Things to watch out for when buying off-the-plan

Print This Post A A A

When the property market heats up, we see an instant increase in the number of off-the-plan properties being offered for sale. With confidence returning to a market, developers seize on the opportunity to ramp up their construction and to make money while the market seems buoyant.

In the old days, off-the-plan was fairly simple. Developers, needing development finance, would offer around 20% of a development to the market at a price which reflected the market price of the day. These ‘pre-sales’ then provided the strength needed in a loan application and gave the lender confidence to advance the development funds. In return for these early sales, on what was essentially a risky product to invest in, buyers taking the risk took delivery of a property in a few years’ time for which they paid a price reflective of ‘yesterday’s’ value. Everybody won – the early buyers made money as soon as they settled and the developer sold the remaining 80% for a profit.

A strange new world

These days, though, developers attempt to sell out the entire development on irreversible contracts, which force a buyer to settle once complete, regardless of the underlying value of the property. In addition they usually attempt to set a buy price that is indicative of what they think it will be worth once settled, rather than at a discount to the future price. Suddenly the risk is placed completely in the buyer’s court, with no recompense or reward available for taking this risk.

When you buy a property ‘off-the-plan’, you are entering a contract to purchase a property prior to its completion. The builder or developer produces a building plan, and you are essentially purchasing the intention to construct.

Once the contract is signed, you will pay a deposit, and you are then required to settle on the property once it has obtained its occupancy certificate from the local authority.

When considering any off-the-plan purchase, it is important to fully understand the contract and the obligations placed on both the purchaser and the builder or developer. Some legal firms now specialise in conveyancing services for off-the plan purchases as the complexities are beyond the experience of the average conveyancer.

What to watch out for

Buying an off-the-plan property must be considered to have a higher risk for a number of reasons.

They include:

  • An inability to be sure that what is promised will be delivered;
  • An inability to effectively visualise the final product;
  • A reduction in the capacity to buy at market value – you can’t forecast market value of any area three years beforehand;
  • An inability to determine future demand for rentals, and actual future yield;
  • An impossibility to determine future demand factors, as well as the potential future supply in that same market;
  • The potential for you to reduce your ability to buy more property as you wait for the off-the-plan property to complete – while you are under contract for that property, a lender may be unwilling to advance funds for more property, effectively stalling your property acquisition; and
  • Disaster if the final product does not value up to purchase price and your lender only agrees to advance 80% of valuation – you are left with an unconditional contract to proceed, and if you are unable to raise the difference in cash or equity elsewhere, you may have to default on the contract and lose your deposit.  This will be particularly problematic for self- managed superannuation funds, where equity in other property held in the fund may not be used to raise any difference, and where, if there are not sufficient funds available to meet the shortfall and you have reached your maximum contributions limit for that year, you will run into certain default on your contract.

Other risks

Additionally, many off-the-plan contracts include a clause that allows the developer to rescind at any time, for any reason. There have been many purchasers who have bought property off-the-plan and when, some years later and just before settlement when it is actually worth more than they agreed, find that the developer exercises his or her rights to terminate and pulls out of the deal, preferring instead to reap the profits him- or herself. Developers who do this have used the buyers’ promises to buy (which are expressed in their purchase contracts), to raise funds from lenders to proceed with their developments, only to keep the profits and provide no reward to the buyers.

It is incredibly sad to see people caught up in this kind of trap, and off-the-plan purchases are particularly dangerous as you are dealing with the unknown future. It is definitely not an appropriate strategy for someone to undertake if he or she is in a weak financial position to begin with, or if they are using a self- managed superannuation fund with limited assets or available funds. In the past few years we have seen a prevalence of off-the-plan properties completed and being worth well below the purchase price and many purchasers defaulting on their contracts. Developers can, and will, pursue the contracts, forcing the buyers into difficult financial circumstances.

As an owner occupied option, an off-the-plan property may be suitable where the buyer has access to enough funds should their finance fall through or not cover the agreed purchase price. As an investment, though, they are risky and uncertain, and in most cases should be avoided.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.