Is buying Off-The-Plan right for you

Is buying Off-The-Plan right for you

The key word in Off-The-Plan (OTP), for me, is the word Plan.

Let me ask you, what does your Personalised Property Investment Plan (PPIP) look like? 

So before we get into the pros and cons of buying OTP, let’s just take a moment to discuss what your PPIP actually looks like?

Having spoken with thousands of investors over the years, I am staggered to see how few investors actually have a written PPIP, which clearly outlines their objectives, strategies, and timelines effectively. To me, creating this plan is perhaps the most important step towards ensuring your success as a property investor, and yet so few actually take the time to create their own PPIP. 

Having gotten that important proviso out of the way, and assuming that buying OTP is a part of your PPIP, let us now take a look into the positives and negatives of buying OTP property.

When discussing OTP property purchases, we are referring to new dwellings that have yet to be fully constructed. That is, they have a set of plans and development approvals to construct but the actual construction (and therefore certificate of occupancy) is yet to be finalised.

Please, also be aware that there is a misconception that OTP purchases only apply to inner city high rise apartments. Such purchases can occur in any location, and be applied to everything from a single house or land purchase, to boutique infill development sites in blue-chip suburbs, all the way through to inner city high rise apartments. Therefore, it is important you understand that not all OTP properties will be equal.

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PROS:

1. STAMP DUTY SAVINGS…

Perhaps the biggest ‘pro’ is the ability to save a significant amount of money on stamp duty. For example, in Victoria, Revenue Ruling DA.048, which came into effect in October 2008, allows for stamp duty concessions to be calculated based upon the type of dwelling being built, and how far along the construction of the dwelling is. Because these calculations can be a bit dry, let me illustrate this with an example. So let’s assume we had $100,000 saved, and we had the ability to get a further $400,000 loan to purchase an investment property; giving us a total of $500,000. Of course, this is assuming this purchase is for investment purposes, you are an Australian resident for tax purposes, and you are not a first homebuyer. If this property was fully built (new or existing) no stamp duty concessions would be available and thus a sum of $26,445.60 would be payable (find out more here). 

Now, let us take a look at the various stages of OTP construction, the various types of dwellings, and the concessions available for each.

There are 2 main methodologies for calculating stamp duty concessions:

  1. Fixed Percentage
  2. Alternative Method (this requires a declaration of land values and the actual cost of construction; it is therefore more complex, and less commonly used)

Additionally, there are 3 classes of buildings

  1. Single lot freestanding
  2. Multi-lot low rise – up to and including 3 storeys (excluding basements)
  3. High rise 4 storeys or above (excluding basements)

To make it even more complex, there is:

  1. Single lot approach (used when construction work for the property, or lot, is not dependent on the completion of construction works for all properties in that development and separate approvals including certificate of occupancy can be obtained for the individual lot, or unit)
  2. Whole of Project Approach (this approach should be used for multi-lot low rise, or high rise developments, but can also be used for a single lot development)

When using the ‘whole of project approach’ the following figures are allowed:

Class of Building  - Building works component (% cost of construction of contract price)

  • Single lot freestanding  - 45% 
  • Multi-lot low rise  (up to and including 3 storeys) - 60% 
  • High rise (4 storeys and above) - 75%

Again, to try and keep this as simple as possible, and for the purposes of illustration, let’s just take a look at 3 basic examples.

Example 1. Single Lot. No Construction or improvements have occurred.
Essentially, if you entered into an OTP contract at this stage, you are only going to be paying stamp duty on the unimproved land value, as it stands at the time of entering into the contract of sale. So, say the finished OTP contract is for a single lot valued at $500,000, and we assume that the land component is 55% ($275,000), and the building component is 45% ($225,000). In this case, stamp duty is only payable on the land component (no construction has commenced) or $12,419.60. Compared with an existing (or 100% completed new dwelling) that is a stamp duty saving of over $14,000.00.

Example 2. Single Lot.
Depending on the stage of construction different amounts of concession would be available.For a single lot, freestanding construction (although the ‘whole of project approach’ can be used at 45% of contract price) the following percentages for the various stages of construction may be used as a guide when determining the percentage of works carried out at the contract date: 

  • 15% for base (slab/foundations etc.) 
  • 30% for frame 
  • 65% for lock up 
  • 90% for fixing 
  • 100% for completion

So, if construction for a single lot was at, say 37% complete (or a bit past framing stage), the ruling also allows that to be rounded down to the nearest 10. In this case, we could say that construction was only 30% complete. Using the ‘whole of project approach’, the deemed building works component is 45%. As 45% of $500,000 = $225,000, the deemed uncompleted building works is 70% of $225,000 =$157,500. Therefore, the dutiable value would be $500,000 minus $157,500 = $342,500, or a total stamp duty payment of $16,627.60.

Example 3. High rise. No construction has begun.
Again, with a contract price of $500,000, the building works component of 75% can be used in the ‘whole of project approach’. So, in this case, dutiable component is based on 25% of $500,000 = $125,000 or stamp duty of $3,248.60. That is a saving of $23,197.00 over waiting until the construction has been completed, or buying an existing dwelling of a similar nature.

In summary, the biggest savings on stamp duty are achieved by buying higher density properties (> 4 stories), before any construction has commenced. Also worth noting, stamp duty is paid over and above the purchase price of the property, and is generally not included in your loan amount. In other words to qualify for an 80% LVR loan on the $500,000 property illustrated above, you would need to have the $100,000 deposit. Plus, you would also need anywhere from $3,248.60 to $26,445.60 to cover the stamp duty component alone. OTP purchases may, therefore, be best suited to those with either low equity/savings, or low Debt Servicing Ratios. 

2. LET TIME BE YOUR FRIEND…

Carrying on from the first point, OTP purchases may enable those with low savings or equity, to provide themselves with the time they need to secure additional funds that they may not have had access to when they entered into the OTP contract.

Imagine you only had $50,000 (10% of a $500k OTP purchase) in savings now, but you knew that you had either for e.g. an inheritance, investment maturing, bonus, or the ability to save the additional finances to settle the property in the future. Given that most OTP purchases will not be ready for settlement for 12 months or more, and commonly 18 to 36 months away, this is when (with the right planning) an OTP purchase can be beneficial to your portfolio growth. 

According to the Reserve Bank Of Australia's Bulletin report in September 2015, the 30 year long term average Australian house price growth has increased by 7.25% p.a. Therefore, in rising markets, the actual value of your OTP property may go up during the contract phase prior to you having to settle the property.  As an example, we currently have a project we are developing over 2 stages, within 11km of Melbourne CBD, where 1 bedroom apartments were valued in September 2014 at $360,000 (valuation available upon request). Obviously, the Melbourne market has been rising strongly over the last few years, and given that these Stage 2 units have not yet commenced construction, and will not be settling till 2018/19, it is probable that by the time these units settle, the value of the property will be greater than the current OTP contract price of $360,000. So, if you had paid a 10% deposit ($36,000) for e.g. the property is valued at $396,000 by the time settlement occurs, you have achieved a $36,000 capital gain, or 100% Return on Investment during the construction process alone.

Additionally, locking away prices now, may be of benefit in economic times when rising construction costs mean that it is more likely that property prices are also likely to go up in the future. According, to the International Construction Market Survey 2016, which looks at labour and materials costs, across both commercial and residential projects, predicts that construction costs in Australia are expected to rise 2.5% on average in 2016.

Our members will often benefit from our bulk-buying power. Being developers ourselves, we understand the critical timing issues developments face, and we are often able to negotiate off-market discounts for our members when the right opportunities arise. Developers requiring pre-sales to enable construction funding, or those looking to move onto other projects quickly, are often far more agreeable to better terms or discounts for our members. Sometimes, rather than looking for discounts it is better to cherry pick the development. For example, the ability to have first choice could mean you get the place with the best view, a northerly aspect, or the furthest from a busy street.

CONS:

1. TIME MAY WORK AGAINST YOU…

There are a couple of ways in which time may work against you, when buying OTP property.

A. THE MARKET TURNS

In some cases committing to buy an OTP property at a certain price today, could be disastrous if the market turned, or you simply paid too much for the OTP property in the first place. Imagine if you committed to buying a $500,000 OTP property today, and the settlement date was 24 months in the future. Unfortunately, if the market changed dramatically, by the time you need to settle the property it may be worth less than your contract price. This could place unwanted financial strain on you to come up with the additional funds required to settle these properties.

Additionally, other factors such as conservative valuers, or changes in bank lending requirements could see many people buying OTP thrust into financial difficulty. This is particularly relevant given the current lending changes the banks have imposed on overseas investors. Right now, a lot of (particularly inner city) apartments have been signed up OTP by overseas investors who may no longer qualify for Australian bank lending. We are keeping a close eye on this, as it may open up some opportunities for our bulk-buying model to swoop in on some serious discounts as developers and borrowers find themselves potentially in some real trouble. Several of my friends love predatory buying, and often quote “If they aren’t crying, I ain’t buying” as their mantra.

B. SUNSET CLAUSES

The majority of OTP contracts are commonly more heavily biased towards the developer. This is because they are usually taking on more risk to complete the development, that an individual purchaser is.

Let me demonstrate this using the example of a sunset clause, which is usually a timeframe (commonly 48 months) that the developer has to complete the development. If the development took longer than the sunset clause to complete, usually both the developer and the purchaser have the ability to exit the contract. So whilst the OTP purchaser, is entitled to get their deposits back, there is an opportunity cost loss in this situation to consider. That is, by having that money tied up for many years, and with no investment at the end to show for it, what else could you have done with that money?

In recent years, there have been examples of developers deliberately stalling projects because the markets had moved so much that they were better off rescinding contracts under the sunset clause; then reselling the properties at higher prices. In NSW, new laws have been introduced to attempt to put an end to this behaviour.

2. YOU MAY NOT END UP WITH WHAT YOU THOUGHT YOU WOULD…

One of the general rules of investment is that “they who can handle the most uncertainty, usually, will get the biggest returns”. If you want to wait for the property to be fully built, so you can literally walk around and check out every nook and cranny of the property, you will generally be paying full retail for that sense of comfort.

If you can handle a bit more uncertainty, then buying OTP perhaps will allow you to reap the benefits of any uplift in value during the construction phase.

Obviously, one of the greatest problems you may face is what you thought you signed up for, may not be what is actually delivered in an OTP purchase. 

Sometimes the finished product will not look anything like the glossy sales brochures, or may be plagued with poor workmanship. 

So, whilst a good property inspector should be able to pick up on any defects, and these will remain the responsibility of the builder to rectify, the hassle and inconvenience for the OTP purchaser (and tenants alike), may be more than what some people can emotionally handle. 

In summary, as with many things in life, buying OTP is neither good, nor bad. It all boils down to your own PIPP and whether buying OTP is the right strategy for you, at this current stage of your investment journey.

As always, we highly encourage you to outperform the market in every strategy wherever possible. You can do so by becoming highly educated, working with a great team, and taking action to secure the future you deserve.

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