Why you should buy existing property rather than purchase off the plan

There is a hotly contested argument in the Australian property investing landscape: Buying off the plan versus buying established properties.  Most investors starting out are likely to enter the unit market instead of buying freestanding houses. This is particularly evident in capital city markets, where detached dwelling price entry points are usually not within reach of first-time investors. So investors look to the unit market for easier accessibility and (arguably) easier ongoing management while holding. As such, they come across this choice fairly early on in their investing career, with some favouring off-the-plan apartments and others preferring established stock only.

But which type is the best?

I favour established stock, and here’s why:

First of all, let’s start with the biggest factor: price. Property is all dependant on location, we know this; but if compare the price of an off-the-plan unit with an established unit (same bedrooms, floor space, parking etc) in the same suburb – and even street –  the cost will be much cheaper. Sure, the older unit may not be as pretty, or have as modern styling or features, but it will be significantly cheaper than the off-the-plan stock, making it more readily accessible for entry-level investors.

Additionally, there is scope for renovation to increase value and rental return, throughout your ‘holding’ life for the property. This is a handy tactic in times where capital growth may be flat, or when increasing interest rates can dip an investor too far into the ‘negative’ in terms of holding cost. Off-the-plan residences have a built-in maximum ceiling rate for rent with little scope to add value via renovation for a good five to 10 years from completed construction.

This flows into my next point. Established stock that has stood the test of time is typically better built than new stock. Not always, but developers look to cut corners with building materials, design, and functionality. Sometimes developers are looking only at what will drive their biggest profit margins, instead of the dynamics of the area they are constructing the block in are demanding. I find this interesting because often developers market most heavily not to would-be home owners, but to would-be investors.

You should always pay utmost attention to your due diligence when Buying off the plan for this reason. It is never a happy discovery when an investor realises that while she signed off on Smeg kitchen appliances two years back, her finished kitchen is furnished with cheap inferior fittings that look OK for about a year but have no wear and tear sustainability. This translates into expensive holding costs in years two, three, and four when inferior fittings break down.

Somebody has to pay for all those marketing costs. Yep, somebody has to pay for all those fancy high-gloss 60-page booklet they print, every billboard ad, every online banner ad they have to buy ad space for. No prizes for who picks up the bill for it: yep, you, the investor. And working for over six years in the media advertising industry myself, let me tell you that mass-scale marketing ain’t cheap. As investors, paying for someone else’s marketing campaign is something that should be avoided, and buying established stock helps reduce your risk of exposure to this.

This is also a good transition in to my other bugbear about off the plan units. Sure; people who are pro off the plan will be quick to retort about how depreciation in the first five to seven years will be a huge tax incentive for them, and they will be able to get great returns for the "golden years" that any depreciation report findings will offer them in these years. But the reality is this; you lose whatever gains you would have made – and then some – by paying for those over-inflated marketing costs to begin with! Savvy investors know this. What good is say $18,000 of additional depreciation revenue over the first five years or so, if you’ve had to outlay an inflated sales price by $30,000 to begin with?

Buying off the plan in areas of high development is a huge risk area. We’ve seen areas of Melbourne, Gold Coast, and more recently inner Brisbane, all suffer from this. Developers find areas that have high demand and then accommodate for that demand in their offering. Sounds fairly logical, right? Here’s the problem; another 15 developers have also had an eye for the same area, yet there may only be demand for say, four or five buildings worth of tenants in that area over the next two years of construction. See the problem? Suddenly that rental appraisal for your off-the-plan apartment of $400 per week now, in 2012, is whittled down to $330 per week in 2014, where, at completion, your apartment is just as vacant as countless others, in a saturated marketplace.

Developers will always have a vested interest in maximising the volume of units they can fit in one block. The result? Too many small units that do not have the features that the local would-be renters in that suburb desire most. The most glaringly obvious casualty, in the fight for maximising floor space, is to lose dedicated separate kitchens in favour of ‘galley’-style kitchens that are really just one wall in a small lounge room. This may be fine for, say, inner-city studio and one-bedroom apartments where the market is happy to have a tiny kitchen in favour of other features, but I am seeing more and more developers building two-bedroom apartments in middle to outer-ring areas of cities with galley kitchens. This is a huge no-no because most times, middle-ring two-bedroom would-be tenants demand dedicated kitchens. Older style units – say, older than 10 years or so – will usually provide dedicated kitchens in units of this type.

Lack of understanding renter demand is one thing developers can miss, but there is another negative flow-on effect here, and that is in strata and maintenance costs. Many off-the-plan developments have special features – rooftop gardens/terraces, water features, lifts, pools, gyms and so on – and while it is no secret that this sharply increases strata costs quarter to quarter, the issue of supply and demand can also adversely affect capital growth here. How? Well, what good is an on-site tennis court, for instance, if the development is in an area that has no demand for such a thing? If I am a tenant looking for housing but am not a tennis player. why would I pay $40 more per week in rent to have a feature I will not use? Older stock tends not to have such extravagant features. This is because older stock was arguably better planned to understand the demands of the community who were to reside in their structures.

Location. Savvy investors will know that well-located older stock can increase in value much faster than off the plan can. And I am not just referring to heritage, character, or other "cherished" types of property. I am referring to prime location. For instance, if there is an old red-brick, three-floor walk-up that is wedged between two community parks, complete with barbecue areas, play gyms and other amenities, you know that a developer won’t come along any time soon, bulldoze the park, and build a 10-story monster next to your block (effectively cutting off views and amenity). Sure, while this does happen from time to time, it is a rarity. Off the plan, on the other hand, usually secures blocks in areas where entire streets and multiple blocks are rezoned for medium-density housing. What does that translate to? Well, that beautiful eighth-storey apartment overlooking the park with city views could very likely have three equally tall buildings constructed around it, a couple of years later, if zoning has allowed for this. This reduces your capital growth and sometimes rent rate achievable too; if once-great views are obstructed and extra stress – parking problems, traffic, and noise – occur as a result.

Last of all, parking issues. Parking may not be in high demand for some areas, but for those that are, often developers simply build big basements in which they simply have dedicated spots, separated only by painted lines. Fewer basements these days are offering dedicated lock-up garages, per unit, in favour of open-air painted-line car park spaces. For areas where car parking is in high demand, lock-up garages will always be more favourable than just spaces. Tenants like the flexibility of having that space – they can have storage, or a car, or sometimes both if there is enough space inside. If parking is a high priority, tenants will usually favour an older style unit with dedicated lock up garage, than a newer block with a security basement without dedicated lock up storage per unit.

Although I am in favour of established stock over off-the-plan units, in the end, any investment is always about the due diligence. If you get down to one of each type of dwelling; and the numbers stack up to favour the off-the-plan unit, then you should obviously go for that. I am keen to be challenged on the points I make above, as I am sure there are benefits to off the plan purchases that I’ve not considered, but for now; this investor remains to keep his buy-and-hold strategy exclusively to existing stock purchases only.

Cameron McEvoy is a NSW-based property investor and maintains a blog, Property Spectator.