Risky business–buying off the plan in a flat market

Construction site - buying off the plan

Construction site in Thailand

Buying a property off the plan means that you are buying it before it has been built. In our most populous capital cities of Sydney and Melbourne, this form of purchase will only get more prevalent as the population grows. As it is, there are a multitude of medium density housing, that is units and apartments, land and house packages that are available on the market in many suburbs which are further away from the CBDs.

One of the most attractive propositions of buying off the plan is that you are buying a property in the future at today’s prices. In a strong and bullish property market, this may result in a large capital gain on paper by the time you move in and indeed, many speculators have made huge sums of money this way. The key assumption here is that prices will rise in the future. But what happens if we are in a flat market or there is an imminent downturn in the property cycle? It becomes extremely risky for the following reasons:

1. Reputation of the developer – This is a key factor as experienced developers are more likely to complete the project on time, within budget and in accordance to the terms and conditions of the contract of sale. Some of Australia’s most prominent developers are listed on the Australian Stock Exchange and although this is no guarantee of quality, it provides some level of credibility over smaller ones, especially during flat markets. There have been developers who “flee the scene” during financial hardship where deposits from buyers have already been collected.

2. Rising costs of construction – Today’s developers are faced with ever rising cost of land, construction materials, labour and finance charges. Buying an apartment off the plan is no longer a straight formula of calculating the price per square metre because developers also need to make a fair profit for the risk they undertake. As a result, apartments sold off the plan are becoming increasingly expensive in absolute dollar terms. The task of the skilled developer is to be able to balance “perceived value” against the asking price and as a buyer, you need to be able to carefully determine and quantify what this value is. Many newer apartments are smaller in size and there is an increasing number of new one bedroom apartments within close proximity to CBDs that do not come with a car space. This, in part, is also due to changing demographics such as smaller / single households, rising value or real estate around CBDs and significant marketing and holding costs.

3. Stagnant prices – In a flat market, the off the plan buyer is essential bearing a significant amount of risk because prices today are likely to be prices in a couple of years time with little or no upside. Unless off the plan buyers are also intending owner occupiers, it makes little sense as an investment proposition in a flat or downturn cycle.

4. Occupant profile – Many new apartment blocks are now being marketed to foreign and overseas investors and in some cases, a very significant majority of eventual occupants will consist of tenants as opposed to owner-occupiers and unless management and body corporate maintenance is effective, these apartment blocks will depreciate more quickly and worse still, develop a stigma of having very transient occupants and affect future capital growth.

5. Finance approval – Due to tighter lending guidelines, major banks now have restrictions of 15% for lending to any one off-the-plan project to limit their exposure to inherent risks. In many cases, pre-approval cannot be given as bank valuations will only be done at the “lock-up” or completion  stage of the project. Even after obtaining finance approval for these project, one may encounter issues with getting the desired  Loan to Value ratio as this is dictated by the bank’s valuation.

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