The risks of buying off the plan

Patrick Bright – EPS Property Search director and author of the Insider’s Guide to Buying Real Estate joins the chorus of those warning to be cautious about how you buy off the plan
Kevin:  It seems that a popular way for investors to get into the market is to buy off the plan. I’m attracted to a release that came out from Patrick Bright, who is EPS Property Search Director and also author of The Insider’s Guide to Buying Real Estate.
Patrick, thanks for your time.
Patrick:  A pleasure.
Kevin:  You say there are risks associated with buying directly off the plan. I suppose there are risks in buying any kind of real estate, but you’re focusing in on buying off the plan. Why is that?
Patrick:  Everything you do investment-wise carries some risk, but the risks have always been a little bit higher with off the plan, which is why you would expect a better than average return. I see that the risks have been increasing steadily over the last decade and they are at a level now, and have been for a few years, where I just think they are too risky.
You have a lot of foreign investment, which is having an impact on it. Essentially, buying off the plan is speculating. You’re punting on the fact that the market will go up, and that doesn’t always happen.
Kevin:  Is it more acute now than it was in the past? And if that’s the case, are there some off-the-plan purchases that do make sense?
Patrick:  Of course, there are going to be exceptions to the general rule view that they’re higher risk and some people will win – and people do. I’ve done off the plan investment 15 years ago and we did win out of it. But if I reflect on that, I have to admit we got lucky as much as we did some good planning. It was a fact that we did well but there was a bit of luck that came with it.
I just see that it’s got a lot harder these days. You have different rules and regulations with off-the-plan properties. We didn’t have the foreign investment impact, which I think people shouldn’t underestimate. The latest stats that I’m reading is that 24% of new off-the-plan property bought in Sydney was bought by foreigners last year. It’s 40% in Melbourne. It’s 33% in Brisbane.
These are very big numbers – and these numbers were less than 2% just eight years ago.
Kevin:  Given that we’re talking here about investment, what about owner-occupiers wanting to buy off the plan? Is that a different scenario, Patrick?
Patrick:  Sure. I’d see it a little bit differently from the point of view that you’re going to be living in it, and if you want to buy at a certain position and a certain view and in a certain building, then you’re going to need to take that commercial risk. You would hope that you would make money and the property would go up, but it’s not as big an impact on you if it doesn’t, because your primary place of residence is more of an emotional purchase rather than looking for a dollar return.
Also, if you’re thinking about having to finance these properties, some of them are not valuing up at settlement, so you could be in negative equity come settlement time, which is a risk that you have in trying to fund that property. So you want to have better than a 10% deposit. In fact, we’re seeing the banks saying that they want to see 20% and in some places and locations, 30% deposits. That is simply because the bank sees this as a higher risk strategy, as well.
Kevin: Why is established real estate often considered a lower risk than buying off the plan?
Patrick:  Simply because it’s there now – you can see it, you can get a return on it, you know what the rent is going to be on it – and it’s finished. A lot of these off-the-plan projects are delayed. I’ve seen some CBA Bank stats that show that one in four developments go broke or are taken over and finished by a different developer, so that obviously sends a message that there is higher risk involved in it, too.
When comparing an existing property to an off-the-plan property, you’re not knowing who is buying it. You can look at the records and see how many owner-occupiers versus how many investors in a Strata Report. You can talk to the Strata manager and get some information on that because they have a record of that. But you don’t know with off the plan. It could be that 100% of a building could be sold just to investors, and then say 20% of those people can’t settle or want to sell it, it can make the price fall.
Kevin:  Some of the developers move all around Australia and are very well known. Are they the ones who are more likely to complete and then be able to provide you with a product that they promised you at the outset?
Patrick:  There are some very reputable larger development companies that are running around, yes, and you can be pretty confident that they are going to finish the project. The challenge is that you don’t know that the price is there.
Again, I come back to this influence that wasn’t really there a decade ago, but this foreign investor influence because they buying because they want to get money into the country, into Australia. They are not buying with their checkbook and calculator; they’re paying premium prices. The locals are having to compete with that, because they don’t care who they sell it to; they’d rather get the most money for it.
So if they can sell it for an extra 10% – and in some cases well above that – to a foreign buyer, they would, rather that than sell it to you. And they are available to sell them to these. They can sell 100% of a new development to foreign buyers, and in some cases a big chunk of these buildings are being sold to foreigners. They are spending tens of thousands of dollars per apartment marketing these products overseas. That has to be paid for, so you’re going to be paying for that.
That’s why my view is that to reduce your risk, steer clear of it. Because you’re less likely to be buying an overpriced product, you can then get an instant return on your money if you buy an established property because you can rent it out the next day. You can see the history of the building. A lot of buildings have problems. I avoid buying anything less than 10 years old because I want to see the 10-year history of the Strata Report to know what issues the building has had and how they have dealt with them.
All buildings have issues. All new buildings have some issues – some a lot more expensive than others – so you don’t want to be hit with special levies and a lot of drama. Most of these issues will show up in the first five to ten years.
Kevin:  Patrick Bright from EPS Property Search and also as I said at the outset, the author of The Insider’s Guide to Buying Real Estate.
Patrick, thanks for your time this morning.
Patrick:  A pleasure Kevin, as always. Thank you.

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