Is it safe to buy off the plan? What you need to know to mitigate risk – Part 2
My blog last week looked at what you need to know about the developer and contract of sale when considering an off the plan property investment.
So what about financing an off the plan property? And how do you mitigate market risk?
1. What happens if I can’t get finance when I’m required to settle?
This is where many investors get caught out with buying off the plan. Once you have entered into the contract, you are required to settle by the agreed date. If you can’t fulfill this commitment you may be forced to sell (potentially at a price lower than the original contract price) and could risk being sued by the developer.
Make sure you’re fully aware of the following before signing on the dotted line.
- Obtaining pre-approval can be challenging. Loan pre-approval from your lender will be required for you to complete the contract of sale with the balance due at settlement. Banks are conservative and won’t lend for something that doesn’t yet exist. They are typically only willing to expose themselves to a certain number of off the plan developments so this can restrict your ability to get pre-approval from certain banks. Because the property doesn’t yet exist, obtaining pre-approval can be challenging when it comes to buying off the plan.
- Your pre-approval may not stand until settlement. The banks will usually impose additional conditions on off the plan pre-approvals because of the ‘unknowns’. These include market movements, interest rates, your personal financial situation etc – all of which can change in the time it takes for the project to reach completion.
The bank may impose a time limit on the validity of your pre-approval and will conduct another review of your financial position when the actual loan is required. When they do lend, which will be close to completion date, finance will be based on the value of the property at completion, usually at a loan to value ratio of 80% – 90%. This means if the market has dropped and the value of the property is less than it was when you signed the contract, you will need to find other ways to fund the shortfall – unless you’re able to obtain a better valuation from another bank.A shortfall situation can usually be avoided with careful market research but it’s still wise to be prepared. Aim to have l0% of the property’s value on hand (in cash or equity) by settlement so that you are not caught short in the event of a market fall.
2. Is there going to be demand for my property when construction is complete?
Market research when buying off the plan follows the same principles as any other property investment. It is absolutely an essential step in the buying process to ensure you’re not going to be left with a property you can’t rent out or a loan that’s greater than the value of the property.
Assess the supply pipeline in the area and the drivers of population growth, and then determine whether an undersupply or oversupply is likely. Two key areas to investigate:
- What else is being built in the area? Look at other developments under construction or in planning and compare location, developers, price, quality etc. Investigate the quantity of development and what impact this supply pipeline will have on future demand.
- Who makes up the rental market and will your property be appealing? Understand who makes up the rental market in the area and make sure your property (both in terms of quality and location) will be desirable to this demographic. Professionals, students and empty nesters – the three main groups that make up apartment dwellers will all have different requirements and expectations.
3. Is the property a fair price?
Based on the above research, do you feel the developer is asking a fair price for the property? Prices for off the plan apartments can be over inflated.
Don’t be afraid to open negotiations and back up them up with market data and comparisons with similar properties.
You may not be able to get them to move much on the price but asking for furnishing and appliance upgrades and packages, a share of the interest earned on your deposit or a rental guarantee on completion are a few ways that you could sweeten your deal.
Don’t discount off the plan investments, just be smart!
Get a lawyer experienced in off the plan contracts to review yours in detail. Off the plan contracts will always, unsurprisingly, favour the developer.
Be absolutely informed about what you’re getting into. If you feel 100% confident about the quality of the build, market demand and your ability to cope if things go pear-shaped, then there’s no reason to avoid buying off the plan!
Are our capital cities facing an apartment oversupply?
There’s concern in the marketplace at the moment over the prospect of an apartment glut in some of our capital cities. While Melbourne has been at the centre of discussions for some time, now Sydney and Perth are finding themselves the subject of media articles on apartment oversupply.
Australia as a whole is well known for having a housing shortage, which is why property is typically seen as a sound investment.
So how can we now be facing an oversupply? Well, in short, it generally comes down to whether the right type of housing is being built in the right areas. Large apartment blocks bring plenty of accommodation to market. But small flats in the CBD only appeal to a certain demographic. Is there enough demand from single professionals and students to fill them?
New and off the plan apartments are appealing investments. They offer a host of benefits: affordability, the option to secure a property with just a deposit, minimal maintenance and the ability to maximise depreciation claims, to name a few.
Some areas, such as inner Sydney, have also delivered impressive capital growth in recent years, returning 12% on average over the last 12 months according to RP Data.
It’s easy to see why investors are drawn to these opportunities. So, should you be considering these types of investments in the current market or are you wise to stay away?
What’s happening?Inner city apartment development has gone into overdrive in Melbourne in recent years as developers have sought to capitalise on the population boom that was fuelled by overseas and interstate migration. Unfortunately, the now slowing population, coupled with many inner city complexes poor reputation for quality and below-standard floor space, has resulted in a glut.
Consequently, price growth in the Melbourne market has been poor, declining more than 2% over the past 12 months and vacancy rates are at 4.6% (SQM Research).
What can we expect? The outlook from BIS Schrapnel’s latest housing report isn’t rosy with continuing poor capital growth and vacancy rates predicted to rise further over the next 12 months.
What this does suggest is that the market is bottoming out. The next couple of years may provide investors with an opportune time to buy in low before the market turns. Selecting quality properties from reputable developers will be key.
What’s happening? Sydney’s inner city apartment market is caught in the middle. On one side there are those who are confident the market will remain undersupplied for at least the near to medium term. On the other, there are those concerned over the influx of Chinese developers and the growing pipeline of supply.
Currently, there is still strong demand from young professionals and students – plenty it seems to absorb supply. However, it could be a different story in a couple of years.
What can we expect? BIS suggests that the level of supply hitting the market combined with affordability issues from skyrocketing price growth could see a price decline in 2016. As I have discussed frequently in my blogs, understanding how to read property cycles is essential to maximising returns. Consider where Sydney CBD apartments are at in the property cycle and what returns are likely before it peaks and enters decline.
What’s happening? Perth has also experienced a surge in inner city development in recent years driven by the resources boom and the ensuing large workforces.
Unfortunately, the mining downturn is now having the opposite effect – rising vacancy rates (sitting at a very undesirable 9% for city units according to RP Data) and slowing price growth have been well reported.
What can we expect? Perth as a whole certainly appears to be trending downwards and BIS forecasts this trend to continue for at least the next three years. As with Melbourne, this presents an opportunity to buy in ahead of the next upswing. Agriculture is tipped to be the next driver of economic growth in WA and investment in civil infrastructure, particularly in inner city areas, will create a highly desirable lifestyle that will help drive the next boom cycle.
For investors already in these markets, a long term strategy is required, with the possible exception being Sydney where some capital gains could be realised in the next 12 to 24 months if nimble investors keep their finger on the pulse.
For those ready to invest now, I would suggest keeping your eye on the Perth and Melbourne apartment markets over the coming months and re-evaluate the situation in 12 months time. In 2014, consider other housing types and locations where demand drivers are more favourable.