Should You Buy Off The Plan Properties?
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Off the plan is heavily marketed and sold as offers that you cannot afford to lose out on, but the reality is that they’re a dangerous game.
They’re not what they’re cracked up to be. Instead, buying off the plan is one of Australia’s riskiest methods for investing in property, and we advise that you steer clear. Here’s why.
New Risks to Buying Off the Plan
With Labor’s proposed changes to capital gains tax (CGT) and negative gearing, the usual risks associated with purchasing off the plan will be compounded.
To summarize, the ALP has proposed limiting negative gearing to new houses (not apartments) and reducing the CGT discount from 50% to 25%.
This is likely to lead to a decreased demand for the purchase of investment/rental properties due to the creation of new markets. Prices will then decline in many areas.
This means the second owner will receive different tax benefits of depreciation as the primary owner when buying a property.
This means no negative gearing claim against their income, and the CGT discount is sliced in half.
The vendor will need to get around this by dropping the sale price as there are now few benefits to the buyer and thus less attractive.
For areas like Brisbane, Fortitude Valley, and others where we see an oversupply of for-sale properties, they will likely experience further price reductions.
Factor in Sydney Olympic Park’s Opal Tower incident and the now decreased confidence in the new apartment market, and you’ll understand what we’re trying to get at.
Despite the above, buying off the plan has always had risks, and we’ve outlined some of these below.
By no means are we saying that buying off the plan is a bad idea – we’re simply stating that there are a lot of risks that you’ll need to consider before taking the plunge.
Marketing Off the Plan
Property developers understand that selling a competing property can get a better price than selling off the plan.
The lenders, however, that fund these projects require a large portion of the units to be sold to prove that the development is viable.
The lenders expect the developers to make a reasonable profit, and they should.
This is then factored into the final price, as is the large marketing budget for out-of-home and traditional media advertising.
Add in the commissions for the marketers, incentives for financial planners, and finally, the commissions for the sales agent, and you’ll find that the initial selling price is inflated.
If it’s too good to be true, it probably is.
After all of the above, if 15% of a project’s budget goes toward marketing and selling costs, these will be passed down to the buyer.
Due to the completion date for many of these developments being three-plus years away, the inflated price of the unit is buried in all of the advertising hype.
Developers know this and take advantage of it – the longer it takes to settle the property, the lower your chance of knowing whether the property’s final price is still good value.
Now, none of this is theoretical. The streets are littered with many property investors who purchased off the plan and found that what they paid was too high and the property’s valuation too low.
Other Off The Plan Risks and Considerations
Sales and Marketing is Not Cheap
Huge commissions are usually incorporated into off-the-plan properties to ensure the marketing and salespeople are covered.
This money will come directly from property investors, meaning they’re paying above value.
Hype is contagious, and so are the good old “only 15 units left” and “40 units already sold”. Don’t buy into this.
Local investors rarely purchase the pre-sales. Instead, they’re coming from overseas buyers who need help to purchase already completed properties,
have poor knowledge of Australia’s property markets, and have their motivations to buy.
For example, they want to immigrate to have their money sitting in a more financially stable country.
Loans Aren’t Easy
When you apply for a mortgage, the approved loan is usually current for three months. This means applying for a pre-approval of a property that will settle in three years wastes time.
Next, the big banks have policies restricting their exposure to any development. For example, most will lend to less than 15% of the properties in new high-rises.
So, in other words, if there are 100 units in a single building and you’re the 16th person to approach the bank for a loan (after completion),
there’s a chance they’ll decline your application, and you’ll need to go elsewhere.
If they manage to loan you some money, you’ll find that something as silly as the postcode of your new purchase will lead to a low loan-to-value ratio and, thus, a larger deposit or downpayment.
If, for whatever reason, you’re unable to settle the property, you’re going to need to sell at whatever price you can achieve.
The banks will value your property at this selling price on completion, not the amount you paid.
If you can’t afford it, you may need to forfeit the deposit to get out of the contract.
Combine this with the developer’s right to pursue you for any loss they may suffer, and you can get hurt. Yikes!
“Land Appreciates and Buildings Depreciate”
Yes, it’s an old saying, but there is a reason behind it. It would help if you usually aimed for the highest land-to-asset ratio – you need as much good land under your apartment as possible.
However, developers are trying to do the opposite as they’re trying to fit as many apartments on the site as possible.
You and the developer are opposite interests.
Oversupply
Sydney, Melbourne, and especially Brisbane are experiencing a large oversupply of new apartments, with approximately 27,000 still under construction in Sydney.
High supply means that the prices will likely decrease over the coming years, making it harder for investors to rely on the property value to increase.
Not only will prices drop, but you’ll be competing with other property investors trying to rent out and attract tenants.
Combine the two, and your new property will need more value.
To only make matters worse, banks have been progressively tightening their lending criteria on locals (and foreign investors)
which will make it harder for developers to let go of their stock.
Rental Guarantees
In Brisbane, new developments have been accompanied by rental guarantees to entice those worried about occupancy and cash flow.
The issue here is that the guarantees, like the marketing budget, are factored into the purchase price, thus inflating the already expensive property.
Once the guarantee ends, you’re back at the market rate, less than what you got during the guarantee period.
Uncertainty on Completion
We’re not just discussing settlement days being pushed back months and sometimes years.
We’re talking about the uncertainty of what the property market would be like upon completion.
How will the interest rates change? Is what you get similar to what you saw in the display suite?
Do you know that awesome view from your future balcony? Is it still going to be there in three years?
These are all important questions you cannot answer and risks that a large discount can only balance.
However, as discussed above, you usually pay a premium and give the developer some capital growth. You may not receive the same.
Also, do keep in mind that while buying off the plan could result in capital growth,
purchasing a completed property should also experience the same growth while waiting for the new property to settle.
Let’s face it, nobody can predict the future, so if there’s no sizeable discount, you may be digging yourself a hole.
Key Takeaway
After reading the above, it may sound like buying off the plan is a bad idea, and that’s because it usually is.
Combined with the potential Labor party changes, off-the-plan properties will be one of the riskiest property investments you could make.
Our Advice
Unless you’ve got independent advice from an investment strategist, steer clear of the plan. Instead, invest in exclusive properties that satisfy at least one of the following:
- Appeals to owner-occupiers as opposed to rental investors. These guys push up the value and are more likely to invest in improving the property’s quality;
- Is part of an area with a track record of strong capital growth that is likely to continue;
- Has a high land-to-asset ratio; and
- It has the potential for you to create your capital growth through renovations or even redevelopment.
Each of these represents a way to earn more from your investment. If you can tick all four boxes, you’ve got a winner.
Joseph Alzein writes this article from the chill. Chill helps you earn more as a property investor through short-term renting.
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Josephine Adriana
Josephine is and chill's Digital Marketing Coordinator. With her experience and background in marketing, she is taking innovative steps to create and maintain long-lasting relationship with our audience. We convert your spare space or empty property into an Airbnb property and provide end to end service, taking care of every element in the process so that you can relax, and chill.
