Managing Risk When Buying Off-The-Plan Properties

As buying off-the-plan properties becomes more common, industry experts say buyers need to be aware of the increased risks involved and protect their investment.

What does buying property off the plan mean?

Buying a property “off the plan” means that a person is buying a property that hasn’t yet been built, and the decision to buy is made solely on the basis of the planned construction. People can view the building and design blueprints or plans, and sometimes artist renderings of the prospective interior, but there is usually no physical display unit to visit and inspect. The most commonly bought off-the-plan properties are apartments, units and townhouses.

Investors often choose to buy off the plan because it means buying a property at today’s prices that will hopefully be worth more money by the time construction is completed in a year’s time or more. While there is less stamp duty payable on off-the-plan properties, it’s not always good news.

Research from Domain shows more than 50% of new apartments bought and re-sold in the 5 years to 2016 in Melbourne sold at a loss, with Carlton, West Melbourne, and Docklands the worst performing localities for off-the-plan apartments.

It’s not all bad news though either – with careful planning and preparation, you can still make a profit.

How can you decrease the risk when buying off the plan?

Director of EPS Property Search, Patrick Bright, says people should consider that there are more risks involved in buying off-the-plan properties because it is a speculative investment. He advised buyers to take precautions to prevent nasty surprises.

Property market crash

Risk: Many investors buy off-the-plan with the intent of reselling the property once it is built, banking on the chance that the real estate market will go up and make their property worth more in the future. But the market has been known to fluctuate unexpectedly.

A buyer can over-pay at purchase, or the market can go down so that the property is worth less at completion than what they paid. Then when they have to finance the property at point of settlement, the bank may not give them full finance, leaving them in negative equity. Buyers then risk being sued for non-performance by the developer and losing their 10% deposit.

It is also more competitive than ever before to buy off-the-plan property, as more foreign investors are snapping up these properties. Prices can be pushed higher as a result.

Solution: Firstly, don’t rely on shiny brochures – get an independent property valuation. Don’t pay a premium; instead, buy at a discount to offset the risk you’re taking.

Secondly, find an experienced lawyer who specialises in off-the-plan conveyancing, and have them add a protective clause to the contract allowing you to terminate the contract if the market drops. Such a clause would state that the buyer is purchasing on the basis that the property is worth the price paid. If the completed property’s value (as assessed by an independent valuer) is below that, then the buyer is not obliged to settle and the buyer’s deposit will be refunded.

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Developer might go bankrupt

Risk: If the developer goes bankrupt, the buyer is likely to lose their deposit because they have to wait in line with every other creditor (everyone else who has given money to the developer).

Solution: Research a developer’s background and previous properties to see if they are reputable. Ask a conveyancing lawyer for advice if you’re not sure.

Delays in construction

Risk: Delays in construction can mean the buyer cannot move in when they expected, leaving them needing temporary accommodation. Or delays can mean the buyer cannot rent it out when they planned, missing out on that rental income.

Then there is the sunset clause, a contractual time limit designed as a safety net for buyers. If construction is not completed in a certain timeframe, the contract is void and the buyer’s deposit is refunded. When the property is finally completed, developers can sell it all over again – and at a greater profit, if the market has gone up. Meanwhile, the initial buyer misses out on benefiting from the increased worth of the property, and has to begin their search for the right property to buy all over again.

Solution: Make a sunset clause work in your favour – alter the clause so that if the contractual time limit runs out, the buyer has an option to buy at the initial agreed price instead of an increased price.

End result not be as advertised

Risk: Buyers can be dissatisfied with the appearance or functionality of the completed unit. Developers are entitled to substitute items of similar quality to that specified in the contract for “finishes”. From fittings such as lighting, carpets, and dishwashers, to fixtures such as plants in the garden, there are a lot of things that can be changed. It is therefore important to specify quality brands for fixtures and fittings in the contract, to set the “benchmark” expectations for the developer high.

Buyers must be notified when changes are made, and you can terminate the contract if anything important is deleted or changed, such as a car parking space, a balcony, or body corporate rights. Once the property is completely built and settlement has occurred, the buyer has a certain timeframe (usually 3 months) to inspect the apartment and notify the developer of any flaws.

What’s more, shrinkage clauses are a standard feature in off-the-plan contracts. They allow the developer up to 3% ‘shrinkage’, meaning they can produce an apartment 3% smaller than advertised. This reduction in space is unavoidable by the buyer.

Solution: Make sure you have input into what “finishes” (fixtures and fittings) are chosen and specify these in the contract. Be sure that you will get what you’ve paid for. Avoid shrinkage clauses like the plague, or look for a minimal shrinkage clause.

Difficult to get homeowners’ warranty insurance

Risk: Developers are required to take out homeowners’ warranty insurance (a.k.a. home building compensation) to compensate a buyer if:

  • The building is incomplete
  • There is defective work
  • The builder or developer goes insolvent, dies, or disappears, or
  • The builder’s licence is suspended.

However, the two main exceptions to this requirement are buildings of 3 or more storeys constructed after December 2003, and certain types of retirement villages, which covers a lot of off-the-plan development properties.

Solution: There is currently no perfect solution, so look for a discounted price that reflects the lack of insurance.

At the end of the day, the decision about whether or not to buy off the plan should be made after obtaining independent financial and legal advice and making a careful evaluation of your current financial situation. Whether you decide to buy an existing home, build from scratch, or invest in a development, you should compare home loans on our website to find the best deal.

Below you can view a snapshot of the home loans available on the Canstar website with links direct to the providers’ website. Please note that this table has been generated based on a $600,000 loan in NSW, with a display sorted by current rate (lowest first).

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