Pros and cons of buying off the plan
A brand new apartment at a discounted price - sounds like an investors dream right?
While buying a property off the plan can potentially end up making you big bucks due to capital growth, there are some risks attached that any savvy investor should know.
So before you sign on the dotted line, read up on the pros and cons of buying off the plan in our handy guide below:
1. More time to prepare
A great aspect of buying off the plan is you’ll have 1-2 years to prepare yourself financially. All you’ll need to do upfront is come up with a 10% deposit, get your solicitor to look over the contract, sign on the dotted line and the waiting game begins. In that period you can start saving, without the worry of making mortgage repayments.
While the property is being built it’s wise to put money aside each month, so by the time settlement arrives you will have saved up another 10% of the property value. For instance, if the property you’re purchasing is worth $500,000 and you originally put down a 10% deposit of $50,000, you will need to save up another $50,000 to have a 20% deposit for settlement.
The reason it’s important to have a decent size deposit is because many banks have introduced stricter loan to value ratios for investors, generally requiring you to have an LVR of at least 80% (so a deposit of 20% or over).
If you want to use the money you currently have for other investment purposes, there is another option of taking out a deposit bond. Deposit bond companies will provide you with the 10% deposit if you pay a small fee and the best part is as an investor you can claim the deposit premium come tax time.
However most deposit bond companies require you to show that you have conditional approval from a bank that shows (based on your current financial situation) you will be approved for the loan.
2. Property value goes up
When you buy off the plan you’re locking in today’s price, so from the moment you sign the contract you don’t have to worry about inflation or property prices soaring skywards. And this could potentially result in a quick profit.
Let’s use the same example as before. You’ve put down a 10% deposit of $50,000 and find by the time the off the plan property is built the property value goes up by $50,000. That will mean you have made 100% on the original deposit you’ve put down.
There’s one thing you can be sure of when it comes to a developer - they want to sell. The reason is because banks won’t approve the finance for their development until they have sold most of the properties available.
Especially in the early stages when developers are eager to get as many contracts sold as possible, you are likely to find that there is a bit of room for haggling. So do your research and know what similar off the plans are selling for.
Another reason you’ll find off the plan properties at much lower prices is because buyers are always willing to pay more for properties they can see in person.
1. Builder goes bankrupt
Buying off the plan can be exciting but there are some factors out of your control, which could turn that excitement into a major property headache. One of these factors is the builder going bankrupt, resulting in the off the plan development never getting finished. This will mean you’ve lost 1-2 years, when you could have put that money towards other investments.
In some cases the builder might not even give you your deposit back. That’s why it’s important to check that there is a clause in your contract that details if the development doesn’t go ahead, you will be reimbursed in full.
You should also do some background research on the builder and go for off the plan developments constructed by bigger companies like Mirvac that have a good reputation. That way the risk will be much lower, plus you’re more likely to be approved for finance as banks prefer to approve off the plan properties constructed by reputable builders.
2. Not getting approved for the loan
It’s important to remember when buying off the plan that the developer doesn’t look into your personal finances and whether the amount you’re borrowing is right for your situation. So generally as long as you have a 10% deposit, the developer will hand over the contract.
But what happens when the off the plan property is finished and you go to get finance but the bank doesn’t approve you for the loan? It’s a risk because if you can’t settle the developer could seize your deposit and if it sells for less than what you’d agreed to pay the developer could sue you.
That’s why we always recommend ensuring you have a decent size deposit by the time the settlement date arrives. This will also act as a protection if the price of the property you have bought goes down due to a slump in the market or the bank values your property at less than what you’ve paid.
Say by the time the $500,000 off the plan property is built the bank only values it at $450,000k. If you’ve only got the 10% deposit of $50k this will mean you’d still need to come up with at least 10% to settle. So the more you’ve put aside in savings the better a chance you have of getting approved.
Quick tip: Studios are harder to get approved finance for, especially if they are under 40 square metres as they are harder to sell and appear riskier to banks. So if this is the type of property you’re going for aim at having an LVR of at least 70% (e.g a deposit greater than 30%).
To check how much you could comfortably afford to repay, punch in your numbers into our borrowing calculator.
3. Everyone’s settling at the same time
What generally happens when a large development finishes is many of the buyers will try to cash in and sell at the same time. If the off the plan property you have purchased is a unit it’s important to keep in mind when there is an oversupply of apartments, what can happen is the value of the property could go down in value.
Consider settling and riding out this period, as you’re likely to make more money selling down the track.
4. Construction goes over the sunset period
One of the biggest stories doing the rounds in the media is around developers cancelling contracts due to construction running past the sunset date and then selling the property at a much higher price. The good news is state governments are catching onto this money grab by developers. For instance in NSW the state Government has announced it will be committing to greater protections for off the plan buyers.
If your property is taking longer than expected, ensure your developer updates your contract so that the sunset date falls at a later date than construction completion. As we mentioned previously, it’s important to ensure that in the worst case scenario of you being pushed out of the contract, there is a guarantee stating you will receive your deposit back in full.
5. Finishes aren’t what was promised
When buying off the plan, you can’t physically see what you’re purchasing which means you might not receive what you had originally expected or what you were promised. Often when developers run into financial issues they will reconfigure the property to save money on things like finishes.
When buying off the plan, go for an inspection on a property that is comparable to see what the orientation of a similar space is like to determine its saleability or tenancy appeal. Also make sure your property is north facing, as this is the best position to get the most of the sun during the day.
6. High strata fees
Last but not least make sure you consider the ongoing costs like the strata fees. While a development with a big pool and gym may seem appealing, the maintenance of these amenities will lift up the cost of your strata fees per quarter.
No matter what kind of off the plan property you’re buying, one of the biggest things to look for is a good location that is close to transport and local parks. An added bonus will be if the development comes with a green communal area, as this will make it more appealing to potential buyers or renters.
For more handy tips when it comes to buying an investment property, click the link to head on over to our investment section.