchaser's share in the property increases.
At the same time, the financier leases its beneficial share in the property to the purchaser. The rent payable by the purchaser can represent either the interest payable to the financier or can be structured to reflect both principal and interest.
10. Lease to Buy
A lease to buy scheme allows a tenant to lease a completed property for a period, and if it decides to purchase the property within, or at the end of, that particular period it will receive a discount on that property.
This works well in a market where there is a degree of uncertainty, lack of investor confidence and restrictive lending conditions.
Both fractional ownership and lease to buy structures work well on both a conventional as well as an Islamic finance basis.
Conclusion
The above provides an insight into some of the most common forms of development structures which are currently being used. However, the structure which is most appropriate for a specific development project will depend on a number of considerations and a developer should always seek professional advice in order to ensure the development is feasible as well as to reduce costs and maximise returns.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
