Seven traps for unwary off-the-plan buyers
Many articles have been written about buying properties off the plan. Most are critical of this approach to buying and conclude that the numbers simply don’t add up. However, as with all investments, there are pros and cons that warrant a balanced analysis based on your own personal circumstances.
Developers sell off the plan because this is usually a requirement for them to secure upfront construction financing from a lender. A certain percentage of the development usually has to be pre-sold before the release of funds by the bank. Buyers would pay a deposit to secure the property, with the balance payable upon settlement.
Below I consider some of the pros and cons of buying off the plan in NSW.
Pros
• Brand new. Everybody likes the feeling of “newness” – be it new cars or new houses.
• Developer discounts. Developers may sell some units at a discount if they need to meet sales targets to get the construction underway.
• Extended settlement period. With delivery usually over a year or two away, it gives you time to sell your place or to obtain financing (or even to increase your income before financing needed).
• Stamp duty concessions. Over the last five years, various concessions on stamp duty have been offered in NSW such as for retirees and first homebuyers.
• Customisation. It is often possible to provide input on final design if a property is purchased before construction (e.g. to merge two apartments into one large one or to choose certain fittings and fixtures).
• Warranty periods. All builders are required to provide seven-year warranty on building structure (in addition to a preliminary period covering finishes defects). However, note that home warranty insurance (with a third-party insurer) is only required to be taken out by builders on residential projects valued over $12,000. Larger developments (buildings of more than three stories) are exempt and the purchaser must rely solely on the builders’ warranty. Clearly this presents a significantly greater risk to buyers. The certificate of insurance, when issued, must be attached to the contract of sale.
• Lifestyle. Newer units are built to reflect today’s tastes and preferences such as open-plan living areas, larger balconies and amenities such as pool, gym and concierge services.
• Potential for capital gains before settlement. Many investors are speculators and love to bank on off the plan properties going up in price before the property is even finished. Beware however, that the reverse is also possible.
• Leveraged investment. The down payment is usually low for the construction period (i.e. it can be a leveraged investment without the need for bank financing).
Cons
• Final product is unknown. Buying something on paper without having seen the item is a significant risk. The finished product may not live up to your expectations (e.g. aspect, quality, etc.)
• Premium price for newness. Just like cars, brand new properties have a certain premium. This is partly due to the newness factor, but also due to Australia’s Foreign Investment Review Board (FIRB) regulation which stipulates that foreigners can only buy brand new properties and not second hand ones. There is a larger consumer base for new properties (as foreigners can also buy) and consequently new prices are higher than in the secondary market. When this property is later sold, it cannot be sold to foreigners (lowered demand possibly leading to a lowered price).
• Lower land to asset ratio. New homes and units alike are usually built at much higher density than those built 25+ years ago. Since land value is the primary influence on capital gains for property, it is not uncommon for capital gains associated with a new property investment to be lower.
• Developer bankruptcy risk. There is always a risk that the developer goes bankrupt before completion (with loss of deposit if the legal structure is not sound) or during the warranty period.
• Expected financing may not be available in the future. While banks may be lending on attractive terms today, and while the buyer may have the capacity to borrow the required amount at the time of purchase, this may be very different in the future when the financing is actually needed. At settlement, when the property is completed, banks may not be willing to lend the same amount (LVR), the valuation may be lower than the purchase price, or the buyer’s income and circumstances may have changed. In all these cases, the buyer would need to come up with a larger down payment than expected. In addition, the interest rates at time of settlement may be very different from those prevalent at the time of purchase.
• Lower capital growth can be expected (at least in the early years) as depreciation is high. The new property will depreciate significantly in the first few years as it goes from new to second-hand – just like a car when you drive it off the dealership.
• Defects can be extensive. There is often a 1-5 year period in which building defects materialise and become visible. In the best case scenario, a very good builder will address these with minimal inconvenience and hassle. A bad builder however, may not fix the defects properly. In which case extensive time and cost is required to address the defects through negotiation, mediation and possibly even court.
Tips for buying off the plan
• Buy from trusted developers with a proven track record. Established developers obviously have much more experience and resources than small developers. Reputable developers tend to make fewer mistakes (which can be extremely costly in the long run) and when problems occur, they tend to be in a position to rectify it more effectively and efficiently. Although many new development projects have mandatory 7 years structural warranty with an insurer as back-up, it is not uncommon for developers to simply go bankrupt before this period is over. It then becomes much more complicated to claim for defects from the insurance company.
Where possible, try to inspect other properties which the developers have completed so you can gauge the quality of the workmanship first hand.
• Understand exactly what you are buying. Read the fine print and seek legal advice before signing any documents. Don’t make assumptions as to quality based on promises made by the salesperson or model/showroom. If detailed specifications are not provided, don’t be afraid to demand more information in writing or to provide you own list of requirements/specifications.
For example, even if the shower screen for the bathroom is specified as glass, this does not tell you whether you will be getting 5mm thick semi-frameless glass screen or 10mm fully frameless ones. There is a significant difference both in quality and price. Most developers know that buyers look at the quality of the kitchen appliances and they tend to splurge on high-end brands. However, most buyers are not as educated or discerning when it comes to accessories such as tap ware, cornices, skirting boards, balustrades, etc. You need to understand whether your money is going towards quality German tap ware or cheaper Chinese ones, for example.
• Understand your rights. What modifications or substitutions are possible without additional costs to you? Can the apartment be on sold by you prior to completion? Where is the down-payment being held (i.e. is it in a trust account? Can the builder use it for construction?). Are you able to get out of the contract if the property is not finished on time? Are you able to visit the site during construction? What is the process to ensure that defects are fixed in a timely manner?
• Have a contingency plan. Few developments are completed according to schedule and you need to make sure that you will not be overly inconvenienced should this occur. In addition, make sure you are financially prepared and able to pay a higher strata levy (where applicable) than what the developers calculate in order to appeal to buyers during the sales process.
• Consider your exit strategy. When it comes time to sell, will it be easy to offload your new property? Without the newness factor, will it still appeal to many buyers? Has the property been well designed to have a timeless appeal? Will there be lots of other similar properties to compete with yours (in the area) when you want to sell? Will buyers be attracted or put off when they find out who the developer is?
At the end of the day, the logic of buying an off the plan property is similar to other investments. You need to weigh the pros and cons as they apply to your life and circumstances. You will also need to understand your level of appetite for taking risks and your ability to mitigate them; because buying off the plan means that you are buying something you can neither see nor touch. You are essentially buying a promise.
Oliver Stier is the director of OH Property Group, a Sydney-based buyers agency. In addition to being a licensed real estate agent, Oliver also holds the Chartered Financial Analyst (CFA) designation. You can follow Oliver on Twitter at www.twitter.com/ohproperty