Is it safe to buy off the plan? What you need to know to mitigate risk – Part 1
For many property investors, buying off the plan is one of the most easily accessible and affordable options for getting a foot on the property investment ladder.
Unfortunately, oversupply issues and criticism over the quality of some developments are rife in the current marketplace. It’s not surprising that investing in property off the plan has developed a reputation for being high risk.
So, is it safe to buy off the plan? It certainly requires another layer of due diligence. But with education, thorough risk mitigation, attention to detail and professional advice, it can be a rewarding investment strategy. Here’s why:
What are the benefits of buying off the plan?
· Low cost entry point – You’re able to secure the property with just a deposit and finance pre-approval. The balance isn’t required until settlement giving you plenty of time to prepare.
· Lock in the price – Secure the property with just a deposit and benefit from the capital gains during the construction period in a rising market. (Of course, the opposite is also true – the market could fall leaving you at a loss – so this is where market research comes in).
· Stamp duty exemption or reduction in some states – Depending on the state, type of property and value, you may be eligible for a stamp duty exemption or discount.
· Maximise depreciation tax and minimise maintenance – Because the property is brand new, you’ll be able to take full advantage of depreciation tax, and will have minimal maintenance costs – all helping to boost returns.
While this all sounds pretty good, it counts for nothing if you don’t do thorough due diligence.
How can you mitigate risk?
So how can investors take advantage of the benefits of buying off the plan and avoid getting themselves into trouble?
The due diligence process for buying off the plan is different and more involved than that of an established property.
These are the questions you need to be asking:
1. Is the developer reputable?
Market risk aside (because that is a factor in any investment), off the plan is considered a risky strategy by many investors primarily because there’s nothing built yet. You are investing in a promise – that is, that the developer will deliver what they say they will deliver.
What you need to know about the developer and sale contract:
· The quantity, design and quality of their previous projects
· The quality of the floor plans, fittings, finishings, appliances, and parking options (will they appeal to prospective tenants?)
· If the specifications of all the above are clear in the sale contract and the process for rectifying defects is clear.
· Whether there are options for customising floor plans and fittings. Depending on the rental market in the area, this may help you add value and attract higher quality tenants.
· Whether the architect, and the construction company undertaking the build, have sound reputations.
· The workmanship and products will be of high quality with suitable warranties.
· The developer can demonstrate solid financial strength and a track record in delivering on schedule.
Don’t be afraid to ask them directly for this information. Just make sure you also do your own research – online, by visiting previous developments, and talking to the residents – to substantiate their claims.
Usually, you will inspect the property prior to settlement to advise if there are any issues with the quality and discrepancies between what was promised and what was delivered.
2. What insurance does the developer have in place?
The developer is legally obliged to have home warranty insurance in place although there maybe some exemptions to this depending on the state and building type. For example, buildings over three storeys maybe exempt, and single level stratas may be exempt if construction hasn’t started.
If a home warranty certificate isn’t attached to the contract, ask the developer why and consult your lawyer.
3. What rights do I have if the developer doesn’t meet its contractual obligations?
Sometimes the finished product will not match your original expectations. It’s important to understand your rights and the rights of the developer, and ensure these are clearly stipulated in the contract.
Issues that may arise:
· The specifications of the completed apartment are different from the contract/display unit. Bear in mind that the plans you sign off on may not have been council-approved yet and the developer will retain the right in the contract to make modifications to complete the project. The specifics of the developer’s rights should be detailed in the contract and any modifications made should not impact the value of the property.
In the event that changes do impact on the quality and value of the property, make sure the contract allows you to withdraw from the purchase and obtain a refund on your deposit. You can ask for these conditions to be added to the contract if they aren’t in there.
· The project’s completion date is delayed. The contract should state when the project is due for completion. It will also give the developer some flexibility – typically another year – if things aren’t running on schedule. If the developer fails to meet this extended timeframe, then it should state in the contract that you are entitled to a full refund of your deposit.
· The project collapses. In the unfortunate event that a project collapses, you need to make sure you will get your deposit back. Deposits should be held in a trust account which guarantees its security if things go pear-shaped for the developer. It’s also worth checking who gets the interest earned on your deposit while it’s in the trust account – you may be entitled to a 50% share. It’s something worth negotiating for during the sale process.
Part 2 of this blog, out next week, will look at off the plan financing and assessing the market.
How long does a property market take to run full cycle?
A regular question I’m asked is ‘How long does a property market take to run full cycle and how can I pinpoint the bottom of the market?’ My answer generally depends on whether it’s a capital city or regional location as the two can be very different beasts.
Understanding how the two differ and learning how to recognise the various stages in the cycles are key to getting comfortable over when to get in and when to sell.
Falling or flat markets often scare investors away as they give the misconception of poor performance. Rather, informed investors know that this can be an indication that a market is at or may be reaching the bottom of its cycle. Markets showing years of little or no growth can present exciting opportunities to buy in at the bottom of a market cycle and ride the capital and rental growth curve as it trends back upwards.
So, what IS the difference between a capital city cycle and the cycle of a resources city or town?
Regular market movements are commonplace in resource towns and the market cycles and annual fluctuations differ greatly from those seen in capital cities.
The housing market in a resources town can turn a full cycle in as little as two to three years, as it responds to infrastructure and economic development activity in the area. During a down cycle, prices and rents may roll back as much as 25% before the market moves through its cycle and begins its upwards swing.
In contrast, capital cities generally experience a full market cycle every seven to eight years with prices and rents detracting by up to 15% on average.
What this means is, investors have an opportunity to take advantage of the more frequent and pronounced growth cycles in regional areas to generate greater returns more quickly.
How do you know when a market has reached its bottom?
News reports in the media are great at telling us when a market is in steep decline, or when it’s booming. However, pinpointing when a market has reached its lowest point can be very tough as we never know the bottom has been truly reached until the market shows a consistent rise again!
This is where market research comes in. It is critical in determining what the growth drivers are for a particular area and when those drivers are likely to come in to play. Check out my recent blog on how to conduct market due diligence here (which applies to both regional and city areas).
Buying in ahead of a boom always requires some risk-taking. Industrial projects can, and do, falter from time to time which consequently impacts the demand for housing in the area. While the greatest returns in resources towns are often made by those who invest before the large infrastructure projects receive final approvals, investors should exercise caution and consider both the best case and worse case return scenarios. Get the timing right though, and you have truly led the pack and uncovered the next boom market ahead of the rest!
Capital cities also experience up and down swings but they are more gradual and less pronounced due to their population size and industry diversification. And while, as a whole, capital cities will experience a broad cycle, suburbs within it can behave differently to the broader market trend.
This means that while the city as a whole may be trending down, you will still find certain suburbs within it weathering the storm. This makes research into capital city suburbs just as important as regional towns.
When should you sell?
Each and every investor’s personal situation is different and the answer to this will depend heavily on your personal circumstances and financial goals.
While it’s true that many investors see resource towns as short term capital growth investments – getting in before the upswing and getting out before the downswing – these are fundamentally positive cash flow markets which provide ongoing opportunities for cash flow and capital growth over the long term.
When taking a long to medium term view of investing it’s important to ensure you’re financially positioned to ride out the downturns during periods when rents and equity drop.
The advantage of positively geared markets however is that yields can typically remain high enough to cover the property’s holding costs during down cycles which can help insulate investors portfolios and repayment ability.
Rather than focus on trying to pick the exact bottom of a marketplace before committing, I suggest doing your research and identifying a location with sound dynamics and growth prospects – if the market has performed well in the past, been through a decline and levelled out in recent years, chances are it may be poised for a recovery.
How to negotiate like a pro and tip the odds in your favour!
This blog follows on from my two previous blogs which provided a thorough overview of how to conduct due diligence on both the market and your identified property. If you’re now at the stage where you’re confident the property ticks all (or enough) of the boxes, then it’s time to make an offer!
The next stage of the process is just as important. How do you approach the negotiation process to ensure a swift close at the best possible price?
I touched on a few negotiation tactics in a recent blog. Here I’ll discuss the process and approaches in more detail. (Note: this blog relates to private sales only, not auctions).
Step 1: What is the maximum you are prepared to pay for the property?
It’s important when entering negotiations to know the maximum price YOU are prepared to pay for the property – regardless of the asking price and the level of buyer demand. As I’ve said before, this is an investment. It’s not your home. Its purpose is to make you money, so you need to know your price limit and stick to it.
Having done your market due diligence, you should already have a very good idea of the local market conditions and the level of demand for housing in the area. This, along with detailed information on the property itself, will help you determine what you believe its real value to be.
Markets around Australia have seen a pivotal shift in recent years. Currently, there is a growing belief among industry analysts that top performing areas such as Sydney, Perth and Darwin may be reaching (or have reached) their peaks. We could start to see these markets shift from sellers markets to buyers markets, which is great news for investors. Other cities and regional areas on the other hand will be entering new growth cycles.
Information you need to determine your maximum price:
· Number of houses on the market vs number of sales – hopefully you’ll have this information from your market due diligence. An increasing number of listings and a decreasing number of sales indicate lessening buyer demand which places you in a favourable position to place an offer under the asking price.
· Property data reports – Consider utilising RP Data’s property report service where for around $40 you’ll get an estimated value and full property sale and listing history (where available). It will show how long the property has been on the market and if the price has been reduced during this time. It will also include recent sales and suburb statistics to give a complete view of the local market.
· Independent valuation report – consider appointing an independent valuer to value the property.
Take all this data into account and set your maximum price. This will then help determine your first offer. This information is now your best negotiation weapon and you shouldn’t be afraid to use it during the negotiation process to support the offering you are making. Have complete confidence in what you believe the property’s value to be and back it up with the facts.
Step 2: Have you secured finance pre- approval?
Agents and vendors love buyers who come prepared and mean business. Obtaining pre- approval can take less than 48 hours and a vendor is much more likely to accept your offer if you have been pre-approved – it will ensure your offer gets to the top of the pile if you have competition.
Step 3: What do you know about the vendor?
Find out as much as you can about the seller. Ask the agent these questions so that you have the full picture before placing an offer.
Questions to ask the agent:
· Why are they selling?
· Is it an urgent sale? If it’s a distressed or urgent sell, this will place you in a particularly strong position ahead of entering negotiations.
· What are the seller’s ideal terms? Being sensitive to their preferred settlement terms could help you negotiate a better price and/or put you ahead of the competition. Price isn’t always the only motivator!
· What interest has there been in the property?
· Have offers been made? How many? On what terms?
· How many sale contracts, building reports and inspections have been requested/completed?
These last three questions will give you an idea of the level of buyer interest.
Step 4: Making your first offer?
Asking prices are generally set to accommodate negotiations; agents fully expect buyers to make their first offer below the asking price. Where possible, try to make the first offer so that you control the negotiation process and have the last right of response.
· In a sellers market, placing your first offer close to the asking price is fairly standard. Where demand is particularly high and time is of the essence, consider going in with your best offer straight off the bat and sticking to it.
· In a buyers market, some investors will start off as low as 20% below the asking price. Bear in mind that going in too low can cause the vendor to shut you out. Make sure you back your offer with your supporting data.
Whatever the market conditions, don’t let the agent know you are too interested. Advise them that you’re considering multiple property options and intend to make a quick decision. This shows the agent that you’re a serious buyer and they may miss out on the sale if they don’t move quickly to bring the deal together. Always show that you mean business by presenting your offer in writing with a 10% deposit cheque.
Step 5: How to close the deal?
The agent will relay your offer to the vendor and then let you know whether it has been accepted. You may need to revise your offer several times before you come to an agreement.
· In a sellers market, one tactic to close a deal quickly is to set the timeframe in your favour. This aims to put pressure on the vendor and remove the opportunity for further offers and more competition. Place a 24 hour expiry clause on the contract requiring the vendor to begin negotiations with you within that timeframe or run the risk of missing out.
· In a buyers market, if you’ve gone in low, make sure youleave room to move. If you know the seller’s ideal terms, use this to gain an advantage by offering better terms if other parties should come to the table.
Just remember, you won’t win the game every time. Rather than feel disappointed, feel empowered by the fact that you knew when to walk away, ready for the next ideal buy!
Step 2 to conduct due diligence like a pro
In my last blog I discussed a simplified due diligence process to help you undertake market risk assessment in a more manageable way.
As promised, this blog will set out the due diligence process that you should follow once you have identified a potential investment property.
When get to this point, it’s important not to let your emotions take over. If you’re satisfied with your market due diligence, you may think you’re onto a winner. But failing to thoroughly investigate the property itself can have dire consequences.
No one wants to find out months into having purchased an investment that it has serious issues which could significantly affect your return. Identifying potential issues will help you avoid buying a dud or it will arm you with the ability to negotiate on purchasing terms.
While your settlement agent will be able to assist with some or all aspects of your property due diligence, it’s essential that you’re aware of what’s required. It starts with asking the vendor for a copy of the contract of sale.
The contract of sale contains information on what the vendor is offering to sell you – but it’s not always clear and the standard inclusions will vary from state to state. Below is a list of what it may or may not include. Where information is not included, you should source it for yourself, or request that the vendor provide it as a special condition of the contract. What is provided to you by the vendor should be checked for accuracy. Even if you never intend to occupy the property yourself, these factors can affect the property’s value and its tenant appeal.
Your property due diligence check list:
1. Land survey – Ideally, the sale contract will include a plan of the land, or land survey, (standard in some states) but it many cases it won’t. A land survey is particularly important if you are intending to sub-divide or develop. Lenders also often require an up to date survey.
How to get one: If you haven’t been provided with one, you can source one from the state land authority or, you may need to appoint a surveyor to undertake one. Even if you are provided with a survey, you’ll need to check that it’s consistent with the actual property and you still may need to appoint a surveyor.
What the survey will provide:
· The dimensions of the land
· The location of the property in relation to other houses and cross streets
· Identification of any easements which may permit a person (usually a government authority) to use your land for running electrical mains or drainage. Easements can affect how and where you build on that land.
· Identification of any restrictive covenants which may prevent you from using the land in a particular way such as not building above a certain height
2. Sewer plan – this shows the location of any sewer mains and the property’s connection to them. As with electrical and drainage easements, if your property contains a sewer main, it may affect your use of that land, potentially preventing you from building on it or near it.
How to get one: Your local water authority will be able to provide you with information on your water and sewerage connections and a sewer plan (for a small fee).
3. Zoning or planning certificate – Zoning information may be included in the contract for sale in the form of a zoning certificate or as part of the Certificate of Title (depending on which state you’re in). It will inform you of what the property can be used for, what planning and development regulations apply and whether it has sub division potential.
How to get one: Your state land authority or local council will be able to provide you with an official record of the property’s zoning for a fee.
4. Local planning and development documentation – in some states, the vendor will be obligated to provide information from the local council indicating whether any works are planned on adjoining properties, local roads etc which could affect the use and value of the property. It’s also worth checking with the vendor or agent if there have been any problems with the neighbours.
How to get this: The local council will be able to provide you with information pertaining to civil development plans and building approvals in your area.
5. Building inspection and termite reports – You must ensure that the building’s structure is sound and not affected by termites if the property is located in a problem area. If buying a strata property, providing this information will be the responsibility of the owners corporation.
How to get this: You may be able to request a building inspection report from the vendor using your chosen licensed builder or architect as a special condition of the contract. Alternatively, you can undertake this yourself with your chosen person.
6. A list of fittings and chattels included with the property – this might seem obvious, but sometimes what the buyer expects and what the seller is offering can vary. Items that can require clarification include carpets, blinds, certain appliances, garden sheds etc. If in any doubt, make sure you check what fixtures are and aren’t included and have these clearly stipulated in the contract.
7. Additional considerations for strata properties – If you’re looking to buy a property under a strata scheme there is some additional due diligence to be done. You’ll need to find out what strata levies you’ll be required to pay, if the financial position of the strata company is solid, and assess its ability to maintain the property and its building insurance policy.
How to get this: You’ll be able to request all this information from the strata company (owners corporation).
Once you’ve satisfied your market due diligence and property assessment criteria, then it’s time to put in your offer!
NEXT WEEK – How to negotiate like a pro and tip the odds in your favour!
Conduct due diligence like a property expert in 4 easy steps
I’ve blogged regularly on the importance of research and due diligence when investing in property.
Risk is one of the biggest obstacles to investment for many property investors. Everyone has different comfort levels – some of us are prepared to take greater risks for greater returns, others are happy with lower returns if it means lower risk.
Risk assessment is a critical element of the purchasing process, but how many of us really undertake comprehensive due diligence?
It’s common for investors to get caught up in hype or act hastily out of fear of missing out. As a result, they skip over or rush through their market research and property assessment.
For others, a full understanding of the risks, getting comfortable with them, knowing the worst case scenario and how they would deal with it is the only way they can overcome their fear and take the plunge.
Risk evaluation can seem a very daunting thing. I have provided comprehensive lists of research areas in past blogs. This time, I thought I would suggest a more simplified due diligence process to help make it more manageable. I have split this into two parts. This blog covers the first part – market due diligence. The second part will cover property due diligence and will be the subject of my next blog.
Right, you have your deposit, you know your borrowing capacity and you have your investment strategy in place. You’ve done some initial groundwork and, depending on whether you’re seeking cash flow or capital growth, you think you’ve identified some potential markets. Now it’s time for the nitty gritty.
The four questions to ask yourself when doing your market due diligence:
1. What will drive market growth?
For our investments to deliver us strong yields and/or capital growth, we need demand for accommodation in our chosen area to outstrip supply. This requires us to identify some solid drivers of sustainable population growth. Local and state governments often publish economic reports on towns, cities and suburbs which provide population and housing projections and predict shortfalls. This information is useful but make sure you look at what factors they are using to reach these predictions, when the reports were published and if they match up with your own research outcomes.
Look for as many of the following growth drivers as possible. These factors can all have a positive effect on population growth and will greatly improve the growth prospects of an investment:
· Proximity to good existing or planned infrastructure and appealing lifestyle amenities such as public transport, shopping and entertainment precincts, good schools, parks, rivers and beaches
· Urban development and revitalisation projects
· Industrial development – the more projects the better. Exercise caution with single-project towns – if the project should run into trouble the property market will suffer swiftly and drastically.
Where can I find this information? Information on infrastructure and urban development planning can be found on the local council’s website and the state government’s department of planning website.
2. Where is the market at in its cycle?
It’s no secret that the best time to buy in an area is ahead of the growth cycle. Buying in at the peak means you’ve missed the boat. Suburbs, towns and cities will all go through cycles – it’s not difficult to evaluate if the market is a buyers market (what you want) or a sellers market. You just need to know where and how to access this information.
Where can I find this information? Source historical sales information (for a small fee) from the relevant state’s statutory authority on land information. For example, Landgate if the property is in WA, Land and Property Information if it’s in NSW, Land Victoria etc.
For historical listings data, you should be able to request this from your state’s Real Estate Institute. Run a comparison of the number of properties for sale and the number of properties sold over the last six months, 12 months, two years and five years. This will give you a comprehensive picture of the market’s cycles and what stage of the cycle the market is currently in. An increasing number of listings and a decreasing number of sales indicate the market is in a downcycle creating a buyers market.
3. What residential development is planned?
Any increasing demand for property in your identified area will be greatly softened if you haven’t accounted for increasing supply. Find out what residential development is underway or planned for the area.
Where can I find this information? Information on land releases, development areas, planning applications and building applications can be found on the local council’s website.
4. What type of housing will be most in demand?
To determine the type of rental accommodation that will be most in demand you need to know what type of people make up the local renting market.
Where can I find this information? Council websites and the Australian Bureau of Statistics (though be aware this information can be out of date) can usually provide you with information pertaining to the area’s demographics, type of housing and the proportion of the population that is renting. But to ascertain the demographics of the renting population, you’ll need to speak to several local agents. They will be able to provide you with a profile of typical renters in the area which will enable you to identify the type of housing most likely to be in demand, whether it be houses, units or apartments and whether there is a preference for new or older style accommodation.
5. What is the worst case market scenario?
Understanding and planning for the worst is an essential step for stress-free investing. A solid back-up plan that you can easily initiate if the going gets tough will give you complete peace of mind. The worse case scenario with any property investment is negative growth and a vacant property.
How do I plan for it? Property in general is a fairly low risk and stable investment. Having done thorough due diligence to this point, you should be in a position to make a well-informed decision. But successful and experienced investors know that you still need a plan B. You need to know your financial limits.
For example, if you plan to negatively gear a property, at point would you no longer be able to afford the interest payments if rates were to rise or the rent dropped? Reducing the risk of not being able to afford your monthly payments is one reason why positively geared property has risen in popularity in recent years. But regardless of gearing, how long would you be able to maintain the interest payments with no rental income if the property was vacant? A rule of thumb is to give yourself a buffer in case of emergency by having the equivalent of four weeks rent in a savings account.
Taking the time to work through these key points will arm you with the knowledge and understanding required to make an informed decision on where and when to buy. Investors who do their due diligence stand a much better chance or getting their investment purchases right the first time and creating a successful portfolio sooner.
NEXT WEEK – Due diligence made easy – your step by step guide: Part 2 – The Property