Why on earth would anybody buy a property that hasn't been built yet?

Plenty of people do, you know. It's called buying off the plan.

With our property markets flattening out at present, some investors are enticed to buy investment properties "off the plan" by the advertising hype of large stamp duty savings and cheap prices. They hope that by getting in today and settling on their properties down the track, when the property markets have moved on, they will make some money as values increase.

Does this mean that buying "off the plan" makes a good investment?

Well… like many other questions about real estate investing the answer is……. it depends.

While there are some potential advantages, there are also many potential pitfalls.

Firstly let's make sure you understand what I mean by "buying off the plan."

It means buying a property before it is actually built. This is usually before construction has commenced, but can also occur while the building is being built but before construction is finished. This is done by reading the "plans", a set of drawings and a list of finishes and not by inspecting the actual property as usual. When considering some of the larger projects, you could be lucky and have the ability to inspect a prefabricated display unit.

Properties are much easier to sell once completed than off the plan. To buy off the plan relies as much on your imagination as your ability to make a sound financial choice. It may require a great stretch of your imagination to visualize the finished product as you stand in your potential new living room in your mud splashed shoes with a tonne of sand piled in the centre of the floor. You don't really have the ability to tap the walls and feel the ambiance. Also prices achieved for completed apartments are usually higher than if they were sold off the plan.

So why do developers pre-sell their projects off the plan?

In truth the lenders who are going to provide the funds for the construction of the project usually force it upon them.  Most lending institutions now insist that before they lend any money for the construction of a multi unit project, and especially large multi storey projects, that the viability of the project is underwritten by a number of pre - sales. Usually between one third and one half of the units must be pre sold before the financiers will advance any funds.

While a few investors have made money buying off the plan, I know many more who have regretted their purchase.

When Bob, a client, asked me the other day how to distinguish a 'good' compared to a 'bad' off the plan purchase.
 
I suggested one interesting test is to look at the dollars spent in marketing the project. As soon as you see full-page advertisements in the weekend papers and very expensive glossy brochures being produced for a project, then start to become worried.  Remember, there is no such thing as a "free lunch." If 10% of the project's budgeted selling price is spent on advertising, then you the buyer have paid for this. This means YOU will have paid 10% extra for your property. 

With many high-rise inner city projects the completion date may be anything up to 2 years away. The inflated price is often buried in the advertising hype, such as "buy at today's prices," and settle in 2 years. The developers are counting on the fact that the longer the settlement period, the less chance you have of knowing if the final price will represent good value for money. 

During the last property cycle many investors who purchased "off the plan" found that the price they paid was inflated and on completion their properties were valued at considerably less than their purchase price. Many purchased their properties with the intention of on selling them at a profit rather than retaining them and didn't have the financial backing to complete their purchase. 

Also in the 2 to 3 years it took some of these large complexes to be built, the real estate market took a nosedive. Interest rates rose and we were in the middle of a property slump. Nobody was buying units. Many of these buyers were prepared to walk away from the sale, lose their deposits and call it quits. But it wasn't as simple as that. As some of these units dropped in value the developers were not prepared to allow the purchasers to walk away from their contractual obligations.

In other cases where the overall market did not change dramatically, prices of the completed units fell for other reasons. Sometimes the finish of the building was not as good as was expected and the final units were not worth the inflated prices put on them by the developer.

In other projects too many investors had purchased units but did not intend to settle at completion. Again they hoped to make capital gains by putting their units on the market on completion, but when there were so many units on the secondary market, with a whole lot of very motivated sellers, the market was swamped with stock thereby lowering prices.

What lessons can we learn from this?

Some of these problems could be avoided by buying from developers with a good track record and buying in buildings in prime locations, as there always seems to be a bigger demand for units in these buildings.

Also while buying off the plan has the potential for capital growth, if you bought a competed property it should also grow over the same 12 to 18 months you were waiting for you off the plan purchase to settle.

With a 2 or more year time frame for the completion of most high-rise projects it is very difficult to be able to predict what the future will hold so in my opinion you should receive a sizable discount for all the uncertainty of buying off the plan.

There is uncertainty about what the property markets will be like on completion, what will the interest rate be then, will the standard of finish be as good as in the display unit or will the developer have cut corners and will be built in the future alongside, behind, or in front of the project.  What appears to be great view today may be totally blocked out in 2 year's time.

So what is a "good or safe buy" today if off the plan doesn't work in this market?

At Metropole we have been able to find clients established properties well below replacement cost. Often these properties have a "twist" or upside potential and the clients can add considerable extra value.

Some are older houses on potential development sites. Others are older apartments bought in high growth suburbs than need minor superficial refurbishment.

We can organise the renovations through our renovation company and it is not unusual for clients to increase the value of their properties by $75,000 to $80,000 after spending say $40- 45,000 on sensible refurbishment.

To see some samples of renovation projects please click here

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