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Better safe than sorry

commentbyjameslowry

In 2007 and 2008, Cambodia experienced a substantial property boom, and with it the “greater fool theory” kicked in. It seemed that all anyone needed to do to make money was to buy a piece of land and wait until a “great fool” came along to buy it for even more.

The classic property speculation-asset conversion cycle kicked in: Cash was turned into property; the property value increased; the land was sold and converted back to cash; a handsome profit was made.

The multiplier effect of all this money sent the economy into a frenzy. From car dealers to hair salons, tailors to karaoke bar owners, the proverbial cup did runneth over.

The only problem was it was not sustainable, and at the same time that the property sector was booming, so was the credit sector. Credit growth was 80 percent to 100 percent per year over the period, and a significant portion of new debt found its way into the property sector.

This was fine while property values and sale volumes continued to increase, but when the music stopped, many property investors faced debt they could not afford to service on an ongoing basis.

Property values and sales have reduced over the past 12 months as buyers and investors have withdrawn from the market, partly as a result of a loss of confidence and the downturn in economic conditions, but also due to limited access to credit through either constrained supply or a lack of appetite by local banks.

We have also witnessed an increase in disputed land transactions. The legal framework is clear about the process of buying and selling property, and many transactions are consummated using standard, legally binding contracts, so why do we read of so many disputes in the local press?

We could all learn something from the old saying, “a fool and his money are easily parted”. It should be enough for each party to trust the other, but it appears this may not be realistic in current times. There is, however, a simple arrangement both parties can use to protect their money and contractual rights.

An escrow account is a bank account which protects both parties and provides confidence that specific obligations by each party will be completed. It is a simple mechanism to manage the payment default risk or nonperformance risk involved in business transactions by placing the settlement money in an independent secure account pending completion of the sale and purchase transaction.

The terms for the release of the funds can be tailored to the specific needs of all parties, and upon completion of the agreed terms and obligations, the funds held in escrow can be transferred to the designated party.

The use of an escrow account in a property transaction could see the buyer agree to lodge the purchase funds in an escrow account to be released only when the seller processes the land title transfer. Using such an account to protect all parties in a business transaction provides a level of protection to ensure each party fulfils its contractual obligations and duly transfers settlement proceeds, thus reducing the risk of default and the incidence of disputes.

James Lowry is head of corporate and institutional banking at ANZ Royal Bank Cambodia.

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