What every property investor needs to know about buying ‘off the plan’

Open any weekend newspaper and you’ll see a large number of proposed new apartment projects being marketed before building has even been commenced and it may make you wonder – why on earth would anybody buy a property that hasn’t been built yet?

Plenty of people do, you know. It’s called buying “off the plan”.

With our property markets on the move again, some investors are considering buying properties “off the plan” enticed by the advertising hype of stamp duty savings and so-called “cheap” prices.

They hope that by getting in today and settling on their properties in a few years time the value of the property will have increased and they will have turned a relatively small deposit into a substantial profit, all while avoiding those nasty holding costs.

Others never intend to settle their purchase, hoping to sell the apartment for a profit on completion.

Does buying “off the plan” 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.

While developers know they can get a better price for a completed property that buyers can see and touch and feel, today the lenders who are going to fund construction of the project insist a substantial proportion of units be pre-sold to ensure the viability of the project is underwritten.

Obviously the banks expect the developer to make a reasonable profit margin – and so they should. This is built into the final price as is 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.

Remember, there is no such thing as a “free lunch”

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 purchased “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.

Here are a few reasons I would steer clear of off the plan purchases:

1. Too many fingers in the pie

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

Don’t be lulled into a false sense of security just because you’ve been told a number of presales have already occurred. You’re likely to find many are at inflated prices to overseas buyers who are unable to buy established properties, have little knowledge of the local markets and have unique motivations for buying property in Australia such as a desire to emigrate in the future or place their money in a more stable country.

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 four big banks in Australia and they each have a policy restricting their exposure to any one building; most won’t lend to more than 15% of the properties in a large complex.

This means that if there are 100 apartments in the building and you are the 16th person to approach the bank when the building is completed, they may decline your application 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.

By the way … some investors who buy off the plan won’t be able to settle and will need to sell their property at whatever price they can achieve.

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.

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. 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.

Fact is owner-occupiers tend to be far more careful when it comes to maintaining the building and enhancing the development’s long-term capital value.

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.

5. Too many too soon

Currently, there is a looming oversupply of new apartments in some of our capital city CBDs. This glut of properties driving down prices poses a problem for investors relying on the value of their property to increase by the time it reaches completion.

You’ll also be competing with all the other investors who are trying to rent out their new investments.

Both these issues mean your investment will lack scarcity value, one of the factors that I look for to help increase the value of my properties.

6. Developer dilemmas

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 flipside, 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.

7. 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.

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 to 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 sizeable 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 have 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).

Michael Yardney is a director of Metropole Property Strategists, who create wealth for their clients through independent, unbiased property advice and advocacy. Subscribe to his Property Update blog.