Is buying off the plan keeping you up at night?
OPINION:
There are inherent risks involved in buying any property, however, in recent years the off-the-plan market has received a lot of the scrutiny, with variables such as construction quality, settlement value and affordability keeping purchasers up at night.
The reality of today’s market is that off the plan purchasers have never been more in control of their buying experience or ultimately their finished product at settlement. Today the power is with the purchaser to mitigate these risks by electing to work collaboratively with a developer and getting involved in the development process.
Never before have the expectations on developers been so extreme. Purchasers expect world-class design and a financially sound and transparent developer. They expect a trusted builder to construct their home with care and diligence.
Below are five key risk-management strategies for potential purchasers or developers in the current marketplace.
1. Problem: Potential building defects
We only have to look at recent news reports on newly completed projects deteriorating rapidly, to understand the legal, emotional and financial hardship that an ill-constructed building results in.
Not knowing how to repair your new home, how long it will take and who pays for it are certainly not the kinds of decisions you should be navigating after settling your brand new apartment.
No other industry operates with the same nonchalance that some developers, unfortunately, get away with. It is unfathomable to think that a car dealership would suggest they have 12 months to fix faults and issues associated with your brand new car. This shouldn’t be the case for a brand new apartment either.
Minor defects or issues should always be covered under good warranty, repaired quickly, and the materials and finishes should remain perfect for many years to come.
Potential problem solution:
Ensure you have trust in the developer. Meeting directly with the developer can be a way to feel comfortable and gain trust in not only the company, but the team behind the brand who are responsible for creating your future home or investment property.
Ask whether the builder has been appointed, and understand what similar projects they have delivered in the past. A builder with a strong track record stands for a lot. Having a builder appointed means the developer knows exactly how much the construction is going to cost. This allows the developer to deliver what is being sold and significantly reduces any risk of value management (code for cutting corners) and reduction of the building specification.
Get professional advice. Speak with people in construction, real estate agents, developers, valuers – seek their professional thoughts on the marketing material, specification, builder, developer and status of the development project. If the advice is based on knowledge versus just personal opinion and it all lines up, it certainly assists in reducing the risks of the unknown.
2. Problem: Delay
Development of any product in any business can be delayed due to many reasons, and there can be consequences to those delays.
If you’re an owner-occupier expecting to be moving into your new apartment on a certain date and the project becomes heavily delayed, you may be caught out having to pay additional rent in your current premises, or be forced to find accommodation alternatives at short notice.
As an investor you do not have to face the issue of not having somewhere to live, however it might impact your tax situation, depreciation, financial approval, arranged tenants and even your personal plans should you need to be physically available for settlement.
Potential problem solutions:
Take the time to fully understand not just when construction is scheduled for commencement, but the details of the construction program. Construction on a typical residential project will likely take between 12 – 24 months, depending on the size of the development project you’re purchasing into. This is plenty of time to coordinate everything, even enough time to sell your home if you’re downsizing and moving into your new apartment.
If the developer doesn’t give you regular construction progress updates, then ensure you are proactive and seek program status information regularly. The developer should immediately highlight any delays incurred. You can also request the monthly builder’s report and/or the quantity surveyor’s monthly assessment of the construction status and program.
Ask your lawyer to review the sunset clause and advise you on your best course of action to protect yourself from the impacts of long-term delays. The sunset clause stipulates the amount of time the developer has to deliver the dwelling following the signing the contract of sale.
3. Problem: Changing market conditions
Being able to forecast fluctuations in the property market is extremely complex, and whilst it may appear that buying off the plan is even more involved than buying an established property, it does not have to be.
There’s no denying that some experts are touting a property bubble, and others are suggesting that you need to buy in quickly before prices get further away from us. It can be challenging to navigate the varying recommendations but premium properties in blue-chip suburbs may be susceptible to different swings from the rest of the market.
Because of this, trying to pick the bottom and top of the market is futile. Demand for property in Australia’s most sought after areas will always be consistent, so seeing long term strong capital growth is a matter of patience. Buying off-the-plan in one market, and selling your existing property in another, can never be perfectly timed. We need only look to history to see that the property market is cyclical but has consistently demonstrated long term upside irrespective of seasonal fluctuations or economic swings. Hold on for long enough and the returns from property can be hugely rewarding.
Potential problem solutions:
The primary reason why you are buying the property makes a large difference to how you should assess the market and your individual purchase criteria.
As an owner-occupier, purchasing your next home is a much more emotional decision and generally, the return in the short term is not so important to some. The average Australian owns their home for 11.1 years According to Corelogic data, and Greater Melbourne’s annual capital growth over the last 10 year period is 4.9% of just shy of a 50% increase in total.
If you look more closely, inner-city suburbs outperform, enjoying higher than the average percentage increase. South Yarra, for example, was assessed as the most liveable Victorian suburb in 2019, while Melbourne was voted most liveable city in the world in 2018 and second in 2019. South Yarra’s nominal change (percentage) since 2010 has been an increase of 104%.
If this is a “stepping stone” home – one that is an interim step towards your dream property - then this decision requires more careful consideration through an investor lens in order to ensure it will further you toward the goal of that next property.
Property investors need to consider market conditions and statistics such as vacancies, supply levels, population growth, valuations and rental yields. The critical figures to keep an eye on is a vacancy level of above or below 3% - under 3% indicates it’s a vendor’s market, with rents going up and therefore yields increasing too. Over 3% vacancies indicates you might be offering a few weeks rent free or dropping the rent. Purchasers need to do their research.
There is a formula for assessing the Australian property market. However, ensuring you are buying (or developing) a first class product, in an outstanding location, that will stand the test of time will certainly assist when it comes to ensuring capital growth and an attractive resale value in the future.
4. Problem: Product not as advertised
Legally there is a 5% or less variance provision for purchasing off the plan. This allows builders to have a very small amount of construction flexibility. For example, if a wall is 10mm thicker than on the plan it could have an impact of 1sqm on the total apartment area. A very minor change which can happen but not enough to detrimentally impact your apartment’s liveability.
If items are drastically different and you do not support the changes, or were unaware they were happening, then you may have grounds for concern. This is, however, very unlikely.
Potential problem solutions:
Make sure that the building specifications are listed within the contract of sale. We ensure they are specific and that materials are listed clearly and precisely. This will ensure items cannot be substituted into your apartment that are of a lesser quality than what was specified.
Investigate the consultant teams including structural, services, geotechnical, acoustic, lighting, traffic and waste engineers. The team of consultants determine the quality of the project alongside a good builder.
This team of consultants can impact the notion of quality which can take on different meanings depending on the team in place to deliver that quality benchmark. For example, quality materials can be purchased and included within a project, however a quality design team ensures the materials are installed, utilised and will continually perform at their best.
It’s important to be clear about what is base build and what constitutes upgrades. Understand what you need to pay extra for. This is the buyer’s responsibility and it is very important to manage this so that expectations are clear and there are no surprises when you settle and move in.
5. Problem: Valuation risk upon settlement
The price the developer sells you an apartment for isn’t necessarily its market value. The price you pay for your apartment could be well above (or potentially below) the value that the market determines. When it comes time to settle, the valuation of your apartment could be less (or more) than the purchase price. This is potentially an issue because in this case, your financier is likely only going to lend you a percentage of the valuation (versus the purchase price) and if the valuation is lower than your contracted price, you (the purchaser) will need to contribute more of your own cash or savings (equity) to settle the purchase of your property.
Potential problem solutions:
Research the surrounding area before you buy and do not just compare the apartment you are considering to other off the plan sales. It is important to review your purchase against a mix of established products. This is because valuations are assessed against resold stock only, and valuers do not take into account any other off the plan sales. Basically, the property has to have re-transacted once completed to be included in any valuation assessment.
Also, assess the value of any car parking included with the apartment you are considering buying. Car Parking spaces are often sold over and above the apartment price for significantly more than the valuer will give them.
Conclusion
Taking into account these considerations, it’s understandable that some purchasers can be wary about purchasing off the plan, as too are developers about the potential risks to their reputation. However, there are avenues to ensure the risks are mitigated and you have greater confidence in the final outcome.
An additional obvious measure is stamp duty concessions available to buyers of off the plan property development projects, making off the plan property an attractive investment strategy when used prudently.
In Australia our immigration and population growth will always mean that demand for housing is strong – people are always going to need somewhere to live. As such, apartments will need to continue to be built to ensure that housing supply meets demand. The proximity of inner suburban development to CBD-based work opportunities will deliver steady growth in demand for quality, medium-density apartment living. Financial restrictions on the capital available to property developers mean that apartments must be sold off the plan to buyers willing to embark on a property development journey with the partnership of a quality property developer who can professionally manage the project on their behalf.
Buying a high-end property might be the biggest financial decision you will make. It’s natural to want to be able to see it, feel it, imagine your family at the dining table, and dream about coming home after a day’s work. This visualisation can be easier with established stock. But it’s harder to get exactly what you envisage without having some input into the development. You can regain some of this control, and mitigate many of the aforementioned risks.