Buying Off The Plan Risks
Luxury two bedroom apartments starting at $500,000! 6% rental guarantees! Only 40% of stock left! Off the plan are heavily marketed and sold as offers that you cannot afford to lose out on but the reality is that they’re a dangerous game. They’re definitely not what they’re cracked up to be. Instead, buying off the plan is one of at Australia’s riskiest method for investing in property and we advise that you should probably steer clear. Here’s why.
New Risks to Buying Off the Plan
With Labor’s proposed changes to capital gains tax (CGT) and negative gearing, the usual risks associated with purchasing off the plan are going to be compounded.
To give you a quick recap, the ALP has proposed to limit negative gearing to new houses (not apartments) only and reduce the CGT discount from 50% to 25%. This is likely to lead to a decreased demand for the purchase of investment/rental properties as a result of the creation of new markets. Prices will then decline in many areas.
What this means is that the second owner will not receive the same tax benefits of depreciation etc., than the primary owner when they buy a property. This means no negative gearing claim against their income and the CGT discount is sliced in half.
The vendor will need to get around this by dropping the sale price as there are now little benefits to the buyer and thus less attractive. For areas like Brisbane, Fortitude Valley and others where we see an oversupply of for sale properties, they’re likely to experience further price reductions.
Factor in Sydney Olympic Park’s Opal Tower incident and the now decreased confidence in the new apartment market and you’ll understand what we’re trying to get at.
Despite the above, buying off the plan has always had its risks and we’ve outlined some of these below. By no means are we saying that buying off the plan is a bad idea – we’re simply stating that there are a lot of risks that you’ll need to take into account before taking the plunge.
Marketing Off the Plan
Property developers understand that when they sell a competed property, they can get a better price than selling off the plan. The lenders, however, that fund these projects require a large portion of the units to be sold to prove that the development is viable. The lenders are expecting the developers to make a reasonable profit and they should.
This is then factored into the final price as is the large marketing budget for out of home advertising and traditional media advertising. Add in the commissions for the marketers, incentives for financial planners and finally the commissions for the sales agent and you’ll find that the initial selling price is actually inflated.
If it’s too good to be true, it probably is.
After all of the above, if 15% of a project’s budget is going toward marketing and selling costs, these are going to be passed down to the buyer.
Due to the completion date for many of these developments being three-plus years away, the inflated price of the unit is buried in all of the advertising hype. Developers know this and take advantage of it – the longer it takes to settle the property, the lower your chance of knowing whether the final price of the property is still good value.
Now, none of this is theoretical. The streets are littered with many property investors who purchased off the plan and found that what they paid was too high and the property’s valuation too low.
Other Off The Plan Risks and Considerations
Sales and Marketing is Not Cheap
There are huge commissions usually incorporated into off the plan properties to ensure the marketing and sales people are covered. This money is going to come directly from property investors which means they’re paying above value.
Hype is contagious and so are the good old “only 15 units left” and “40 units already sold”. Don’t buy into this. The pre-sales are rarely purchased by local investors. Instead, they’re coming from overseas buyers who cannot purchase already completed properties, have poor knowledge or Australia’s property markets and have their own motivations to buy. For example, they want to immigrate to have their money sitting in a more financially stable country.
Loans Aren’t Easy
When you apply for a mortgage, the approved loan is usually current for three months. This means applying for a pre-approval of a property that will settle in three years is a waste of time.
Next, the big banks each have policies restricting their exposure to any development. For example, most will not lend to over 15% of the properties in new high-rise. So in other words, if there are 100 units in a single building and you’re the 16th person to approach the bank for a loan (after completion), there’s a chance they’ll decline your application and you’ll need to go elsewhere.
If they do manage to loan you some money, you’ll find that something as silly as the postcode of your new purchase will lead to a low loan to value ratio and thus a larger deposit or downpayment.
If, for whatever reason, you’re unable to settle the property, you’re going to need to sell at whatever price you can achieve. This selling price on completion is what the banks are going to value your property at, not the amount you paid. If you can’t afford it at all, you may need to forefeit the deposit to get out of the contract. Combine this with the developer’s right to pursue you for any loss that they may suffer and you can really become hurt. Yikes!
“Land Appreciates and Buildings Depreciate”
Yes, it’s an old saying but there is a reason behind it. You should usually aim for the highest land to asset ratio – you need as much good land under your apartment as possible.
However, developers are trying to do the opposite as they’re trying to fit as many apartments on the site as possible. You and the developer are completely opposite interests.
Sydney, Melbourne and especially Brisbane are experiencing a large oversupply of new apartments with approximately 27,000 still under construction in Sydney. High supply means that the prices are likely to decrease over the coming years making it harder for investors to rely on the property value to increase.
Not only will prices drop but you’ll be competing with other property investors trying to rent out and attract tenants. Combine the two and your new property is going to lack scarcity value.
To only make matters worse, banks have been progressively tightening their lending criteria on locals (and foreign investors) which will make it harder for developers to let go of their stock.
In Brisbane particularly, new developments have been accompanied by rental guarantees in an attempt to entice those worried about occupancy and cash flow. The issue here is that the guarantees, just like the marketing budget, are factored into the purchase price which thus inflates the already expensive property.
Once the guarantee ends, you’re back at market rate which is going to be less than what you got during the guarantee period.
Uncertainty on Completion
We’re not just talking about settlement days being pushed back months and sometimes years. We’re talking about the uncertainty of what the property market would be like upon completion. How will the interest rates have changed? Is what you get similar to what you saw in the display suite? You know that awesome view from your future balcony, is it still going to be there in three years time?
These are all important questions you cannot answer and risks that can only be balanced by a large discount. However, as we’ve discussed above, you’re usually paying a premium and giving the developer some capital growth. You may not receive the same.
Also, do keep in mind that while buying off the plan could result in capital growth, purchasing a completed property should also experience the same growth during that period you were waiting for the new property to settle.
Let’s face it, nobody can predict the future so if there’s no sizeable discount, you may be digging yourself a hole.
After reading the above, it may sound like buying off the plan is a bad idea and that’s because it usually is. Combined with the potential Labor party changes, off the plan properties will be one of the riskiest property investments you could make.
Unless you’ve got independent advice from an investment strategist, steer clear of off the plan. Instead, invest in complete properties that satisfy at least one of the following:
- Appeals to owner-occupiers as opposed to rental investors. These guys push up the value and are more likely to invest in improving the property’s quality;
- Is part of an area with a track record of strong capital growth that is likely to continue;
- Has a high land to asset ratio; and
- Has the potential for you to create your own capital growth through renovations or even redevelopment.
Each of these represents a way to earn more from your investment. If you can tick all four boxes, you’ve got a winner.