Is buying off the plan risky?


What are the risks associated with buying off the plan?

Many investors and home buyers choose to buy off the plan. Buying off the plan means that a purchaser will buy the property (usually an apartment or townhouse) before the property is built or completed. There can be risks associated with buying off the plan.

The purchaser buys the property by signing the contract of sale on the basis that the property is built in accordance with the plans, display apartments and/or marketing brochures prepared by the vendor.

Stamp duty concessions when buying off the plan

Prior to 1 July 2017, both investors and home buyers were attracted to purchasing property in this way because it attracted stamp duty concessions. After that date, changes to the law mean that stamp duty concessions are now only available to purchasers buying an off the plan property as their principal place of residence (PPR).

However, even if you are considering purchasing a property off the plan you must meet a number of criteria in order to qualify for the stamp duty concession. You can contact our office to find out if you qualify.

Investors buying off the plan

Investors and others are often attracted to buying off the plan because they pay the current price (the price listed in their contract) and then once construction is finished (sometimes several years later) they settle on a property which has usually increased in value; and they don’t have to pay for the increase in the capital value.

Over the last 8 years Melbourne, we have seen a sharp increase in property markets which has resulted in great returns and minimal risk for purchasers buying off the plan.

What happens if the property market drops?

With the recent drop in the Melbourne property market, particularly for apartments and units, our firm has seen first-hand how quickly the risks associated with buying off the plan can change.

The main risk for a purchaser is demonstrated in this scenario:

  • We are leaving out bank fees, adjustments and stamp duty in this scenario to keep the example simple.
  • A purchaser pays $500,000 for their property and pays their 10% deposit of $50,000 on signing the contract.
  • The purchaser seeks a loan from the bank for 90% of the purchase price, being $450,000.
  • At the time of signing the contract, the purchaser is comforted by the fact that, based on the current market value of the plans, the bank has indicated they will lend him 90% of the value of the property.
  • Three years later construction is complete and the purchaser is required to settle.
  • However, the market has dropped substantially and the property is now only worth $440,000.
  • The bank still agrees to lend the purchaser 90% of the value of the property but this now equates to only $396,000.
  • This amount ($396,000), together with the 10% deposit paid at settlement, equals $446,000. This means the purchaser needs to come up with a further $54,000 to make up the shortfall.
  • The purchaser must now find a second financial institution to fund the shortfall or risk defaulting on the purchase and losing their10% deposit.

Finance companies taking advantage of the current Melbourne market decline

There are a number of finance companies currently taking advantage of this situation. Because the risk for these financiers is high, they mitigate this risk by charging high-interest rates and often exorbitant fees.

If a purchaser finds themselves in this situation, they are usually financially stressed and desperate. Emotions and pressure run high and they are often vulnerable to the funder who may take advantage of the situation. These purchasers often find themselves in financial hardship with two loans, either or both of which may have arduous terms.

Seek advice before buying off the plan

Before buying off the plan, purchasers should seek professional advice from their accountant or financial advisor and have the contract reviewed by their lawyer. When engaging a lawyer, they may be able to negotiate added conditions to the contract which provide the purchaser with an option to avoid the contract where the purchase price has dropped.

What is a sunset clause and is it risky?

A sunset clause provides a time frame in which the off the plan property is to be completed. If that property is not completed within the nominated time frame then a sunset clause operates. It provides the purchaser and/or the vendor with an option to terminate the contract and any deposit money is returned to the purchaser.

Sunset clauses were initially designed as a safety net for purchasers; they put a limit on developers delaying completion indefinitely. Delays in completion of construction could mean that a purchaser cannot rent the property out as planned or even live in, or on-sell the completed property. This results in the purchaser not having the use of their own money when needed.

However, in recent years, during the property market boom, sunset clauses were used to the advantage of the vendor and developer.

Our firm dealt with a number of property developments that appeared to be deliberately delaying completion. Vendors enticed purchasers to buy at current market rates and then several years later when the developments were getting towards completion, the completion appeared to be delayed until the time limit stipulated in the sunset clause had expired.

At this point, the developer usually advised the purchaser that they would exercise their right to terminate the contract of sale of land in accordance with the sunset clause unless that purchaser agreed to pay the current market value (which, in a booming property market, could be substantially higher!). This issue was reported widely in the media.

As you can see, there are some risks associated with buying off the plan. If this is a purchase or investment you still wish to undertake, the best advice we can offer is to seek professional advice in relation to financial and legal matters.wh

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