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Buying "Off the Plan"


One way of buying a quality property is to agree 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, I am sure, 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, which cannot be merely overlooked. 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:

  • 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 a ”fleeting” opportunity, which is sometimes only seen retrospectively!

  • Position – position – position. There are plenty of new properties being built in poor areas – lack of public facilities, distance from transport hubs and other infrastructure. Even though the initial prices may seem attractive, nothing can detract from the reason for these. They are lower for a reason – and the possibility for capital appreciation will forever be compromised by the inherent disadvantages of the location.

  • Always ensure that your own financial situation can comfortably cover periods of low occupancy, increased interest rates, unforeseen repairs etc. Such expenses generally will 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 can go “over” 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.

  • One can 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. This situation may then “feed on itself” and it take years for prices to recover.

  • 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 – with 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. No lender is going to issue a formal loan approval so far out from a final settlement. However 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.

THE CONVEYANCING CHALLENGES

Unlike buying a property which is already established the actual contract for the purchase of a new 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 in to 30 – 40 – 50 pages – and it is easy for conditions prejudicial to the purchaser to be buried in this “noise”. Such conditions which have been noted over the years 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 – which are no more than an enhancement of the price.

  • Other hidden charges. Some examples we have seen are a fee to move in and an additional fees if the purchaser requires a “face to face” settlement – rather than an “electronic” settlement!!

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 now take some comfort from recently enacted legislation requiring that a developer now obtain court consent before it can so cancel. Although this legislation has only recently been enacted it does apply to contracts already in place at that time. The developer would need to convince the court that it has acted in good faith to meet the “sunset date” Although it is early days, 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 in a contract 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 complications 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 approaching $500,000.00 – which amount is adjusted annually. Most individual property investors would not pay land tax – unless they own a substantial portfolio of properties.

The developer of a project would, because of the substantial value of a building site, 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 far in excess of the amount actually paid – as the basis for adjustment in favour of the developer at settlement. Again, this is a contract provision which a prudent conveyancing practitioner would request be removed from the contract.

Defects

Although all new property has statutory structural guarantees – it is important to understand that this guarantee is generally 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

The big issue around “inclusions” is that these must be specifically set out in a schedule to the contract. Will the appliances be high quality? European – or basic “cheap” models from developing countries? And what about floor coverings, light fittings, blinds? Because a purchaser cannot see these it is important to ensure that there are no misunderstandings. We recommend 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.

#Buyingofftheplan #conveyancing #paulsopinion

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