What you must consider before purchasing an off-the-plan property
ACCORDING TO CORELOGIC RP DATA, RIGHT NOW THERE ARE 90,000 APARTMENTS UNDER CONSTRUCTION IN AUSTRALIA THAT HAVE BEEN SOLD OFF-THE-PLAN. OF THOSE APARTMENTS, 18,000 OF THEM WERE EXCHANGED WITH LESS THAN A 10% DEPOSIT, WHICH MAKES ME VERY NERVOUS...
Change is among us in the mortgage world. In an effort to reduce the likelihood of a potential property bubble down the track, APRA has limited the amount new investor loans on their book by a maximum of 10% per year.
In order to comply with this restriction, banks have been making changes to the way in which they look at investor loans. For investors, banks have:
- increased interest rates,
- increased servicing requirements, and
- reduced loan-to-value ratios
The increased interest rates isn't too much of an issue. The cash rate is still at a historic low and whilst some investors feel hard done by having a higher interest rate than owner occupiers, the reality is that investor loans are still below 5% which is a full 2% below the historical average of 7%.
However, it’s a different story for the last two points. For many of the 90,000 people who've bought property off-the-plan, they would have reviewed their servicing requirements based on bank calculators which are now out-of-date. Possibly the biggest issue is that there will be a large percentage of people who do not have more than a 10% deposit saved. As most banks have now reduced maximum LVRs down to 80%, by the time settlement rolls around they will not have enough funds available to complete.
If you have purchased an off-the-plan property or are thinking about it, let me help you understand whether or not this investment strategy is suited to your financial requirements and what to do about it if you are affected.
What is an off-the-plan property?
When you buy an off-the-plan property, you’re purchasing something before it’s even been built.
Now, just like you and I, developers need to obtain finance in order to cover the costs of a build (not many people have a lazy $8-$20M lying around). Before approving funding for a development, banks make sure there are a certain number of 'pre-sales' to gain confidence that there is sufficient market interest in the property.
In an attempt to get their funding approved, developers will offer a certain number of discounted units off-the-plan. The idea is that by the time the unit block is built (usually around 18 months), the market will have increased and those who purchased their units off-the-plan will have made a significant capital return on their investment.
However, the thing to remember here is that when you purchase something off the plan, there is no cooling off period. You must put down a full 5 or 10% deposit and unconditionally exchange on the property, which means there’s no backing out.
Also, as settlement is usually 18 months away, banks don't provide pre-approvals at the time of exchange. As we know from what's happening in the market at the moment, a lot can change in 18 months.
Who should purchase off-the-plan?
I’ve had a number of clients come to me over the years to ask if I think they should purchase an off-the-plan property or not. I always advise them, “If you won’t have another 15% (25% in total) saved by the time the unit block is finished then don’t do it.”
Why such a conservative view?
In 2009 a potential client, Ross*, came to me and explained that he had purchased an off-the-plan property two years earlier, right before the Global Financial Crisis. The property was due to settle in a few months and he wanted to arrange finance for settlement.
When I looked into his situation I realised that he had no savings, and had been allowed to exchange with only a 5% deposit. What was more alarming was that rather than saving the 5% over time and exchanging in cash, he had obtained a personal loan for the deposit which he was still repaying.
The property salesman had told Ross, "Don’t worry, if you don’t have any savings, by the time this thing settles in 18 months, the property value will have risen by 25% which means you won’t need to put down a single thing!"
The salesman failed to tell Ross that when a bank values any property, they go off the lesser valuation or contract of sale price. If you purchase a property for $400,000 and 18 months later it's worth $440,000 the bank will only lend you money against the lesser valuation.
I ordered a valuation and the property had actually decreased in value by $30,000; the GFC had taken it's toll on the property market.
Unfortunately, Ross ended up with no savings and needing to borrow another $30,000 because of a lesser valuation than when he bought off-the-plan.
*Named changed in the interest of privacy.
What's the moral of the story?
18 months is a long time in the property market and you never know what’s going to happen to the economy during this time.
The last two years certainly has been a fantastic time to be in the property market but every cycle must come to an end eventually. Based on the way things appear to be heading, I think there is going to be some pain on the way for the 90,000 people who have bought off-the-plan properties.
If you have bought off-the-plan, now is a good time to revisit your numbers to make sure you are not going to have any issues when settlement rolls around.
If you are thinking about purchasing an off-the-plan property, make sure you seek advice about what strategies you should take in order to limit your exposure to risk.
Moving forward, if you would like to discuss potentially purchasing an off-the-plan property and whether or not this strategy would fit into your own personal situation, get in contact with us today.