What are some risks and benefits of buying off-the-plan properties?

Buying off the plan is one option to consider when delving into the real estate market. But what is it and what are the pros and cons? We take a look.

After a COVID-19-led real estate buying run saw house prices reach giddying highs, and although they’ve fallen in some areas recently, development is still booming across much of Australia. The Australian Financial Review reported earlier this year that there were a ‘record’ number of cranes adorning our skyline, hoisted by developers scrambling to provide apartments for “first home buyers and owner-occupiers unable to meet the fast-rising prices of detached houses”. And while this increase in construction activity could partially be the result of ‘COVID catch-up’ as construction gets back on track after pandemic disruptions, it ultimately adds up to a growing supply of apartments and townhouses that are typically cheaper than the average price of a house.

For example, real estate data firm CoreLogic’s Hedonic Home Value Index for July put Sydney’s median house price at about $1.35 million and the median unit price at about $806,000. Melbourne’s median house value was $964,950 versus units at about $614,351. Brisbane’s was about $884,336 for houses versus about $504,520 for units.

Buyers might rejoice in the potential benefits of securing an apartment or townhouse off the plan from a developer. Such benefits can include the potential to earn capital gains, to get a foothold in the market or to enjoy the facilities on offer in a modern house or apartment complex. But it’s important to weigh up the potential cons as well, such as the risk that the property could decrease in value by the time it’s fully built, or, as has happened in a few high-profile incidents of late, not be built at all. Plus, there is the spectre of rising construction costs and supply chain issues that could impact how the property looks, when it can be finished and, depending on the type of contract you sign, if you will need to pay more than was originally negotiated. There are also the ongoing costs associated with apartment ownership, such as body corporate fees.

That’s why it’s a good idea to get legal advice if you are considering purchasing an off-the-plan property. Or as the Queensland Government puts it: “Getting legal advice is just as important as getting financial advice and organising a mortgage.”

What does buying off the plan mean?

Buying a property ‘off the plan’ means buying a property that hasn’t been built yet. There are lots of ways to buy real estate. The most common way in Australia is to purchase an existing property via an auction or a private treaty. You are able to view and in many cases walk around inside the exact property you will own before you sign a contract.

But when you are purchasing a property that does not yet exist, such as an apartment in a complex that’s yet to be built or a house on a block of land that’s yet to be subdivided, that’s called ‘buying off the plan’. In this scenario, you cannot view the exact property you will be purchasing. Even though you may be able to view a display apartment or home that is promised to represent or be similar to what is for sale, you really only have a plan to look at when making your purchase decision.

When you buy an off-the-plan property, the sales and home loan process is different to what happens when buying an existing property.

What can you buy ‘off the plan’?

In Australia, the phrase ‘buying off the plan’ is most commonly used when referring to apartments, units and townhouses, although off-the-plan houses, often referred to as ‘spec homes’, may also be available in some cases.

What happens when you buy off-the-plan property?

For the buyer, the decision whether or not to purchase off the plan is made on the basis of what the developer promises will be constructed. Potential buyers are usually supplied with a wide range of information about what the property will look like once it’s constructed, to help them visualise their purchase. This could include design blueprints or plans, artist renderings of interiors, architectural models of the exterior and even display suites and site tours.

Buyers are usually only required to pay a deposit to the developer or their real estate agent when signing a contract to purchase the property, usually between 5% to 20% of an estimation of what the property will be worth once it is built, although this can differ from project to project. The remainder of the price can sometimes be broken up into progress payments timed to construction milestones, or may be required to be paid to the developer when the property is completed and its new owner is able to take possession.

When it comes to getting a loan to pay for the purchase, you may need to have a deposit or a predetermined portion of the total contract price already saved, or have suitable equity. However, this varies across lenders depending on many factors. The lender will also typically re-value the property prior to the final payment being made to the developer.

What are the pros and cons of buying a property off the plan?

Canstar asked buyers agent Jarrod McCabe, director of Melbourne-based Wakelin Property Advisory (pictured), what the potential advantages and disadvantages of buying off-the-plan properties were. Mr McCabe, who has more than two decades of experience in the property market, including as a former valuer, said that while the ‘pros’ included potential tax benefits, the possibility of attracting a premium rent level and the need for a small deposit, possible ‘cons’ included a higher risk when purchasing, not knowing 100% what the end product will be, and the possibility that economic circumstances could change the expected outcome. Below we explore these and other potential advantages and disadvantages of buying a home off the plan.

Potential advantages of buying off the plan may include:

• Potential tax benefits

“Buying off the plan definitely has some attractive potential tax benefits,” Mr McCabe said. “Firstly, there are significant stamp duty savings that can be locked in.”

When purchasing any property in Australia, most buyers have to pay stamp duty, which is sometimes also referred to as transfer duty. This is a tax levied by state and territory governments. When buying off the plan, some buyers can apply for an exemption or concession. Check with your state or territory government to see if any exemptions or concessions apply in your case.

Where concessions are available, it’s worth keeping in mind that the rule for calculating stamp duty can depend on a number of factors, including the location, contract price, whether you are a first home buyer and whether you’re buying the home as an investment or to live in. Canstar’s Stamp Duty Calculator can help you work out how much that might be.

Mr McCabe said if someone were to purchase an off-the-plan property as an investment, there were also potential benefits in regards to property depreciation, which could allow them the opportunity to secure income tax breaks.

Learn more: Property investment tax deductions, depreciation & stamp duty

• Potential for premium rent

“Brand new properties often attract premium rents, given the fresh and modern fit outs,” Mr McCabe said. This could be of interest if you’re planning to purchase an investment property off the plan and rent it out.

• Lower maintenance costs

“New properties are far less likely to require major repair and maintenance spending in the early years of ownership, when compared to decades-old properties,” Mr McCabe said.

• ‘First owner’ feel

“For owner occupiers, buying off the plan offers significant excitement and enjoyment,” Mr McCabe said. “Just like driving a new car, being the first to live in a new home has a particular appeal.”

• Ability to tailor new property to personal preferences

“Another pro is the potential to engage with the developer to make alterations and additions prior to the build, thereby avoiding the need to retrofit an existing property,” Mr McCabe said. “Bear in mind, this is usually only applicable to high-end, prestige properties.”

Check the terms and conditions with your developer before entering into any contract.

• Smaller deposit and more time to save

“Often only a small deposit is required, as the settlement usually occurs 12 to 24 months after the purchase agreement,” Mr McCabe said.  “This is a major benefit for first-time buyers, who can take that extra time to build their savings, thus minimising their mortgage.”

Allowing for construction time means there is a gap between paying the contract deposit and handing over the rest of the purchase price upon completion. This extra time could be an opportunity to continue building up your savings. The extra cash you accumulate could then provide more of a buffer should you encounter financial difficulty. Alternatively, you could use it to help with moving costs, or potentially put it down as extra money towards your loan deposit.

There may also be some cases where a lender does not require you to make a deposit payment upfront, which would give your savings more time to earn interest while the property is being built.

• Government grants

It could be worth checking to see if you are eligible for government help with the costs involved in buying an off-the-plan property. For instance, you may be able to get a government grant if you’re a first home buyer. The First Home Owner Grant (FHOG) scheme is designed to encourage and assist homeownership across the country. The details of the grant can differ between states and territories but in most parts of the country, it is only available to those buying new homes, including off-the-plan properties. You may want to contact your state or territory government to find out if you’re eligible for the Grant or any other incentives.

• Capital growth if property prices go up

If house prices happen to go up in your area after you have signed a sales contract for an off-the-plan-property, there’s the potential that your property could actually increase in value by the time it’s finished being built.

This lift could mean that your loan-to-value ratio (LVR) goes down. Here is an example of how an increase in property value could reduce your LVR, excluding any extra fees or costs that your lender may charge:

• Let’s say you purchase a property for $400,000 and you have a deposit saved up of $80,000, meaning you need to borrow $320,000. This means your LVR would be 80%, because $320,000 is 80% of $400,000.
• A few years later when the property is completed and it’s time to pay, the value might have gone up to $450,000. Even if you haven’t been able to save more and still need to borrow $320,000, your LVR would go from 80% to around 71%.

A lower LVR could help you avoid paying the added cost of Lenders Mortgage Insurance (LMI) – a fee which is sometimes charged to borrowers who put down a deposit of less than 20% of the total value of the property they’re buying.

Potential disadvantages of buying off the plan may include:

• Risk that the end product doesn’t meet expectations

“Buyers need to recognise they are purchasing something that doesn’t exist yet,” Mr McCabe said. “While the brochures may dazzle, the end product may fall flat. There are some horror stories out there, where things have gone awry in between the purchase date and the scheduled move-in date.

“There’s always the risk of the unknown when buying off the plan, that includes quality of construction, appliances and fixtures, as well as the aspect of the property. And that’s if the development is actually completed.”

That’s why it could be a wise investment to seek out advice from a suitably qualified professional such as a property lawyer, when considering buying an off-the-plan property. They should be able to assist you in understanding any terms and conditions before entering into a contract, and to help you navigate any issues that may arise.

• Development does not go ahead

In some cases, if a developer decides that a project is no longer viable, they could cancel the project. Typically this would mean that the buyers who have paid a deposit would have that refunded in full. However, to the buyer this represents lost time, and a lost opportunity to have had that deposit invested in another way that could have earned interest. And it also sends the buyer back to square one when it comes to finding and securing a property.

• Developer goes broke before completion

Mr McCabe said: “There’s always a risk developers can become insolvent mid way through the build, leaving the would-be homeowner high and dry, which can lead to some nasty battles with developers and builders.”

If a builder or developer does go bust, this typically means that construction work stops at the site. There are different rules in each state or territory about what happens next, and which government authority can help. Check with your local building authority. It could also be a wise idea to seek legal advice to find out your options.

• Risk of vacancy

When buying off-the-plan as an investment, Mr McCabe said another risk was the potential for it to sit vacant for a period of time. For example, this could occur when it comes to apartment block developments, where there can sometimes be a lot of similar properties hitting the rental market at the same time. This would drive up supply (the number of available rental properties) in the area, which might exceed demand (the number of renters looking for a property), resulting in the choice of either lowering rents to meet market expectations, or leaving the property vacant. This could leave an investor having to cover all of their mortgage repayments without the help of a rental income.

“If the property is of low scarcity value, premium rent may not in fact be achieved and costly vacancy periods may ensue,” he said. “For example, an investment property in high-rise developments often sees dozens and dozens of similar apartments hitting the rental market all at once, as settlements occur within a short space of time of each other.”

• Risk of property value dropping after settlement

Mr McCabe said property market supply-and-demand forces could also impact a property’s potential sale price after settlement. This means that buyers might not achieve the sale price they want – or need – to cover the cost of buying the property, which could leave them out of pocket.

“From a capital gains perspective, a ‘developer premium’ is usually baked into the cost, which is often not recoverable on re-sale,” Mr McCabe said. “There are commonly significant price reductions on the first re-sale, as the off-the-plan product is usually associated with the oversupplied new apartment sector.”

• Bank valuation changes and impacts to mortgage amount

Another risk is that lenders will typically re-value the property at settlement, which could impact the amount of funds they will lend to you. If your lender considers that the property you’re looking to purchase has dropped in value or is not worth the purchase price, they may not offer a loan that covers what you need to complete the contract.

This could mean you may need to come up with extra funds to cover the shortfall or pay LMI. In extreme cases, a lender may decide not to give you a loan at all. In this scenario, you would need to find another lender to enable you to buy the property. If you were not able to do so, this might mean that you forfeit all or a portion of funds that you have already paid to the developer or builder. It’s a good idea to read any loan documentation carefully to understand the terms and conditions prior to signing a loan contract.

• Developer might change the rules which could disadvantage investors

“There is also a heightened risk of ‘change of use’ between the off the plan purchase date and post settlement,” Mr McCabe said. “For example, developers don’t want to hold unsold apartments, so have been known to offload some to serviced apartment companies, which then lease out the apartments on the short stay market. This can significantly alter the characteristics and nature of the development, often to the detriment of owner-occupiers.”

• Construction delays

If you’re buying the property as a place to live, unexpected delays in construction could mean you are unable to move into the property as planned, leaving you in need of temporary accommodation. Or, if you’re an investor, delays could leave you unable to rent it out when you originally planned to, resulting in you missing out on valuable rental income.

However, in most off-the-plan contracts there is a safety net for buyers, called the sunset clause. This sets a time limit on the contract, so if the property is not completed by a certain date, the contract could be voidable, meaning the buyer could choose to walk away and have their deposit refunded. The risk here is that when the property is finally completed, the developer could sell it all over again – and at a greater profit – if the market has gone up. Meanwhile, as the initial buyer, you could miss out on benefitting from the increased worth of the property, and may have to begin your property purchase process all over again.

Given delays could tie up your money and impact your financial plans, it could be a good idea to check whether your contract has a sunset clause, how long the developer has to finish the build and if this matches up with your expectations and requirements. A professional conveyancer or property lawyer may be able to provide assistance here.

• Body corporate fees

Living in an apartment building or townhouse complex may involve being a part of a strata scheme, whereby you own your own apartment, but fees are charged to you for the shared ownership of common areas. Strata fees – also known as strata levies or body corporate fees – are regular fees paid by the owner that go towards regular maintenance of shared facilities such as pools, gyms, lifts, gardening, cleaning and plumbing.

It’s worthwhile considering the amenities on offer at your off-the-plan development, and whether you are willing to potentially pay extra on top of the cost of your property for the use of them.

• Interest rate changes or changes in your personal finances

In other types of property purchases, there is typically only a short gap between signing a contract and owning the property, as well as being able to actually see what you are going to buy.

For an off-the-plan property, however, a lot of things could change between paying your deposit and taking ownership. For example, interest rates could go up, which will change the amount you will need to pay in home loan repayments (either during the periodic payment schedule or at settlement). This could, in turn, impact whether or not you can afford to pay your mortgage. Either way, lenders state they will typically re-value the property once it is completed, and this could impact whether or not you are given the loan amount you need to complete the settlement process.

What can an off-the-plan buyer do to help protect themselves from risks?

Griffith University researchers recently looked into the off-the-plan buying process, reviewing disclosure information, interviewing industry practitioners and surveying buyers. The study found “opportunities to improve the system”, including some tips for buyers:

• evaluate the credibility of the builder
• consider how changes in the local property market and other economic conditions could impact the value of your home
• obtain independent legal advice on contract documents
• understand the rights and obligations associated with community living
• consider an independent building inspection
• know where to seek assistance (typically via your state or territory fair trading or consumer protection authority).

Source: The Conversation. 

One of the most important things to do before buying a property off the plan is to do your research. This could include investigating:

• the property market and any predicted rises or falls;
• how the development market is faring, such as supply chain issues or other pressures that may impact the financial health of the sector;
• the area in which you would like to buy, such as (if you are an investor) the average rent and supply of properties, now and into the future; and
• any other aspect that could help you to make a decision armed with the right information.

It’s also a good idea to do a thorough examination of your financial position, and think about strategies for action if something were not to go to plan. A professional financial adviser may be an option to consider.

And as with any financial transaction, it’s important to understand all contract terms and conditions, read documentation such as Target Market Determination (TMD), Key Facts Sheet (KFS), and find out your rights and responsibilities. It could also be wise to seek suitably qualified legal advice.

Further reading:

Buying an apartment checklist

What is the cooling-off period when buying a property?

Body corporate fees: What are they and what do they cover?

What is a strata title and how does it work?

Additional reporting: Ellie McLachlan.
Cover image source:  Franck Boston/Shutterstock.com.