Buying off the plan. To some investors, that term conjures images of dodgy Gold Coast unit developments and poor quality suburban housing projects.
But is that reputation really deserved? When buying off the plan, it comes down to your personal financial situation and your appetite for taking a risk that might pay off enormously, or might have you eating baked beans and noodles for a while, but most likely will result in a solid investment and a tidy return.
Let’s get straight to it. There are two main risks to consider when buying off the plan. The first is ensuring you get what you paid for: that is, the quality of the finished product is what was sold to you in the first instance. You can manage this risk by hiring a good property conveyancer and, it goes without saying, buying from a reputable builder. But that’s a topic for another day.
Today I’d like to explain the second major risk, and how to manage it, so you can take advantage of the benefits of buying off the plan.
And that second risk is this: from the time you sign the contract, the value of the property at settlement can be different from the price you agreed to pay. This can good, if the value has increased; and it can be bad, if the value has dropped.
What is ‘buying off the plan’?
So how does buying off the plan work anyway? Well, in buying off the plan, you are shown a property (maybe units, an office tower, or a housing development, etc) that won’t be built for another 6, 12, 18 months, or even longer. The developer or their agent will talk about the expected rental yields, outgoings, depreciation benefits and things like features, local amenities and market trends, that affect the likelihood of attracting and retaining a quality, cashed up tenant. You will then be asked to put down a minimal deposit (sometimes cash, often a bank guarantee or deposit bond) to secure the property at an agreed price, to be paid when the property is built.
Now it’s worth considering what the other party (ie the developer) is getting in return for offering you this opportunity. As you could imagine, developing a unit block or residential precinct is an expensive business, and developers need help from banks to fund the project until they can break even (and make their profit) through property sales. Before a bank will give a developer money, they usually require a certain amount of the units be ‘pre-committed’, meaning already agreed to be purchased. And the greater the pre-commitment amount, the better the lending terms the developer will get. So it’s in the developer’s interests to get pre-commitments on as much of the property as possible. Which is where you come in.
What can go wrong?
So what can go wrong when buying off the plan?
As I mentioned earlier, it can really ruin your day when you arrive at settlement date only to find that your bank won’t lend you the amount you requested because they’ve valued the property at less than what you agreed to pay the developer. Because you are bound to buy the property, you now have to make up the difference from your savings, equity in your existing properties, or a rich uncle.
How did this happen? Two reasons: property valuers and markets.
Sometimes, property valuers can get it wrong. It’s the job of the bank’s valuer to protect the bank from bad lending decisions, so they’re a bit more conservative than a more optimistic developer. When it’s a large development, or there hasn’t been a lot of comparable sales in the area to get a guide, a bank’s valuer may err on the side of caution and inadvertently ‘undervalue’ a property.
The property market is not terribly volatile (we’re not talking about trading futures here) but it gets more difficult to predict property values the further out you go. Markets can turn in 3-6 months, and when buying off the plan, you’re often expected to agree a price 12-18 months in advance, sometimes longer.
How can you take advantage of buying off the plan?
On the upside, if property markets are hard to predict, that means they go up as often as they go down, and this is where you can reap the rewards of some due diligence and a bit of luck. If the property value goes up, for little to no deposit you’ve secured the property under your name, paid little or no deposit and made a capital gain without paying any interest.
So how do you increase the chance of that happening?
Firstly, do your research. Take into account where the market is in its cycle, have a look at how comparable properties in the area have changed in value, or if it’s a unique development in the area, look for similar scenarios in other locations.
Secondly, and most importantly, don’t overcommit.
Accounting for the worst case scenario – that the value of property actually falls by say 10%, would you have available equity, or surplus funds to cover the shortfall? If not, buying off the plan may be a strategy better left until your portfolio is larger or more mature, and you have more room to move.
On the other hand, if the value goes up by 20 or 30%, then the biggest concern you’ll have is how to spend the money and whether you should console the developer who wished he’d priced higher. Maybe send him a Pinot and some tissues.
For a few more tips on buying off the plan successfully, watch my video.
And if you’re looking to buy off the plan, we have hand-picked and negotiated access to several quality properties across the greater Sydney, Brisbane and Melbourne markets. Call us on 02 9634 5040 for info on pricing and yields.
About Owen Davis: Owen Davis is the Principal of DFG Property, a full service property management, finance & sales firm based in Sydney. Owen has over 15 years experience in property financing, real estate and property management. More than a third of his clients are among the top 10% of property investors in Australia.