Buying off the plan with all the riches you’re promised by developers, what really happens though when you go to settle in two or three years after you signed that contract?
Nearly daily we field calls from clients wanting to buy property off the plan, and daily we ‘stress test’ what it is you can and can’t do when it comes to off the plan purchases.
Let’s go through some of the terminology, explain what it means and why you need to have your eyes open right from the onset.
The deposit
Are you using a cash deposit, a bank guarantee or a deposit bond? Sometimes you will have no choice in the matter as some developers will insist on either cash or bank guarantee. It’s usually their funder that is dictating this to them and they pass it down the line. So what’s the difference between them all?
Cash.
Cash is cash, typically 10% of the purchase price, you can either use some from your Line of Credit or you can dip into your savings. The selling agent or a solicitor will hold it in their trust account, so the developer isn’t actually receiving your hard earned. Simple!
Bank Guarantee.
In essence this is where a bank underwrites your deposit to the developer and issues a letter of comfort to the developer. If the developer needs to call on the letter because you won’t settle then the bank will pay up. Now for the bank to offer a letter of comfort they will always take some sort of security that they can liquidate if they have to. This is most often real estate, but it can also be a term deposit too. The bank guarantee is usually renewed either on an annual or ½ yearly basis at a cost to you.
Deposit Bond.
This is an insurance policy that you purchase for a premium. The insurance company does all of their due diligence on you by asking for a statement of position and then from this charge you a premium relative to the risk they’re taking on. The premium charged is controlled by two main factors, the sunset clause date (see below on this) and the size of the deposit; the larger it is the higher the premium. You need to know that if the insurance company has to pay out your deposit at settlement because for whatever reason you don’t; expect the insurance company to vigorously come after you for their loss.
Sunset clause
This is the date when the developer must deliver the property to you. Typically they can be two, three or even four years away from the date when you actually purchased the property. The reason for it is, it allows the developer to pre sell enough of the properties in advance so that they can reduce their risk of having too many properties left over at the end. It also allows the developer to sell enough in advance so that when they go to the bank for funding they can demonstrate how they will be clearing the banks loan with pre committed contracts in hand.
Furniture packages
I’ve put this in as a warning… If you elect to have a furniture package put into your unit and it’s on the sales contract note that the valuer will deduct what he believes to be its value from the value of the contract. So in other words you cannot borrow for furniture packages. They must be paid for in either cash or from another facility against other security, like a line of credit.
Getting a loan pre approved for the property
When you apply for a pre approval it is typically only good for three to six months. If the property is settling in three years time, your pre approval will be worthless then.
So what to do, do you get one or not? I think you should because that will open the door for your broker to explain and ‘stress test’ your position today and use it as a basis to predict your position at the time of settlement.
Getting it valued before you sign the contract
This is a wise thing to do. Talk to a major valuation company that is on the banks panel and discuss with them absorption rates into the area and how the market is tracking. They will be aware of other developments that are being released and what effect this could have on you and the value of your future property. I recall back in 2005 when the Q1 tower on the Gold Coast was settling and 526 new apartments were about to be released onto the rental market. There was concern that the local economy may not be able to absorb them, history tells us that it did and in fact there was some nice capital gains made immediately as they became quite popular to rent upon settlement. This isn’t always the case!
There can be so many variables
- When settling on a property so far into the future you really need to be sure that you will be in a position to actually settle, so some things to consider…
- What happens if the valuation comes back below your purchase price? Do you have sufficient funds to make up the difference? (This happens more often than you think)
- What happens if interest rates escalate by 3%, can you still afford it?
- What happens if rents drop across your portfolio?
- What happens if you cannot find a new tenant for five months?
- What happens if your wife says she’s pregnant and is out of the work force for a period of time?
- What happens if you were to get retrenched?
These are all very real situations that I’ve seen, plus many more. My advice is have your broker ‘stress test’ your position before you buy.
Notice to complete 21 days
This is the timeframe the developer has to notify you of when settlement is going to take place. Rarely can a bank be ready inside 21 days and typically a conveyancer acting for you will not make mention of this. My advice is to have the contract altered before you sign to a minimum of 28 days.
Conclusion
So my message is this… When you go to purchase an off the plan type of property, discuss it with your broker (Hopefully us) and ask them to ‘stress test’ your position today and at the end of the sunset clause. If you’d like to discuss the financing of an OTP purchase today feel free to call my team on 1300 657 132.
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).