Buying Off The Plan

One way of buying a quality property is to buy it either before or during construction. It is important to understand the dynamics that drive this sector of the property market.

Some developers would prefer to hold off on offering their properties for sale until they can see the optimum value (and profit!!).

However, these developers generally rely upon funding from lending institutions to pay the acquisition and construction costs. As part of the approval for such development loans the lender will, as a condition to be fulfilled before the actual provision of funds, insist that a certain proportion of the properties be pre-sold. This is the main reason why such properties are offered for sale at an early stage.

There are a number of advantages in purchasing property this way – tempered by some notes of caution.

Overriding all of the advantages of buying “off the plan” there are a number of “golden rules” of property investment generally – which apply even more acutely for such purchases:

• Before considering this type of property purchase, it is recommended to make enquiries about the reputation of both the developer and the builder. One way is by an internet search for reviews, and speak to someone who has had personal experience with that developer/builder. No matter how strong the contract seems to be to provide ongoing protection (rectification of defects etc.), if the developer/builder loses interest after they have their money there is little that can be done without incurring significant legal expenses.
• Always treat property investment as a long term investment. The costs of buying and selling are just too high! Although there can sometimes be significant short term gains to be made, such opportunities are often not more than ”fleeting” which is often only seen retrospectively!
• Location Location Location. There are plenty of new properties being built in areas which may lack public facilities, considerable distance from transport hubs and other infrastructure. Even though the initial price may seem attractive, nothing can detract from the reason why. The possibility for capital appreciation will forever be compromised by the inherent  disadvantages of the location.
• If buying as an investor – always ensure that your own financial situation can comfortably cover periods of low occupancy, increased interest rates, unforeseen repairs etc. Such expenses generally have a perceived tax benefit (commonly called “negative gearing”). Nevertheless such tax benefits are still an actual outflow of money earned elsewhere and may become unsustainable. In an extreme scenario this may trigger a forced sale.

Advantages

• A significant advantage is the opportunity to secure a quality property of your choice at today’s price – even though settlement may be some considerable time later. In recent years this has translated into substantial capital gain for the property – secured by a small deposit up-front. Such capital appreciation will be of benefit when the final funding arrangements are being finalised for settlement. Such capital appreciation, however, cannot be taken for granted.
• The construction time is often well in excess of 12 months giving the purchaser an opportunity to further build up equity.
• The end product is a “new”, contemporary, property fitted out with brand new appliances and one which will not require any significant maintenance for some considerable time. Often a purchaser has the opportunity to select a colour scheme.
• The property is also more likely to be wired with all the current communications technology. One would assume this will translate into a better rental return.

Some Notes of Caution

• Projects are sometimes delayed by many months and, sometimes, years! Whilst this is happening, the contracted buyers are restricted in their ability to invest in other property. Significant costs can also be incurred in keeping loan approvals active.
• Never exclude the possibility of a reduction in value which then impacts on the amount that can be secured by mortgage over the property and could lead to a purchaser’s default. Depending on the severity of the decrease in value – this can also be accompanied by a general exodus of buyers.
• Be aware of the limited control over the standard of finish. Hence the importance of buying from developers who have a long established reputation for building quality property and are proudly committed to rectifying any defects after completion.
• The final product may also vary from those shown in the draft documents – both in layout and finishes. Although most contracts allow the possibility of cancelling if the variations are significant – this is of little comfort if the value of similar properties have increased during the term of the contract. The only remedy will be for a return of the deposit. There is no compensation for the general escalation in values, having a deposit tied up for a significant time, legal and loan costs already incurred and the payment of stamp duty (although application can be made for a refund of this).
• Uncertainty of final financing arrangements. Lenders do not issue a formal loan approval so far out from a final settlement. It is strongly recommended that an early approach is made to a potential lender before committing to a purchase. At the very least a purchaser will get some comfort that, all things being equal when settlement time approaches, the lending proposal would fit into current loan assessment guidelines. Purchasers should also be aware (and budget for) stamp duty on the contract – due within 3 months of exchange of the contract. This period is extended by an additional 12 months if the purchaser intends occupying the property as the principal place of residence after settlement.

The Conveyancing Issues

The contract for the purchase of an “off the plan” property is of critical importance – and requires skillful examination by a conveyancing practitioner who knows what to look for. Often the conditions in these contracts run to 30 – 40 – 50 pages – and it is easy for conditions prejudicial to the purchaser to be buried in this “noise”. Such conditions may include:

• GST being added onto the price shown on the face of the contract (an additional 10%!)
• All interest on the deposit being paid to the developer. This interest should be shared between the buyer and the developer.
• Unreasonably large “adjustments” of rates paid to the developer at settlement. This is no more than an enhancement of the price.
• Other hidden charges. One example is a fee to move in!!

Whilst many of these are not huge amounts they can certainly add up to quite a few thousand dollars.

“Sunset Date”

Contracts for the sale of “off the plan” properties generally nominate a (future) date for completion and registration of the title documents after which either the vendor or the purchaser can withdraw from the contract. There is no such thing as an ideal date – although it should be set at least 6 months after the expected date of completion. There are advantages and disadvantages to both the vendor and the purchaser if the date is unrealistically short or extended.

Consider the situation where the date is unrealistically extended. The advantage to the purchaser is that he has secured the property during a time when (presumably) the market price continues to increase. The opposite is, of course, true in a declining market. Imagine how painful it would be for a purchaser to see the market price continue to decline when a purchaser is already “locked-in” at a higher price. The contract cannot be cancelled until the “sunset date” arrives and the property remains incomplete. From the Vendor’s point of view the opposite is the case. In a rising market the Vendor could be tempted to deliberately delay construction with a view to cancelling a contract already in place and selling at the then current (presumably higher) price. For this reason, a diligent conveyancing professional would always require a clause in the contract requiring that the vendor proceed with construction with due haste.

Consider also the situation where a “sunset date” is unrealistically short. Say the estimated completion and registration date is 6 months – and the “sunset date” is the same! There is a very real possibility that the sunset date will arrive before the completion and registration. This could place a purchaser in the position where they prepare themselves for settlement (pay stamp duty, loan approvals etc) and the contract is cancelled by the vendor on the verge of final settlement.

Purchasers can take some comfort from recently enacted legislation requiring a developer obtaining court consent before it can so cancel. The developer would need to convince the court that it has acted in good faith to meet the “sunset date”. The expectation is that this will restrict those few unscrupulous developers from manipulating the construction timetable to the detriment of buyers who have already been locked in to contracts.

In the situation where a contract is cancelled, either by the vendor or the purchaser, then the deposit is refunded and application can be made for refund of any stamp duty – if this has already been paid.

“Sunrise date”

A curious new provision in some contracts which is becoming increasingly common. This is a provision where a developer (but not the purchaser) can cancel a contract if the project has not commenced before a certain date. This failure to commence could be for delays with planning and building approvals, insufficient pre-sales to trigger the provision of funding or just a commercial decision to not proceed.

Land Tax

Land Tax is a state tax payable by any entity that holds property in New South Wales. It is not payable on a person’s own home nor for property with a land value just exceeding $1,000,000.00. Most individual property investors would not pay land tax, unless they own a substantial portfolio of properties.

The developer of a project would be liable for a considerable amount of Land Tax annually whilst the whole property is still being developed.

Often contracts for the sale of “off-the-plan” property contain a provision nominating a fixed amount – sometimes bearing no relationship to the amount actually paid – as the basis for adjustment in favour of the developer at settlement.

Defects

All new property has statutory structural guarantees – and the law requires a proportion of the building cost to be quarantined to cover the cost of rectification of defects. It is important to understand that this guarantee is between the owner (ie, the Owners Corporation, if strata titled) and the builder (who may not be the owner/developer).

For this reason it is recommended that the contract of sale contain a clause giving the purchaser direct access to the owner/developer to rectify defects that become apparent immediately after settlement. This is often called a “defects liability” clause and should provide such cover for a period of 3-6 months.

Inclusions

“inclusions” must be specifically set out in the contract. Will the appliances be high quality? And what about floor coverings, light fittings, blinds? A purchaser will not see these until settlement. it is important to ensure that there are no misunderstandings. It is recommended that all promotional brochures are retained and that photo records of a display suite are made for comparison for later use.

Summary

In general many purchasers have bought well off-the-plan – for good reason – but it is important to not ignore the basic rules of property investment and to be alert to any adverse movements in the property market in the period leading up to settlement.

WRITTEN by Paul Denny

Paul denny has over 45 years conveyancing experience and has assisted over 30,000 clients with their property transactions.

Contact us today on 02 48 111 554 or email info@bowralconveyancing.com.au to discuss how we can assist you with your conveyancing needs