Buying off the Plan, Can be Riskier than People Think
History shows time and time again that:
- real estate is a good investment, whether it be your home or an investment property;
- we Australians love property; and
- we love to talk about it.
We are all looking for that next big investment or wanting to up-size our family home. Buying our next home or investment property off the plan is one of the most common ways we Australia buy property today.
It is often sold to us by real agents armed with nothing more than a floor plan and some glossy brochures and is pitched to us consumers as a great way to buy and save money on stamp duty and holding costs. This is music to the ears of most investors and first home buyers.
It can be a good investment, and a great way to save money on taxes – who doesn’t want to avoid paying tax? However, it risker than people think, a lot can go wrong from the day of sale to settlement.
For this reason, I believe if you are going to consider buying a property off the plan that you complete a risk assessment beforehand to identify any potential risks that could impact and hopefully provide a solution if things were to go wrong.
Your risk assessment should take into consideration the following circumstances.
Shortfall in Bank Valuation at Settlement
Unfortunately, this is a common occurrence and a 10% shortfall from purchase price to bank valuation is far too common for many people who bought off the plan. In fact, in today’s world it is more often the norm. I have witnessed valuation shortfalls from as much as 20% below the contract price.
The challenge for the purchaser is that a bank will lend only up to 80% of the contract or bank valuation, whichever is the lesser of the two, without mortgage insurance and 95% with mortgage insurance.
Therefore, a shortfall of 10% could cause you problems with raising enough money at settlement in order to take possession of the property. Often valuations are done a couple of weeks prior to settlement which does not leave you a great deal of time to raise the additional funds.
Change in Lender Policy
Right now, this is something we are experiencing. The Banking Regulators (ASIC, APRA and RBA) have enforced regulations on our banks to restrict the amount of investor lending being written.
These changes have been significant and will cause financial hurt to many people, potentially causing quite a few to lose their 10% holding deposit and opening themselves up to being sued by the developer for expenses or losses incurred by you not settling on time.
Your Personal Circumstances
It can be months or even years from the day you sign the Contract of Sale to the day you take possession. A lot can go on in one’s personal life between the day of sale and settlement i.e. loss of a job, separation from a partner, an illness or perhaps a new-born child.
I do realize the above can happen at any time, and if we were to focus on them, we’d never do anything.
However, all of the above can have a negative impact on your ability to obtain finance.
Unfortunately, when you sign a Contract of Sale, it is a locked tight contract and developers are generally ruthless if you don’t settle on time. They can charge you penalty interest for each day you are late and I have seen examples where the penalty interest has run into the tens of thousands of dollars.
The developer can even rescind the contract, keep your 10% deposit and sue you for any losses they incur.
Its Smaller than you Thought
The regulations regarding advertising materials for selling properties Off the Plan are loose. There are 3 ways to measure the floor area of a property and all 3 ways will provide a completely different measurement.
There are no regulations stipulating which method the developer/selling agent must use in their advertising and marketing material. (Buyer beware!)
This can often lead to heartbreak when settlement rolls around and you get to see your new home/investment for the first time and it is a lot smaller than you anticipated.
The 3 methods are:
Internal Wall to Internal Wall
Measurements are taken from the internal walls to determine the size of the property. Lenders use this method for calculating a property size and require their Panel Valuers to use this system when conducting a valuation for bank purposes. Internal wall to internal wall gives you the true measurement of the actual living space.
External Wall to Mid-Cavity
This method is the prescribed method for determining the floor size of a property when there are multiple dwellings that share common walls i.e. apartments and townhouses.
Under these circumstances the measurements are taken from the external walls (if there is an external wall) to mid-cavity of the common walls between adjoining properties i.e. from the external wall of the front of the dwelling to the mid cavity of the common wall
The Property Council Guideline of Australia stipulates that this is the standardised method for measuring the size of a dwelling when there are common walls.
External Wall to External Wall
External wall to external wall is used when there are no adjoining properties which share common walls.
All 3 methods will provide a completely different size. Real estate agents and developers are not required to disclose their method. There is a significant difference in size from an apartment that is 90 sqm, where the size has been determined by measuring internal wall to internal wall as opposed to external wall to mid cavity.
Variations to Size and or Floor Plan
Most developers structure their Contracts of Sale to stipulate there can be a variation of up to a 5% reduction in the actual size of the apartment from the size of floor plan inserted in the contract of sale, with no recourse to the purchaser and with no need to advise the purchaser of the variation.
If an apartment complex is selling well, some developers will take advantage of this clause by reducing the size of apartments that have already been sold to fit an extra apartment or two on each floor. Developers do not need to notify the purchasers of this size reduction providing it is within the 5% margin.
The Developer Circumstances
Most developers are no different from you and me. Most of them need finance in order to complete the property development and most will seek a Pre-Approval just like you and me.
This is where the lender will insert Finance Conditions upon the developers prior them obtaining the finance required to build the complex.
Most lenders will set pre-sale targets the developer needs to meet to obtain finance; what types of deposits are acceptable i.e. Cash, Bank Guarantee and Deposit Bond and how many Overseas Buyers can buy into the Development?
At present most projects are selling fast, however in normal markets it can take months, even years, for the developer to achieve the necessary pre-sales required to obtain construction funding. This means that the proposed completion date the selling agent provides you when purchasing the property can fall way short of the actual completion date.
Off the Plan Contracts generally don’t stipulate the actual settlement date which happens when you purchase an established home.
Even if a proposed settlement date is stipulated, there will be a clause that overrides the inserted date. Settlement will be determined by the Registration of the Plan of Subdivision and the receipt of the Occupancy Permit. Most contracts will stipulate the purchaser must settle within 14 days from when the latter of the 2 has been issued.
For most people, the 14 days can be a stressful period due to the fact the most lenders won’t order valuations until the Certificate of Occupancy has been issued and some won’t issue loan documents until receipt of the Plan of Subdivision and Certificate of Occupancy.
Should anything go wrong with your finances during this 14 days it does not leave a great deal of time to find a solution.
Another potential problem is that the developer could go broke during construction or before construction even begins. One may think that if the developer goes broke, you would be entitled to a refund of your deposit and you get to walk away scot free. This is not the case.
If the Administrators decide to proceed with the development, then you can be made to proceed with the contract. However the downside for the purchaser is that it could take months, even years, for the insurance company to payout and instruct a new builder to finish the project.
In the meantime, your money is tied up until a resolution is found or the Sunset Clause is executed. Until then you have a pending obligation to settle the property.
A Sunset Clause forms part of the Contract of Sale in an Off the Plan purchase. This Clause sets a completion date for the project which means that if the developer has not completed the project by the date of the Sunset Clause then the purchaser(s) have the right to terminate the Contract of Sale without penalty and the deposit is refunded in full.
The developer has the same rights. If something occurs which prevents it from achieving the desired goal, this Clause may be invoked.
If there has been a significant increase in property values, some unscrupulous developers will intentionally cause delays so that current contracts can be terminated and the property resold at the higher price.
Sunset Clauses vary between 36 months to 60 months from Day of Sale. The developer sets the Sunset Clause and will determine the date based on the size of the development, the market conditions and environment.
Contract of Sale
The Sale of Land Act in each State of Australia sets the parameters for every sale of land contract and stipulates the General Conditions and Terms. However the vendor/developer and purchaser are able to add additional Special Conditions to the contract providing the Conditions do not override the General Conditions or Contract Law.
Because the developers’ solicitors construct the contract for their clients, they are always heavily tilted in favour of the developer.
Declan Hanratty – Managing Director
M: 0409 089 456 F: 03 9416 1916 ABN: 19 880 907 430 POSTAL: PO Box 1551 COLLINGWOOD Victoria 3066 MFAA Membership No. 50217 Australian Credit Licence No. 383120 Credit Ombudsman Service No. 412201