Last week I witnessed the glorious sight of 120 women drinking wine and listening to a seminar on getting started with investing.
Girls Just Wanna Have Funds was a puntastic pleasure. I liked Molly’s description of investment being like the free weights room at the gym: full of men and very intimidating.
(Personally, I am that bitch – the one who struts around the weights room, frowning at men who don’t unrack their weights).
Anyway, the seminar focused a lot on listed investments such as shares and ETFs. This is great, because they can be a wonderful way to get started. (Click here for an explainer).
But I know that when many Australians think of investment, they think of property. And so, I wanted to talk about something in the news recently: buying off-the-plan apartments.
I know people who have done this successfully, so I’m not here to throw shade at the whole idea.
But when a big developer went bust last week, it added to the negative headlines around this sector. Remember the infamous Opal Tower, whose residents were evacuated at Christmas thanks to some big concrete cracks? It was followed by a similar issue in Mascot recently.
As a result, people are scratching their heads about whether purchasing off-the-plan is such a great idea. So, let me give you a quick rundown on the pros and cons of this style of investment.
Why do developers sell off-the-plan?
So they can borrow money to build. Most developers don’t just use their own money for a project; they usually need a loan.
And the lender wants to know that buyers have put their money on the table to provide ‘debt cover’ for the loan. Once the lender feels comfortable that they could be repaid if things go wrong, they’ll stump up the money for construction to start.
Why do people buy off-the-plan?
Lots of different reasons, but here are some:
- Brand spanking new – nobody else has lived there when you move in. Some people really like that. You can often choose the fixtures and finishes too, so it is like buying a made-to-measure wedding dress – the design is standard but the details are yours.
- Lock in a price upfront – this is appealing in a rising market. Say you agree to pay $500K and then the market rises by 5% over the next year – your asset has increased in value by $25K without you doing anything.
- Have time to save up – the time that the developer spends marketing and building the property is often a couple of years. So, you have that time to keep saving and boost your deposit/reduce your mortgage – all the while knowing you have locked in a price that won’t go up.
- Depreciation tax benefits – when you buy a property as an investment, you may be able to claim ‘depreciation’ as the property ages. It’s quite complicated, but it can give you some tax benefits.
So, there are definitely upsides to the idea. But there are some risks to consider too:
The project may not go ahead. The developer normally has to wait and sell a good chunk of the units – maybe 75% or more – before building can start. In the market peak, when projects sometimes sold out in days, that wasn’t such an issue. But at this point in the cycle, sales have slowed significantly.
So, it could take months or years to reach the minimum debt cover; and in the worst case scenario, they never get there. That doesn’t mean you lose the deposit – you have just have that cash locked up in some sort of trust account, earning little to no interest. The contract should have a sunset clause that says if the project doesn’t start by X Date, the buyers can have their money back. So, be clear what that date is when you sign up!
The value of the property might fall by the time it’s finished. As explained above, you can make money in a rising market by locking in a price and just waiting. Perhaps that $500K unit is worth $550K the day you move in.
But in a falling market, it can lose value instead, and the unit is now valued (by a professional valuer) at $450K.
It’s only a paper loss at this stage – i.e. you don’t lose the money until you sell it. But where it can cause trouble is if you’re getting a mortgage. The bank will agree to lend a percentage of the VALUE, not the PRICE. So, if they are providing 80%, it’s 80% of that $450K. If they won’t go any higher, you need to find the extra money somewhere else. If you can’t find it, you may have to walk away … and lose the deposit.
The finished building may be poor quality. That’s what happened with the Opal Tower. Most finished buildings end up with some defects, anything from broken tiles to leaking windows. Many only appear over time, and the builder is contractually obliged to fix them within a certain period from completion.
It’s when that period is over, or when the cause of the problem is unclear, that things can escalate.
I should point out that this isn’t unique to new buildings. My own apartment block is 20 years old and had a very expensive water seepage issue a few years ago. That’s why the strata has insurance and collects a sinking fund. Although if that’s not enough, you can get hit with a ‘special levy’. Home ownership can be hard!
The developer could go broke before it’s finished. This is a remote risk, but the key is to be aware of what your contract says. We don’t know all the facts yet, but word on the street is that Ralan, the developer who just collapsed, had convinced its buyers to release their deposit to cover interest costs. This is highly unusual – some are saying it’s even illegal – but the fact is, everyday buyers wouldn’t have realised what they’d signed up to.
And if it’s true (as some have suggested) that the conveyancers they used were recommended by the developer, it’s even fishier.
Life pro tip: whatever big purchase you make, always get your own, independent advice, from mortgage brokers through to lawyers. Don’t use the people your vendor recommends!
So, should you buy off the plan?
It’s totally up to you. Like every single investment, there are risks and rewards. The key is to see them all in advance.
One option is to buy recently completed apartments – this ‘residual stock’ may be marketed as ‘Final Release’ and is made up of the units that weren’t sold in the pre-sales period. They don’t want to dump them on the market in a fire sale, so they sell them off one by one. These are an option if you want a brand new place, but also want to see it first – like a wedding dress that’s ‘off the rack’.
Overall, any investment comes down to your personal goals and preferences. Buying property for investment creates concentration risk – i.e. putting all your eggs in one basket – but some people like the feeling of being able to see and touch their investment. If you’re buying to live in it, the risks (and benefits) can be different, but they still exist.
Before you make any decision, be sure to have a clear view of your timeframe, risk appetite and lifestyle preferences. And please, if you do go ahead, get decent legal and tax advice. Think of it as part of the cost – you need someone providing you with objective advice and pointing out any red flags.