Guide to buying new property off the plan
If you are looking to buy a new property then buying property off the plan can be a rewarding experience for an investor and it does come with a number of risks.
Thanks to the high demand and lack of current supply buying off the plan may be the only option for those who want new property as an investment. For self managed super funds, off plan property has also become a very popular option in recent times since the allowance of limited recourse borrowing.
Buying off the plan
When you buy off the plan it means that you are buying a property before it is constructed.
As the name suggests, since it doesn't exist you will need to go off the architects drawings and blue prints when making a decision to buy, just like building a home from scratch. Typically a property off the plan may take up to 18 months or more to complete and at completion you then settle the property and pay up the difference from the initial deposit.
A finance pre-approval is not usually required as the settlement time is more than 3 months away (a pre-approval with a bank may only last 3 months before it expires) and just a 10% deposit is all you may need to secure the future purchase of the property.
For example if you were buy a property in Sydney for $600,000 then you would need to make a 10% deposit now. Upon the completion of the property you would need to get a pre-approval for the rest of the capital to complete the purchase plus pay stamp duty. In this case the other 90% or $540,000 would need to be funded by your bank or other capital means.
You would also need to allow for stamp duty. According to the office of state revenue a $600,000 property in Sydney NSW would attract stamp duty of $22,490. So you need to factor in this additional cost at the final settlement date, the good news is that stamp duty does not need to be paid for another 12-18 months post settlement of the property.
Some of the key benefits of buying off the plan property:
1. Fixed price contract
The amount you pay is exactly as per the contract, there are no additional construction costs that may pop up during the building process. This reduces the risk of over spending should there be delays in the constructions or last minute changes due to council compliance as an example.
2. Lock in potential for future growth
While you won't need to fork out any interest costs on the mortgage and running costs such as agents fees during the building phase. You can also benefit from the potential for capital growth. If you have bought at the right time in the market you can get an increase in the final valuation upon completion.
3. Maximise depreciation and tax cash flows
With a new property a lot of capital items can be depreciated that offset your taxable income over a number of years. For example the fixtures and fittings in a new property will be worth a lot more than in an older property. In the above example a 2 bedroom unit worth $600,000 in Sydney could easily have over $60,000 worth of fixtures and fittings that can be depreciated over the first five years, which could equate to a tax deduction of over $12,000 per annum. See more about how depreciation works read the guide on depreciation here. Depending on your situation this could lead to the property having a slightly positive cash flow.
4. Higher rental potential
A new property can attract a higher rental yield as tenants may prefer to live in a nice looking newer establishment over an older less attractive pre owned residence. So it may be easier to find a tenant which means less chance of vacancy.
5. Less maintenance
A new property will require less maintenance and can have lower running costs since there are no fixtures or fittings that need to be replaced or renovated. For SMSF property investor's this reduces the risk of having to dip into precious retirement capital to make major repairs or maintenance.
6. Time to save some additional capital
As the completion date is typically more than 12 months away, this gives you a chance to save additional capital to put towards it or reduce the final loan value when it settles.
7. State government incentives
There are various government incentives for new property. In NSW you can get a $5,000 stamp duty rebate for newly built property. The full details can be read on the Offiice of State Revenue website. Another incentive is the National Rental Affordability Scheme (NRAS), which provides a 10 year rental subsidy guarantee via generous government tax rebates of over $10,000 per annum. You can read more about NRAS here .
If you are looking to build a multiple property portfolio, get in touch with a property consultant here.
There are also risks of buying off plan property so you need to be confident with your future purchase decision regardless of how much you may be attracted to buying brand new. You need to conduct due diligence accordingly.
Here are some of the risks you can face when buying new property off the plan:
1. Property could be over priced
Many new properties built by developers have a marketing cost built into the purchase price, so you could be over-paying for the property if it has been marked up significantly above the local prices of property. Check with your adviser or use a property specialist that conducts market research to avoid this. An example may be a $600,000 property purchased in Sydney that is $100,000 more than a very similar property in a nearby location that is pre-owned or older than 5 years. The gap might mean the property is overpriced, so check with your property adviser if you need help finding a good property.
2. Lag time before completion
While the property is being built you can?t receive any rental or claim any negative gearing benefits so there is a lag as to when the cash flows start coming in. Also check the sunset clause in the contract, this allows the developer to go over the estimated completion date. Get independent legal advice from a lawyer or conveyance.
3. Loss of income
If you lose your income from illness, accident or job loss just before settlement it can be very difficult to get a loan approval to finance the purchase and settle the property. You could be forced to sell it to another party at the current price or potentially less. A way to mitigate this is have insurances in place like income protection and having a capital reserve. There are many income protection providers out there, check with a financial adviser or get the best priced quote here.
4. Market declines
Alternatively the market can decline where once the property is complete the value is less than the purchase price according to the banks. This means you may have to tip in more deposit or not be able to get a loan approval if you can't fund the short fall. An example is of the property bought in Sydney for $600,000 ends up getting valued at $550,000 there is a $50,000 short fall. This means you will need to find an additional $50,000 in cash or equity from your other properties to get the loan. Remember the bank will only lend against the property value at the time and not the purchase price on the contract.
Research can help mitigate this risk, a property specialist can provide you with property selection using market analysis such as demographics, price trends, infrastructure, nearby amenities, transport and vacancy rates.
5. Developer goes bust
In some cases the developer can go bust for various reasons. Depending on the contract you signed and where your deposit is held on trust you may either get your deposit back or you could lose it all. Check with your property adviser or solicitor to see how you can protect yourself against this risk.
6. Less control over the finishing?s
The final product and finishing?s may not be exactly as you read about in the design documents. Dropping by the building site to check from time to time and see where the property is at in the building phase can provide some confidence that the end result will be what you are paying for.
Things to look out for:
Inflated pricing - check the local sales and factor in the cost of new building materials, marketing fees, fixtures and fittings. If an older property is selling for less it does not necessarily mean you are overpaying for a new property, again get professional advice to avoid this problem. Always know that in a property transaction someone is earning a fee or commission for it, so if you use a property agent or professional let them do all the work for you and find the right property.
Defects period - Make sure you get an independent property inspection post completion to check if there are any major defects in the property such as leaks and cracks. Normally you have 90 days to get all of these sorted and make sure you stay on top of it by pushing the developer/builder to get them fixed. They have a legal obligation to make sure there are no defects left on your property as part of the final settlement. There are many qualified property inspectors available in your local area that will provide a detailed property report discussing any defects that may apply to your property.