Is now the worst time to buy off the plan?

Adam Smith 10 October 2017

Block of new apartments

In an apartment market tipped for price falls, off-the-plan properties could prove too risky right now.

Much has been made of the cooling apartment market, and the potential oversupply of units in many capital cities. With conditions softening for units, off-the-plan apartments could present new risk for buyers right now.

The forecasters at BIS Oxford Economics have predicted a marked slowdown in unit construction through 2019, as oversupply begins to take the heat out of the market. BIS Oxford Economics senior manager for residential property Angie Zigomanis went so far as to tell The Australian that apartment resales could rise at a rate faster than completions.

“The challenge for people who have recently bought off-the-plan is whether they can get the same price back when they on-sell it in a market where there are a lot of competing products,” he told the paper in September.

The risk of off-the-plan purchases

So with demand easing and previous off-the-plan buyers flooding the market with stock, is now a terrible time to buy off-the-plan apartments? To understand this, first it’s important to understand the inherent risks in off-the-plan properties.

Settlement risk

The challenge for people who have recently bought off-the-plan is whether they can get the same price back when they on-sell it in a market where there are a lot of competing products

One of the biggest dangers in buying an off-the-plan apartment comes in the protracted time between signing the contract and settlement. It’s during this period that things can really come unstuck.

When you sign a contract for an off-the-plan apartment, you generally put down a 5-10% deposit and agree upon the purchase price. The developer should be able to demonstrate sound reasoning for why the property is valued at its sale price. But even if the developer’s price seems reasonable, there’s still a major risk in the protracted settlement period.

Depending upon the progress of construction of your off-the-plan property, you could be waiting months or even years for your unit to be completed and ready for settlement. A lot can happen in that time.

For instance, NAB recently predicted that unit prices in Melbourne will fall by 2.6% at the end of 2017, and then drop a further 2.4% in 2018. That's potentially a 5% drop come settlement time. How would that play out?

Let's say you purchase an off-the-plan unit:

  • Agreed price: $750,000.
  • Completion date: December 2018.
  • Value after 5% (predicted) price drop: $712,500

If NAB's prediction plays out correctly you've lost $37,500 in property value.

This might not seem like that significant of a drop, but it could cause some major problems at settlement. When your home loan gets to settlement, your lender will value the property. They will then lend you funds based upon that value, not upon your original purchase price.

Again, let’s say you applied for a home loan assuming a 10% deposit on your $750,000 property of $75,000. The bank then agreed to lend you 90% of the property’s value, or $675,000. But when it comes time to settle, the bank will only lend 90% of the property’s current value, or $641,250. With this amount and your $75,000 deposit, you’ll have enough to cover $716,250. But you agreed to pay the developer $750,000, meaning you’ll still have to come up with $33,750.

This shortfall is what can put off-the-plan settlements at risk, and this isn’t merely conjecture. WBP Property Group’s Greville Pabst told the ABC in May that off-the-plan properties being valued below the contract price was a common occurrence.

“We conducted a study of about 1,700 properties that we value off-the-plan. We found that in up to 50% of cases the value actually came in lower than the contract price,” Pabst told the ABC.

Completion risk

Another risk to consider with off-the-plan purchases is the danger that the project doesn’t go through to completion at all.

If a developer runs out of money or goes into receivership, there is a chance that the project won’t be completed. This recently happened with Chinese developer Hua Cheng International. According to an Australian Financial Review story, the developer’s collapse put funds already paid by 14 buyers for a Hurstville apartment block at risk.

This story is an extreme circumstance, as much of the funding was obtained from offshore and unregulated lenders, but it does demonstrate the risk inherent in off-the-plan properties. Their success often relies on the financial stability of their developer.

Most off-the-plan contracts have completion clauses written in. This means if the developer cannot complete the project, your deposit will be refunded. But even in this best case scenario, you could end up wasting months and walk away without the property you paid for.

Quality risk

Quality can also be a risk when buying off-the-plan. Since you’re buying a property that has yet to be constructed, you’re relying on the developer to give you an idea of the quality and specifications of the completed property.

A common complaint with off-the-plan properties is that the quality of the finished product does not match the buyer’s expectations, or the quality implied by the developer. This is why it’s important to check your contract when buying off-the-plan. It should contain a fittings clause to ensure a certain quality of appliances and fittings, and it should also contain an agreed-upon time period in which to address faults and defects.

Resale risk

Finally, off-the-plan buyers can face difficulty when it comes time to sell. In a falling apartment market, there’s the risk that you won’t be able to recoup your initial investment should you want to sell. If BIS’s Angie Zigomanis is correct, we could see the market flooded with secondhand off-the-plan properties.

This could put sellers in a very difficult position. With a saturated market, there’s very little to distinguish one off-the-plan apartment from another, except for location and price. If you’ve bought in a location with many off-the-plan developments, you could find yourself hard-pressed to find a buyer.

So should you avoid off-the-plan?

Knowing the risks, is it a bad time to buy off-the-plan? The answer depends largely upon the circumstances.

While some cities like Brisbane and Melbourne are facing severe oversupply of off-the-plan stock, most property pundits believe Sydney’s apartment market could show more resilience.

Whether or not to invest in an off-the-plan purchase comes down to how strongly your investment is likely to grow in value and how certain you are of its quality and completion. An off-the-plan apartment can still be a good investment if it’s in an area of high demand and low supply, and if it’s being built by a reputable developer with a proven track record.

Timing is also important when considering an off-the-plan purchase. First releases of off-the-plan properties are often the least expensive, and can be enticing for buyers. But buying the first release of an off-the-plan development can mean waiting many months or even years for completion. The longer the waiting period between contract and completion, the less certainty you’ll have about market performance and the risks associated with settlement.

These are all factors to take into account when weighing up the wisdom of an off-the-plan purchase. The right property in the right location at the right time can still be a great investment. But if the property you’re considering is in an area of high supply and if the time to completion is many months away, you might want to take off-the-plan off your menu.

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