Buying Off The Plan – What Every Property Investor Needs to Know

Are you considering buying an investment property off plan?

There are just too many risks involved in the off the plan sector of the property market.

As property prices continue to climb across the nation, reaching or surpassing their pandemic peaks while stock dwindles by the day, I can understand why some investors think it's a good idea to put a deposit down on an off-the-plan property to settle in a few years’ time.

They’re hoping to turn a relatively small deposit into substantial equity, all while avoiding those nasty holding costs.

Meanwhile, other investors are being tempted into buying off-the-plan properties, enticed by the advertising hype of stamp duty savings, depreciation allowances and so-called “cheap” prices.

How does buying off the plan really work?

Buying an off-the-plan property means the buyer is purchasing a property before it has been completed, or even built, based on plans and specifications which are provided by the developer.

It’s something we commonly see for large apartment blocks, housing developments or villa complexes.

The idea is that a buyer would put down a deposit on a property that will be built in the future, and those funds provide an element of security for lenders to the project, as banks won't advance development funding until a certain number of presales are made.

Here’s a breakdown of how it would work:

1. Reserve a property: Once a buyer has chosen a property and is happy with the design plans, they would usually need to sign a reservation agreement and a (usually) advance a non refundable fee.
2. Pay a deposit: The buyer would then need to pay a deposit to secure the property, often around 10% of the purchase price.
3. Sign the contract: A buyer would then (after getting a legal review) sign a contract of sale which legally binds them to purchasing the property. There might be a cooling off period here too.
4. Stay informed about construction updates: As the construction progresses, developers usually provide regular updates, including details about timelines and any changes to dates or plans. There may be opportunities to inspect the property over this timeframe too.
5. Final inspection: Once construction has been completed, you’ll need to do a pre-settlement inspection to make sure it matches the agreed plans.
6. Settlement: Like a usual property purchase, the next point is settlement, which is the final stage when the balance of the funds are paid and the property is transferred to your name.
7. Handover: This is when you’ll receive the keys and can move into the property (or lease it out).

Benefits of investing in off-the-plan properties

There are several reasons that buying an off plan property might seem to be beneficial versus buying an existing property, such as the following:

• Price: The purchase price might seem less compared to what you may pay for the same property in a couple of years’ time when it's completed, but in fact, this isn't usually the case.
• More time to pay: Because you pay a deposit to the developer and then the balance when the property is completed at a later date, it gives a buyer extra time to save, arrange funds and pay the balance.
• Potential for capital growth: Your property might increase in value before it has been built, providing instant equity gains, but in reality, this never seems to be the case the cause one pays a premium up front.
• Stamp duty savings: Some states and territories offer stamp reductions or savings for properties bought off the plan.
• Tax benefits: Investors should eligible for depreciation tax benefits when buying one of these properties.
• Ability to personalise: Off-the-plan buyers can often select their own finishes, fixtures and sometimes make layout adjustments to suit their needs.
• Defects liability period: Many developers offer a defects liability period (usually around 12-24 months), during which they will fix any construction defects that have been identified after the handover.
• Builders guarantee: New properties generally come with a builder’s guarantee or warranty for the building works.
• Less competition: There is generally less competition for off-the-plan properties, especially those that are early in the construction or development process. This means a buyer has more choice and less competition.

Risks of investing in off-the-plan properties

While the benefits of buying an off plan property might seem attractive, it's also vital to understand that these types of transactions also come with significant disadvantages.

Add to this the recent concerns about the well-publicised structural integrity issues in Opal Towers and many other buildings, which have dampened investor confidence in the new apartment market and falling apartment values, and you can start to see what I'm getting at.

Here are a few other risks:

• Market risk: Because the building takes time to complete, the property market may fluctuate and you could end up having overpaid for the property, losing value before it's even built. Economic changes could also change during the construction period which could affect demand for the property as a rental.
• Financing risk: Changes in interest rates, and therefore borrowing capacity and cost, could change significantly between putting your deposit down and the [property reaching completion. There is, therefore, a risk that you can’t borrow as much as you expect when the time comes.
• Builder bankruptcy risk: If the developer goes bankrupt before completing the property, the project could be significantly delayed, but as your deposit is held in trust it's unlikely that you will lose your money, however you will lose the opportunity to buy better property.
• Delays: Not only are they infuriating, but construction delays are completely out of your control.
• Expectation failure: The property, when seen in person, might not meet your expectations.
• Complex documents: Contracts for off-the-plan properties are usually lengthy, complex and sit heavily in favour of the developer.
• Limited negotiation power: Buyers often have limited ability to negotiate terms and conditions in the contract.
• Penalty payments: The contract might include some restrictive clauses or penalty interest payments in the event of a default or late settlement.
• Unexpected costs: There might be unexpected costs associated with the completion of the development, such as special levies or additional charges for amenities.
• Scarcity risk: Lack of scarcity for these developments poses an investment risk for investors when they come to sell or even rent the property.

So does buying off the plan ever make good investment sense?

The answer is usually no.

While a few investors have made money buying off the plan, the road is littered with many more who have regretted their purchase.

Frequently they’ve found the value of their property on completion is considerably less than they paid.

There are many other issues with buying off the plan, but before I explore them let’s first understand why projects are marketed this way.

Obviously, the banks expect the developer to make a reasonable profit margin - and so they should.

This is built into the final price, as are the substantial marketing budgets which cover the cost of those full-page ads in the papers and expensive glossy brochures produced for the project.

Add to this the generous selling commissions given to project marketers and incentives offered to financial planners and you can understand why the initial selling cost is inflated.

If 10 -15% of the project’s budgeted selling price is spent on marketing and selling costs, then the buyer must pay for this.

As the completion date for many high-rise inner-city projects may be a few years away the inflated price can be buried in advertising hype such as “buy at today’s prices” and settle in two years.

The developers are counting on the fact that the longer the settlement period, the less chance you have of knowing if the final price will represent good value for money.

Looking back, many investors who have bought off the plan over the last decade found that the price they paid was way too high and on completion, their properties were valued at considerably less than their purchase price.

Few reasons I would steer clear of buying off the plan

1. Too many fingers in the pie

I’ve seen far too many off-the-plan properties sold with large commissions built-in for middlemen, marketing budgets, and salespeople, meaning the investor pays well over its true underlying value.

Many of these apartments have been sold to naive investors by introducers.

These range from project marketers to salespeople disguised as mentors at "free" seminars, to mortgage brokers, financial planners, and accountants who are paid “kickbacks” often in the range of 8% - 15% of the purchase price.

You’re also likely to find many of these properties have been purchased at inflated prices by overseas buyers who are unable to buy established properties, have little knowledge of the local markets, and have unique motivations for buying a property in Australia such as a desire to emigrate in the future or place their money in a more stable country.

Of course, valuers are familiar with these practices and that's why, on completion, most of the plan properties value at considerably less than the contract price.

2. The banks won’t buy it!

Given that most loan approvals are only current for three months, obtaining a formal pre-approval for an off-the-plan purchase is a waste of time.

The problem is, currently we have 4 big banks in Australia and they each have a policy restricting their exposure to anyone building; meaning they may decline your application to lend against your purchase and you’ll have to go chasing finance elsewhere.

And if they do lend for your purchase you may find because of the inner city postcode of your new high-rise purchase, they will lend at lower loan-to-value ratios, meaning you need a bigger deposit.

Unfortunately, that’s what the banks will value your property at – the going selling price on completion - not what you paid for it.

Combine this with a lower loan-to-value ratio and you’re likely to need an even bigger deposit than you initially thought.

3. Low land-to-asset ratio

Remember that old investment rule; land appreciates while buildings depreciate?

If you go by the book, you should aim for the highest land-to-asset ratio possible and aim to get as much valuable land under your apartment as you can.

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However, the developer wants the opposite and squeezes as many apartments on the site as they possibly can.

So essentially, the interests of the developer and you - the investor - are in direct opposition.

4. No scarcity

This is an important factor limiting resale value as these properties have little owner-occupier appeal.

Not only will most of the new apartment blocks have many similar dwellings (in size, layout, and style); chances are there will be many similar apartment blocks in the surrounding neighbourhood.

5. Investor imbalance

Most off-the-plan developments are sold to investors.

This means you end up with a building occupied by far more tenants than homeowners.

By the way…it’s not much fun going to a body corporate meeting full of investors who are not keen on spending (or simply don’t have) money to maintain the building.

6. Too many too soon

The recent significant oversupply of new apartments in our capital cities' CBDs has slowly been soaked up, but considering how many apartments come on stream at the one time when a new apartment tower is completed, it's likely a glut of properties will once again occur - even if only for a short time.

An oversupply of properties for sale and for rent means your investment will lack scarcity value, one of the factors that I look for to help increase the value of my properties.

Of course, the various landlords will be in competition with each other for tenants and I've seen this quickly turn into a race to the bottom.

Sure many aspiring investors think:

Oh, but the developer is giving us a rental guarantee.

This just means that the developer is nominating a (likely inflated) rental promise and matching any differential for a year or two and in the meantime inflating the price you pay to cover his risk.

And things will get worse…

With many investors unable to settle on their off-the-plan purchases because the banks have tightened their lending criteria - and this doesn't just apply to foreign investors, locals are having real trouble too - there will be a glut of unsold properties hitting the market as developers try and unload their stock.

7. Developer dilemmas in off-plan purchases

Did you know that many of the off-the-plan projects currently being marketed won’t get out of the ground?

Sure, you’ll get your deposit back, but it means you’ve lost precious time with your money not working in the market.

On the flip side, when the developer completes the project don’t be surprised if they have made some amendments to the floor plans or substituted different finishes or fittings.

While they have the right to do so in the contract, you’ll usually find the changes are in their favour and not yours.

You see...developers generally insert a clause in an off-the-plan sales contract that allows them to vary the property within a certain percentage if they chose to do so, and without the buyer having any recourse.

8. Rental guarantees are not as solid as you might think

Often developers will offer a rental guarantee to entice investors who might be more focused on their cash flow and worried about vacancies.

The problem is you pay for these rental guarantees in the purchase price, which is another cost that inflates the apartment’s already premium price.

And once the guarantee expires, the rental income reverts back to the going market rate which is usually lower than that offered in the guarantee.

9. Excessive Owners Corporation fees

Generally, owner's corporation levies are high in these buildings diminishing your rental yields.
And don't necessarily believe the fee quotes by the project marketer as these are usually unknown and often underestimated at the time of sale.

Then give it a few years the ongoing maintenance costs start creeping in with the need to upgrade, paint and replace items.

What lessons can we learn from this?

Some of these problems could be avoided by buying from developers with a good track record and buying in buildings in prime locations, as there always seems to be a bigger demand for units in these buildings.

Also, while buying off the plan has the potential for capital growth, if you bought a completed property it should also grow over the same 12-18 months you were waiting for your off-the-plan purchase to settle.

With a two or more year time-frame for the completion of most high-rise projects, it is very difficult to predict what the future will hold so I feel you should receive a sizable discount for all the uncertainty of buying off the plan.

There is uncertainty about what the property markets will be like on completion, what will the interest rate be then, will the standard of finish be as good as in the display unit or will the developer has cut corners, and what will be built in the future alongside, behind, or in front of the project.

What appears to be a great view today may be totally blocked out in two years’ time.

To cover all these uncertainties, surely you should be buying at a substantial discount, but in reality, you are usually paying a premium – therefore giving your developer your first couple of years’ capital growth (and he doesn’t deserve it).

What’s the alternative to buying off the plan?

I prefer buying established apartments, and to ensure I buy a property that will outperform the market averages, I use a Strategic Approach. I buy:

• A property that will appeal to owner-occupiers (because they’re the ones that push up property values.)
• Below its intrinsic value – that’s why I avoid new and off-the-plan properties, which come at a premium price.
• In an area that has a long history of strong capital growth and which will continue to outperform the averages.
• I only buy properties with a substantial land-to-asset ratio
• I look for a property with a twist – something unique, special, different or scarce about the property, and finally
• A property where I can manufacture capital growth through refurbishment, renovations or redevelopment.

By using a strategic approach I minimise my risks and maximise my upside.

Each strand represents a way of making money from property and combining all five is a powerful way of putting the odds in my favour. If one strand lets me down, I have three or four others supporting my property’s performance.