What to be aware of when buying off the plan?

At Blue Key Finance we have seen a spike in interest in buying off the plan investment properties since 2010, which is what has inspired this FAQ.

Buying a property ‘off the plan’ simply means purchasing a property before it is completed and registered with the Land Titles Office.

When buying off the plan the purchaser typically pays a deposit—usually 10% of the purchase price, and once the property is completed is when you pay the balance.

Buying property off the plan has many potential advantages—including reduced stamp duty, access to properties that could be sold out by completion, customisation options, a chance of a capital gain prior to completion, and greater tax benefits for investors with two depreciation allowances and loan costs that can be claimed to help maximise your annual tax refund and therefore minimize your tax burden.

The following are 12 tips you need to be aware of when buying “off the plan”.

When buying off the plan make sure the developer has a good reputation

Research the background of the developer and its track record. Have there been court actions against the developer? Does it have a history of delivering what has been promised and settling disputes quickly and neatly?

Ensure there is an office where you can meet people face to face. Visit the property site and check the location. You should also carefully inspect the display home, models and plans as well as the fixtures and fittings.

Capitalise on stamp duty concessions on offer

In Victoria, you can find off the plan properties where stamp duty is simply calculated on the value of the land at the time you sign a contract of sale, rather then basing it on total ‘land + construct’ price.

Go to our stamp duty calculator to help you calculate the amount of stamp duty payable on a state-by-state basis depending on whether you are an owner occupier, investor or first home buyer.

Take rental guarantees with a grain of salt

Be careful buying into a development that is offering a rental guarantee because it is always factored into the sales price, and once the guarantee expires, the unit’s yield will revert back to market forces.

If an investment has a gross return of 6% and the developer guarantees $300 a week rent that would put the purchase price at $260,000. But if the market rent is in fact $250 a week, the property is really worth $218,000. This would have you paying 19.2% over the market value. The developer only has to pay $5,200 in total over two years to guarantee the $300 a week rent and the company would pocket $42,000—$5,200 = $36,800 net on the sale price.

When buying off the plan you need to take into consideration rising and falling valuations

Do not always assume that property prices are going to rise in the short term. You could pay more for a property at settlement than you could hope to sell it for in the current market.

Some developments may see Banks restrict their loan sizes to 80% loan to value ratio (LVR). So, when a valuation is done two weeks out from settlement and comes back lower than the price on your contract of sale you will have to come up with this shortfall difference!

For example, if you signed a contract of sale to buy off the plan for $400,000 due to settle in 6 months time, and you’ve arranged a preapproval for an 80% lend, i.e. $320,000—all well and good. BUT, when you go to arrange formal approval two weeks from completion and the bank’s valuer determines its value to be $370,000, then the bank will only lend you 80% of $370,000 or $296,000. This $24,000 shortfall, you would hope you have already set up an ’equity release limit’ secured against your home that has enough funds available in it to accommodate for such a shortfall.

Do your due diligence

First, it is absolutely essential to understand the buying process, precisely what funds are required and when you will need them. This will allow you to make an accurate cash flow analysis.

Have your finance lined up when you put down your deposit. Don’t be caught out close to settlement by not having your finance ready. Remember, something as simple as changing jobs and entering into a probation period can affect your capacity to get finance.

Don’t underestimate the risks of buying off the plan

One of the biggest risks is that a developer or builder will go under before completion or that a project will fail to get off the ground, but this should result in no financial loss for the buyer. When you pay your 10% deposit to secure your property it is held in trust either by the selling agent or vendor’s solicitor, buyers will get their money back.

Another big issue is often the final product. You should look at the schedule of finishes for all parts of the property, including floor coverings, colour schemes and kitchen appliances.

Become familiar with what is on the contract that will allow the ‘sunset’ completion date to be moved.

A new consumer law aimed at improving transparency and disclosure for off the plan property came into force early 2012. The front page of all sales contracts must state three things: that the amount of a deposit is negotiable but cannot exceed 10% of the purchase price; a substantial period of time may pass between signing the contract of sale and when the buyer becomes the registered owner of the property; and the value of the property may change between the time the contract is signed and when the buyer takes ownership. These detailed and clear warnings on the contract highlight the risks that are taken when buying off the plan.

Consider buying off the plan using your self managed super fund (SMSF)

Property investors can use limited recourse borrowing (LRBA) to fund off the plan investments using their SMSF.

Under this strategy, your SMSF receives a concessionally taxed rent, pays off the loan while you are still working, and transfers the property to you upon retirement.

After your retirement, you can either:

  • Take the property as a non-cash, lump sum benefit (although capital gains tax is payable on any capital profit, the tax rate is an effective 10% – if the property was owned by the fund for at least 12 months); or
  • Buy the property from the fund for its market price. No CGT is payable if the property is backing the payment of a superannuation pension, but you are personally liable for stamp duty.

Remember that the contract of sale needs to be worded correctly so that when the asset is transferred from the bare trust to the SMSF, the SMSF beneficiaries don’t risk having to pay double stamp duty. The bare trust is the arm’s length holding trust that holds the property until the mortgage has been paid off.

Buying early can have its advantages

Before a property is constructed developers look for possible pre-sales to give to the bank so it will provide funding for construction.

Many developers are willing to give good deals upfront to secure sales. Discounts can start from about 5% to about 10% on the completion price.

When buying off the plan as an investor, ensure you don’t miss out on tax benefits

The tax benefits are greater when property is newer because more tax depreciation items are available.

Be sure to have a schedule of inclusions such as fixtures and fittings on the sale contract, and commission a depreciation schedule from a reputable quantity surveyor.

The ATO requires that a period of 12 months elapses before you’re eligible for the 50% capital gains tax discount. This period begins when the contract of sale has been signed, so provided your settlement period is 12 months or longer you could in theory sell your recently purchased property the day after settlement and still qualify for the generous tax concession.

Consider using a deposit bond rather than tying up your cash

Buying off the plan will require investors to pay a deposit, usually 10% of the purchase price. While developers prefer cash, some will allow buyers to use a deposit bond or bank guarantee instead of requiring a cash deposit.

A deposit bond is a guarantee that says the insurance provider will pay the 10% deposit to the vendor in any of the circumstances where the deposit would ordinarily be forfeited by the vendor.

The Deposit bond provider will then seek to recover the money from the borrower. There is no exchange of money with the deposit bond in place until settlement. At settlement the buyer pays the purchase price in full, and the deposit bond lapses.

The main benefit of using a deposit bond is that savings remain intact, as the cost of the deposit bond is far less than the deposit itself.

We can arrange deposit bonds for our clients through Deposit Power. They provide short term deposit bonds for settlements of up to 6 months and long term deposit bonds for settlements from 6 months and up to 4 years, tailored for those buying off the plan.

Keep in mind negative gearing benefits

Look to take advantage of negative gearing allowances to reduce your annual tax bill.

Although investors can claim the negative loss on their tax returns at the end of the year, an investor must carry the cost of that loss throughout the year.

While most of the negative gearing benefits will come post-settlement when then apartment is rented out and the mortgage is being paid off, investors can also claim the interest or costs associated with funding their 10% deposit from the date they sign the contract. Interest paid on deposit funds is tax deductible, as are the costs associated with a deposit bond, if you choose to use one, from the date of exchange.

Borrowing expenses are amortized over five years.

Be aware that you cannot easily get out of a contract of sale

Generally, if you don’t proceed with the contract you will lose your deposit and may be pursued by the developer for the balance of payment or for any shortfall should the property be resold at a lower price.

Changes in personal circumstances such as divorce, unemployment, illness or death of a partner are not grounds for legally cancelling an off the plan contract.

You can generally only cancel a contract if the terms and conditions have not been met by the developer or builder.

These may include conditions set out in a “sunset clause”, which usually pertains to a period of time in which the project must be completed and settlement should occur. You may also be able to cancel a contract if the builder has not registered the plans for the development by a set date in the contract.

About the author

Matt Carra

Matt Carra

Matt Carra is the Owner of Blue Key Finance, a Finance Broker since 2004, an SMSF Lending Specialist, a Property Investment Educator, and a Mentor to new Finance Brokers entering the finance industry. Matt is passionate about providing valuable guidance and honest advice, educating Australians on how to buy their first homes and invest successfully while protecting them with knowledge. Matt has strong long-term relationships with his panel of lenders and extensive knowledge on their credit policies, and utilises that skillset to give you peace of mind by recommending you to the right lender the first time, to negotiate a better deal, and to fight for your cause – that’s Matt’s commitment to you. Contact Matt today to start the conversation on 03 9700 7033 or email matt.carra@bluekeyfinance.com.au