Each week I strive to provide quality and relevant FREE education for property investors… to empower them to buy real estate wisely, rather than being sold to. Our unique customer care program works for all clients… because investing is personal. Today I want to look at the good and the bad associated with “Off The Plan” purchasing.
People insistent on seeing and touching a property before contemplating a purchase may be missing out on the benefits associated with an off the plan purchase. Off the plan is simply property not yet registered with the Land Titles office; either near completion or perhaps before construction has begun. There are numerous advantages buying off the plan but you need to understand the potential pitfalls.
Our initial research is to identify affordable areas with strong capital growth potential. Where demand for housing is strong and growing but available land is limited (the irrefutable law of supply and demand). Land value in areas of strong capital growth will generally make the construction of a single dwelling prohibitive. It’s in these areas located around infrastructure, employment and services that we tend to see more dense housing under construction; such as apartments and townhouses. With such development comes the opportunities to purchase off the plan.
Profiting From An Off The Plan Purchase
- Developers of medium to high density projects typically secure construction funding from banks and institutional lenders
- Any finance approval will generally be conditional on a percentage of pre sales first being achieved
- Price incentives may be offered to aid in securing quicker pre sales. This normally results in the first handful of purchasers buying at below market value
- Incremental price rises are commonplace after the required number of initial pre sales has been achieved
- Incremental price rises throughout the construction period are not unusual. This means that although all purchasers may ultimately settle on the same day, those who contracted early will pay less than someone who committed to their purchase later in the timeline
In a rising market it is not unusual for people who purchased off the plan to settle their property at well below market value (tomorrow’s property at yesterday’s prices). Developers often hold back some property sales in a project until the very end… when they expect to realise a premium sell price. As a rule of thumb, land values are rising and construction materials and labour costs are steadily increasing. That’s why property bought tomorrow will almost always cost more than property bought today. Once you have your name(s) on a fully executed contract of sale, the purchase price is fixed and any capital growth the property experiences throughout the construction phase is yours to keep!
Buying Off The Plan Benefit Summary
- Commit to purchasing a property today
- Will not have to pay for it for months or even years
- NO cash flow shortfall to subsidise pre settlement
- NO rates payable pre settlement
- NO body corporate fees payable pre settlement
- NO need for a tenant pre tenant
- NO maintenance pre tenant
- NO wear and tear pre tenant
- Property will still be brand new at settlement (maybe 2 years away)
- Settle tomorrow at today’s (or perhaps yesterday’s) price
WARNING: In my considered opinion, based on much experience… any investment property worth owning will initially be negatively geared. Prior to the recent interest rate falls, the cash flow shortfall on the best buys was often in excess of $200 a week. Someone buying off the plan would effectively be saving this $200 a week shortfall until the day of settlement (rent plus tax refund… less interest, council rates, body corporate, maintenance, insurance, management fees etc). That’s about $10,000 a year! Many times people mistakenly set out to purchase an already completed property to secure an immediate tax benefit. As important as a tax deduction is to a property investor, it is just one part of the equation and should never be the sole driver of any investment decision.
By Way Of Example
- A property costs $300 a week (before tax) to hold
- The negative gearing benefit produces a $100 tax saving
- Your net cost (after tax) would be $200 a week
- Buying off the plan means you would not save the $100 in tax while the property was under construction (negative)
- Buying off the plan means you would not be paying the $200 a week shortfall (positive)
- So therefore, buying off the plan means that my $100 a week still goes to the tax man but I don’t have my $300 a week holding costs
- Buying a completed property means I will have $300 a week in holding costs; less $100 tax savings
- Even though you are not saving your tax you are still $200 a week better off having an off the plan property that has not yet settled
When A Project Runs Over Time
Another advantage of an off the plan purchase that is often overlooked is that many of them run over the scheduled time and complete long after they were originally supposed to. Why is this an advantage? Because it means the savings in the example above are multiplied. Given the price is fixed, the longer it takes a developer to complete a project that I have bought into the better. My capital gains clock is still ticking away in my favour as it’s MY NAME that will appear on the title post settlement, yet I am avoiding that cashflow shortfall in the meantime. The longer a project takes to complete… the more money I save. I could end up settling on a property with two years capital growth already in it, yet my carpets etc are still brand new. This allows me to ask a better rent than if the property was already two years old.
Some of my off the plan purchases have simply been because that was all that was available. Brand new projects are normally sold out well before construction completes; so the person waiting to see it and touch it will miss out completely. Due to the current climate we have been able to secure on behalf of clients some great developer offerings on completed stock.
The Other (Negative) Side To Off The Plan Purchasing
While I freely subscribe to the many positives that result from an Off the Plan purchase, there are pitfalls that you need to be aware of. The biggest PLUS in buying off the plan is also the biggest MINUS; the time frames involved! While these time frames can work to your advantage (as outlined above) they can also work to your detriment when it comes to dealing with banks. Any finance assessment and approval done with your lender will expire after 3 to 6 months; which is really of little good to someone not needing the funds for say 12 or 24 months.
You will need to satisfy your finance clause and go unconditional on your contract at the front end of the process (normally 21 days from the date of contract) but you will not have unconditional finance approval from your bank until the end part of the construction timeline.
The way to approach this is to ensure your broker assesses your borrowing capacity now to ensure you would qualify for the necessary finance under the current lending criteria and with consideration for your ongoing financial and family situation. As completion of the new property draws near a formal application will then be lodged with your lender to secure the funds required at settlement.
Unconditional Without Unconditional Finance
Once the finance clause has been satisfied, your contract normally becomes unconditional. However, for the most part of the construction phase you will not have unconditional finance approval from your lender. In almost all cases this is not a problem, however, responsibility and care need to be shown in a few areas:
1. Changes to your financial situation. Changes to your financial situation will change your borrowing capacity. You need to ensure that any changes you are contemplating will not disqualify your ability to secure the settlement funds required. Don’t quit a job or cut back your spouse’s hours or borrow money to renovate your home etc without first having your broker assess how such a change will impact on your ability to secure the funds required for the new purchase.
2. Bank lending criteria. In response to the global credit crunch our banks have greatly tightened their lending criteria. Someone who previously qualified for funding could now find themselves outside their bank’s lending parameters. If you are currently contracted to buy an off the plan property and you have any doubts whatsoever as to how the recent changes to the bank’s lending rules may impact on you, I suggest you speak with your broker and have him/her reassess your borrowing capacity. Of course we are here to help too; but not until Monday 5th January.
3. Valuations. The Valuer is potentially another “curve ball” for you to consider. Valuations generally come in at between 5% and 7% under contract price; therefore it is vitally important to keep a little “up your sleeve” for a contingency. Where possible I suggest you consider having your home valued and lines of credit set up against the unused equity during the initial 21 days finance clause. This will eliminate the nasty surprise of having a low valuation also applied to your own home later on. For these reasons we discourage people from going to contract on a property that would require all of their borrowing capacity. For more on valuations see my article “Valuations; Will Somebody Please Explain” click here.
4. Sunset Clauses. Where a project is delayed and titles have not issued by the sunset clause date, either party can terminate the contract. I have heard of instances on a few occasions where a developer has cancelled contracts and reissued them at a higher price; either because of greed or to recoup the additional costs he has incurred because of the delays to his project. I only know of one instance where this has happened to mrd clients back in 2003. Normal practise is that the solicitors will arrange to have the sunset clause extended to cover any delays.
In Summary
- There are pros and cons for buying already constructed property as there are with those off the plan. Whatever choice you make ought to be after you have identified the ongoing strategy necessary to manage your portfolio:
- With an already completed property purchase you will need to manage any weekly cash flow shortfall and be mindful of your tenants needs
- With off the plan property you need to manage your personal finance situation until settlement - Obligations and entitlements are imposed upon all that are party to a contract. Just as a developer has his obligations to you that he must meet, so too do you as the purchaser need to ensure that you meet your obligations
- Buying off the plan offers great advantages but you need to understand your obligations and address them with responsibility and discipline
- Off the Plan purchases are most suited to those who have a strong employment history and/or strong equity backing them
- When buying off the plan ensure you consult with your broker before making any employment or family changes that may affect your ability to secure funding. If you expect a change to your situation, such as adding a little person to your family, please advise your broker upfront so they can factor that into the initial calculations
- If you know your situation will be changing down the track, speak with us ahead of time about helping you plan a strategy that will work for you both now and when your situation changes
From all the team @ mrd have a wonderful Christmas break; we look forward to helping you make 2009 your year of financial possibility.
Happy Investing,
Nick Lockhart
mrd customer care program… because investing is personal
