Buying off-the-plan

There are pros and cons to purchasing property off-the-plan (or before completion). In understanding the risks, you must first understand the various critical stages of development before deciding if buying off-the-plan is right for you. The critical stages of development in chronological order, are:

Development (DA) and building (BA) approvals :

At this stage the Developer has secured the land, completed their feasibility assessment, completed the draft development and/or architectural plans, and has obtained the council approvals for the project.

Pre-sales:

If the Developer is borrowing some of the funds required to complete the project, commercial lending arrangements will generally require the Developer to achieve a specified number of sales, with no contract conditions, before approving the borrowing arrangement. This requirement is known as Pre-sales and can represent as little as 10% or as much as 100% of the total number of lots in the project. Lenders will generally require fewer pre-sales in good property markets and more sales in uncertain markets.

Contract Signing:

This is the time to engage your Solicitor and work with your agent to ensure you understand the terms of sale.

Building Commencement:

This usually happens once bank funding has been secured. The Developer has usually made considerable investment by the time construction begins and so it is less likely that they will risk termination at this stage. It also becomes easier to make predictions around completion dates once building has commenced.

Title Registration:

This is when the main building works have been completed, all regulatory requirements have been met, and individual lots have been issued titled by the State Titles Office. There may still be minor defects to attend to at this stage, however, the individual properties are practically complete and ready for settlement.

Settlement:

By this stage the purchaser’s lender has usually completed valuations and unconditionally approved the loan if lending is involved. The property is ready for the transfer of title from Developer to Purchaser, and Purchasers are usually offered a ‘pre-settlement inspection’ to have any concerns attended to before settlement.

They are the six critical stages that need to be understood in order to either maximise the advantages, or mitigate the risks, associated with buying off the plan.

The Pros:

• Greater Selection – You will usually have greater selection within a project in the early stages of the marketing cycle. Often the most rentable or saleable properties are snapped up early and the less desirable properties will be sold last.

• Discounts – Prospective buyers are sometimes offered discounted pricing in the pre-sale phase, as Developers often become very motivated to reach their pre-sale funding target. Significant financial investment by the Developer can be lost if the project cannot proceed past this stage.

• Upside – Having ownership of an investment that has the potential to grow in value while the holding costs are nil, is definitely desirable to the investor. Of course, the market can go backwards too, however, property has historically risen in price over time.

• Customisation – You will sometimes be able to customise the design and inclusions of your property to suit your own tastes or to give the property a unique point of difference.

• Stamp Duty – If buying land and contracting a builder to construct the dwelling, you will only pay stamp-duty on the land and not the total house/land package.

The Cons:

• Opportunity Cost – Securing property off-the-plan will usually require the purchaser to sign an unconditional contract and pay a deposit of 10% of the contract price. The longer the timeframe the greater the opportunity cost of having your money invested elsewhere. As mentioned above, this could be a positive or a negative depending on investment markets during your contract period.

• Contract Terms – If you enter into a contract prior to the issue of council development or building approvals, your contract will usually contain a clause that allows the Developer to make immaterial modifications to building plans, floor plans. It is important to understand the difference between material and immaterial changes before signing the contract. Purchasers would understandably be disappointed if changes are made that can affect the rentability or saleability of the property but are deemed immaterial under the contract terms. In this event, the purchaser has little recourse, and they will be unable to terminate the contract. In the past few years there have been many examples of builders been unable to lock in supply or labour agreements, finding themselves losing money on projects. Consequently, we have seen many creative ‘get out of jail free’ clauses creeping into contracts which allow developers to either reprice or terminate contracts.

• Sunset Clauses – If you enter into a contract on a lot within a development before the pre-sales target is achieved, keep in mind that the Developer may never obtain the financing required to start the project. However, you will usually find within the terms of the contract that the Developer has the right to hold you to your contractual obligations and deny access to your deposit for a specified period of time. This is referred to as the Sunset period or the Sunset clause. Time frames for Sunset clauses will vary from project to project but 3 to 5 years is common. If the Developer cannot complete the project within the Sunset period, you may find that your contractual obligations prevent you from investing your money elsewhere over this period. Some developers use Sunset clauses creatively to give them the advantage in any upswing of market prices whilst holding you in for longer if values decline. 

• Time Frames – Once construction has commenced, the risk of non-completion significantly diminishes. However, the weather, industrial relations, and bureaucratic red tape can still see lengthy delays to expected completion times.

• No Finance Clause – Most off the plan sales will require the purchaser to sign an unconditional contract without a finance clause. This means that if you are unable to secure funding and settle on the property, the Developer will have the right to keep your deposit and pursue you for any other costs incurred in rescinding your contract and acquiring another purchaser. Most banks will provide pre-approvals to provide more certainty around access to funds. However, most pre-approvals are only valid for 3 months, depending on the lender. After this term has expired, the banks will reassess the application based on their usual criteria. It is also possible for your bank to simply change their borrowing criteria at any time prior to Title Registration. If you have lost your job within this time, or interest rates have gone up, and you cannot service the loan for any reason, you risk losing your deposit and may be responsible for the developer’s resale costs.

• Low Valuations – If you have signed an off-the-plan contract and paid your deposit, you need to make allowance for the bank valuation to come in lower than what you have paid for the property. Low valuations are quite common, particularly in uncertain markets. If you do not have enough funds to make up the shortfall, again, you may find yourself in a position of not being able to settle. Allowing for equity and serviceability buffers when obtaining borrowing capacity or preapprovals is crucial when purchasing any property.

• Builder/Developer Reputation – Sometimes you do not get what you expected when buying off-the-plan. The images in the glossy brochure may not look anything like the finished product. This risk can be reduced by researching the Developer’s and the Builder’s reputation, visiting completed developments by the same Developer, and getting professional industry feedback. Someone experienced in this area can often reconcile the inclusions with the images or may be familiar with other work by the same Builder or Developer. There are other issues that can make the whole process seamless or nightmarish depending on the overall business strategy of the developer. Charging separate service costs or excessive default interest are just a couple of examples.

• Two Part Contracts – There are additional risks if you purchase the land first and contract a builder to complete the house/dwelling. These include being unable to negotiate a fixed price on the construction; delayed time frames; providing a larger deposit; having to make mortgage payments on the land and construction but having no income until the construction is completed and tenanted; and having the stress of making decisions about design, inclusions, landscaping etc. Many Builder/Developers will try to pass on their development risks to the purchaser.

Conclusion

There are clearly many risks that must be considered when buying off the plan. However, the advantages are significant and can certainly supercharge investor’s wealth if managed properly. All risks can be mitigated using a variety of tools, so avoiding off the plan purchasers altogether is not always appropriate. Getting good advice from experienced property professionals who also have access to the tools and professional services required, is vital in order to shift the balance of risk vs return.

At NPA, we have been involved with hundreds of off the plan sales over the last 10 years and have been able to reduce the risks enough to empower even the most risk adverse investors enjoy the benefits of buying off the plan. Don’t exclude yourself from some excellent investment opportunities simply because you cannot see a way to mitigate these risks. Get in touch with one of our friendly Investment Strategists for a chat about your circumstances and how to build property portfolios of significance.

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