Buying off the plan – is it a good idea?

There’s a lot of uncertainty and bad press surrounding off-the-plan developments, so people often ask for my take on them. 

Firstly, let’s start by looking at what buying off the plan means. To get a full picture of whether or not buying off the plan is a good idea, we’ll look at the pros and cons, so that you can decide for yourself – because, as with most things in real estate, buying off the plan is neither good, nor bad.

1. What is ‘buying off the plan’?

Buying off the plan is when you sign a contract to buy an apartment that is yet to be built or is in the process of being built. Without a physical property to inspect, buyers base their decision on plans and artistic renderings of how the apartment might look, in addition to information about the project and developer.

2. What are the advantages to buying off the plan?

The main advantage to buying off the plan is that you agree upon a purchase price before the building is completed, and generally only need to offer a small deposit.

In theory, this means that buying off the plan means you could pay a lot less for a property than it’s worth at the time you move in, as property prices could increase significantly during the time it takes for the developer to build the home.

It’s a fairly logical assumption, given how property prices generally tend to go up over time. And it’s also not the only advantage to buying off the plan.

3. Stamp duty discounts

An advantage to buying off the plans means that you could save a lot of money on stamp duty, as most states offer greater discounts on newly constructed properties.

If a buyer signs a contract before construction begins, stamp duty will only apply to the land value, not the finished product.

4. Near-perfect condition

Another positive of buying off the plan means that because the apartments are brand new, these properties will be more energy-efficient and in better condition than a lot of older homes, meaning you likely won’t need to shell out as much on repairs and utility bills in the months and years ahead.

5. Offer buyers more time

Buying off the plan also gives you a bit more time to get your finances in order, as you’ll generally only need to put down a 10% deposit to secure the contract, and can use the extended construction time to save up the outstanding balance.

6. Tax benefits

Finally, if you’re an investor who plans to lease out the apartment, buying a brand new property off the plan allows you to maximise the tax deductions available to you via depreciation.

7. What are the risks associated with buying off the plan?

There are always tradeoffs and for every upside to buying off the plan, there’s a potential downside.

Just like the the pro above where you could save money by only paying stamp duty on the land value, the exact opposite is also a possibility. That is, a buyer could agree to pay a lot more for a property than it is worth by the time they move in, if property prices drop during the time it takes to build the apartment.

And so, if you’re someone who’s looking to buy and sell a property fairly quickly, buying off the plan is probably not a good idea during a market downtown.

8. Developer might go bankrupt

In addition to researching the current market conditions, buyers need to do their due diligence on the developer before they sign a contract, as the biggest risk they face when buying off the plan is losing their deposit if the developer goes into administration during construction.

Prospective buyers should ask the developer for evidence of past projects, contact people who have previously bought apartments from them, check for negative media reports, and, if possible, visit previous projects to assess the quality of the developer’s work.

9. The sunset clause expires before the project is completed

A sunset clause is a statement in the contract of sale that effectively puts a time limit on the contract’s validity. Should the developer fail to complete the project by the date outlined in the sunset clause, the contract is declared null and void and the deposit returned to the buyer.

The clause is meant to protect the buyer from excessive delays. But, in recent years, some developers have purposely run over the time outlined in the sunset clause, so that they can terminate the contract and attempt to resell the apartment for a higher price.

Simply put, it’s yet another reason to interrogate the developer’s reputation and past history before you sign a contract.

10. Excessive speculation

Another major issue with buying off the plan is the possibility of excessive speculation applying downward pressure on prices. It’s a problem that predominantly affects investors, but it can also negatively impact other buyers, by pushing up their loan-to-value ratio.

It’s often an issue, as speculators like to get involved in off-the-plan schemes, because they can see there is a quick profit to be made: Sign a contract in 2015 to buy a two-bedroom apartment for $500,000 and then sell in 2018 for $600,000.

This is not an unreasonable calculation to make, as, in this case, the property value will have needed to increase at just below 7% per annum to reach $600,000 in three years – which is not too dissimilar from the price hikes experienced by most Australian cities during the recent property boom.

However, many speculators come unstuck as they forget a basic economic principle: that price is a function of supply and demand.

Let me explain below with a case study.

Case study

Let’s imagine that, in 2016, a developer planned to build 200 apartments, and that they managed to sell 150 of the apartments off the plan: 20 to owner occupiers, 50 to investors who plan to find tenants for their apartments, and 80 to speculators, who hope to sell their apartments within three years for a quick profit.

Now, let’s fast track to today in 2020, when the apartments are completed and contracts need to be settled.

The 20 owner-occupiers will be happy, as they will finally be moving into their new homes. Twenty of the investors will be happy, too, as about that many will have been able to find tenants.

Meanwhile, 30 more investors will be trying to find tenants, and 80 speculators will be trying to find buyers for their newly finished homes. The problem is the developer will also be trying to sell another 50 similar apartments, increasing the likelihood of supply exceeding demand.

Given the market conditions in many of Australian suburbs right now, the supply of apartments might exceed the demand due to the COVID-19 pandemic.

In this situation, the price of these apartments would drop – cutting into the developer’s profits, the speculator’s profits and the owner-occupier’s equity.

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