Off the plan Top 10 questions answered
Oversupply, inflated prices and one-sided contracts ... these are just some of the challenges facing the off-the-plan investor
Q I’ve heard it’s harder to get finance for off-the-plan purchases. What will a lender look for when approving a loan for an off-the-plan property?
The lender will look at things such as the amount of deposit the buyer has to put forward, along with recent values in the area and the amount of saturation of the particular type of property. Some lenders also restrict lending completely in certain areas if they have already invested heavily in funding the development – they are less likely to fund purchases as they would essentially be moving money from their residential book across to their commercial book. For some banks, lending can be restricted based on the development size or even the postcode. MICHAEL SALIBA
Q How do I avoid buying a dud?
Concentrate on the numbers and not your emotions. Beautiful pictures and expensive 3D models that show off stunning gardens, pools, gyms, saunas and 24-hour concierge may be great features if you live in a property but often cost a fortune and could quickly turn an investment from good to bad. Stick with small developments in inner-city areas with low strata costs, as these are more likely to offer the best long-term growth. In particular, look to invest in areas where there is demand from highly paid workers from multiple industries.
Above all, you should analyse the numbers unemotionally and not pay more than a property’s true worth. Paying for an independent valuation can help reduce the risk of overpaying. It’s also essential to hire a building inspector to check out a developer’s previous projects and assess property quality as well as how it stands up years later. To gain further insight into any problems with the property, it’s also worth asking current tenants about their experience with the development. CHRIS GRAY
Q Is apartment oversupply a problem everywhere in Australia?
Given there isn’t one single property market in Australia, but hundreds each with their own supply and demand, apartment oversupply is not a problem everywhere. Established areas often have three-storey height limits and properties sandwiched next to each other, leaving minimal land for redevelopment and little profit potential for developers. In these areas, it’s the boutique developments of 10 to 12 units built by small family builders who care about what they complete that are popping up. The issues of an oversupply are more likely in CBD areas with no height restrictions and outer areas with lots of rezoned industrial land. Big-time commercial developers can build tens of thousands of apartments and every dollar they can save counts – that’s where the future issues lie. CHRIS GRAY
Q What happens if the development is delayed or doesn’t go ahead?
If the development doesn’t proceed, your deposit will be returned to you. However, if the development is delayed, the developer is usually protected by a “sunset clause” in the contract which specifies a date by which the project must be completed. As the buyer is committing to a property that has not yet been built, there need to be some conditions built into the contract to ensure that the project is completed in a fair and timely manner and settled at the price originally agreed upon.
At the same time, the developer is protected by a sunset clause because it means that the buyer can’t back out of settlement at completion of the project, if it is completed before the sunset date, which is usually set for a number of years ahead.
Developers have recently come under scrutiny for using the sunset clause to their own advantage. There have been reports from disgruntled buyers of developers who purposely run over time in order to invoke the sunset clause and therefore nullify all unset clau contracts. They then put the same properties back on the market at a higher price to increase their profit margin.
This scenario leaves the buyer at a great disadvantage because while their money has been tied up in the off-the-plan development, they have not been able to make offers on other properties, and properties that they could afford at the time of deposit have increased in value and are now out of reach. MICHAEL YARDNEY
Q Can I resell the property before it’s completed?
Depending on the contract conditions, you may or may not be able to resell a property before it is complete. However, you shouldn’t be going into an off-the-plan purchase with that intention unless you are a highly educated speculator who has the funds to risk a change in the market. Property investing is a long-term game, due to high entry and exit costs, and not something that is highly profitable in the short term. The more profit you try to make, the more risk you will be taking on. Buying an off-the-plan property on a deposit bond and thinking you’re going to flip it for a profit before you have to pay for it is a high-risk strategy, and not something most people can pull off. CHRIS GRAY
Q Is it true that prices are inflated for properties with a rental guarantee?
Yes, it’s true that properties with rental guarantees have inflated prices. In life you never get something for nothing. Rental guarantees are provided to help make the buyer and the lender feel comfortable and so the seller can get more money out of the buyer.
For example, if the market rent for a particular area was $500 a week for a two-bedroom apartment and the going yield in the area was, say, 5%, then the value of the apartment
Buying a property on a deposit bond and thinking you’re going to flip it for a profit before you pay for it is a high-risk strategy
would be around $500,000. So what some sellers do to inflate the price is offer a $550pw rental guarantee. They then adjust the sale price up by $50,000 to $550,000 to reflect the 5% market rental yield.
When the apartment rents for only $500pw due to market demands it may cost them $5200 over two years to honour the rental agreement. However the buyer ends up at least $ 45,000 out of pocket plus the extra percentage on the purchasing costs and mortgage interest they paid. That is a very expensive guarantee.
The bottom line, in my view, is that a good property doesn’t need a rental guarantee, so if one is offered I would run in the other direction. PATRICK BRIGHT
Q Is there anything in particular I should look out for in the contract?
Off-the-plan contracts often allow for a variation in floor area, typically of 2% to 5%. If this type of metreage is lost from one section of the apartment, for example a bedroom that is already on the small side, then that bedroom becomes a study, which will severely impact the property’s value and rentability. This decision is solely up to the developers, leaving the people who purchase the property with no say in it. Compared with a typical property sales contract, off-the-plan contracts are very one-sided documents that favour the developer. If you are looking to purchase this type of property you must have an experienced off-the-plan lawyer review the contract. PATRICK BRIGHT
Q What happens if there are any defects or problems with the property after it’s finished?
Don’t be disappointed – there will always be some defects in a new building and many won’t become evident until the apartment is lived in. Reputable builders will return three months after handover to fix all the minor issues at the one time.
Many off-the-plan purchasers don’t realise that buildings over three storeys are not covered by the same type of builders’ warranty insurance as a typical home. However, builders are responsible for rectifying structural defects for six years after completion and non-structural defects are covered for two years.
However, it’s often harder to get developers to rectify major building issues such as water leaks. A 2012 study by the City Futures Research Centre at University of NSW found that 85% of off-the-plan properties built post-2000 have building defects and of that number 75% are yet to be repaired.
If defects arise the first point of contact is the builder, but if the builder is unwilling to correct the issue the owner can lodge a complaint with the local tribunal (such as the Victorian Civil and Administrative Tribunal in Victoria) up to 10 years after the completion date. MICHAEL YARDNEY
Q Is there a risk the bank won’t lend me the money at completion and is there anything I can do to stop that from happening?
Yes. While this is a limited risk, in today’s market it is becoming more likely, particularly in larger apartment developments or in certain pockets around Melbourne and Brisbane. If values fall in any given area, or if the bank policies change (often that in itself would drive a change in value) the bank may no longer lend. This could mean that a pre-approved loan at the time of the contract exchange may not stack up the same way upon completion. To avoid this it is best to ensure that buyers plan to save a further 10% of the original value of the property between the time they exchange versus the expected settlement date. MICHAEL SALIBA
Q How can I make sure the developer is reputable and will deliver at the end?
You can’t be 100% sure. A couple of things you can do to lower your risk is to investigate several buildings they have already completed. Ideally you would want to avoid buying into the biggest development they have taken on and built (as most go bust on their biggest project).
Further I would order strata reports and speak to the strata managers on at least two buildings they developed no less than 10 years ago to see what the history of defects is like over that time with those buildings. Keep in mind that the developer isn’t always the builder so you could be buying from a developer who isn’t actually responsible for the construction and for all the warranties they appear to be offering. PATRICK BRIGHT
For the answers to more off-the-plan questions – such as whether you should use a deposit bond, what happens if you change your mind after the cooling off period, what happens to your deposit of the developer goes bust and what happens if the property market falls between when you exchange contracts and the building is completed – visit moneymag.com. au/offtheplanquestions.
In my view a good property doesn’t need a rental guarantee, so if one is offered I would run in the other direction