Buying off the plan - pay a deposit, wait few years and settle with capital gain, or sell with profit, right? Wrong! Investing or speculation? Follow investor’s rules when looking at residential or commercial apartments, here are same considerations.
Buying apartments off the plan sucks
Buying off the plan - Good investment decision or not?
Listen to the selling agent - buy off the plan, pay a deposit, wait few years and settle with capital gain, or sell with making good profit, right—it is a marketing tool. Wrong—because it is speculation. Nobody really know if the final product will be worth money and how the market will develop over coming years.
Buying off the plan might be interesting for people trying their luck like playing LOTTO because it breaches property investor’s rules:
· Never trust the promotional figures and glossy leaflets painting a rosy future. Actually, nobody can predict the economic future years ahead. Just look at reality- who could predict the credit crunch, Japan's tsunami or Canterbury’s earthquake?
· Never buy a property that can’t be checked in terms of building standard, quality and value. Do you think the leaking house crisis is over because of a changed building code?
· Never enter a business relationship with a ”body” that does not exist at the time you sign a contract. After units’ settlement the apartment building is owned by a body corporate, managed by the management company that was engaged by the developer who sold for profit. The first year’s budget of the body corporate normally has been made very optimistic to attract apartment buyers and to entice “off the plan” buyers to settle.
· Speculation —“off the plan” buyers who never intend to settle their purchase by hoping to sell for a profit on completion have one problem. If the market has turned or with stiff competition the expected profit might be far out of reach. Often found the value of their property on completion is considerably less than they paid for.
The basics of selling off the plan
Developers have to present reasonable profit margins for getting finance. That has to be built into the final price. To follow this through the sales funnel must include a substantial budget for advertising. In other words the price structure covers all the cost for agents, full-page ads and expensive glossy brochures to promote the project.
If that sounds very seducing to you — brand new, everything covered by warranties, no repairs, amazing capital gain on glossy leaflets with fictional values, you might think about
generous selling commissions given to project marketers and financial planners as well. Do you see why the initial selling cost must be inflated?
Looking back over the last decade we found that the price we paid was way too high and on completion the apartments were valued at considerably less than their purchase price.
How to estimate the apartment value?
The selling agent has some valuations on hand. Are they convincing? My first question would be—what is the basis for the presented value? Most larger developments are sold to investors. The commercial use of an apartment building could be renting holiday apartments, student accommodation, or more commonly short-term accommodation like serviced apartments and renting by room.
Important to know that residential and commercial properties are assessed differently on yield or cap rate. Owner occupied apartments, penthouse apartments, and lifestyle units (city apartments) for families would be classified as residential apartments.
Because of possible commercial interests estimating the value of apartments can be quite challenging. I look firstly at the size of apartments in square-meters and the percentage of owner-occupiers. Our experience is that owner-occupiers tend to be far more careful when it comes to maintain the building and long-term capital value.
By knowing the expected cash-flow, you get easily the apartment value by dividing the annual rent with the yield or the cap rate. Example:
Two-bedroom apartment (50sqm), rent $600 per week:
- Pre-approved loan 300,000 Dollars, 7% interest rate
- Expenses: BC levies 6k, council levies 2k, maintenance 2k
Annual rental income: $600 multiplied by 52 weeks = $31,200
Annual expenses: 21k interests + 10k expenses = $31,000
Estimated Value by Gross yield of 10%
= annual rent / yield = 31200 / 0.10 = approx value of 312k
Divided by 50sqm = 6240 Dollars per square meter
The cap rate or yield indicates the potential how much income an apartment will produce. The rule of thumb— Higher Income (rent) = Higher Apartment Value
Developers and investors want the opposite
We talked already about the small allocation of land on the unit title. So, the developer wants to squeeze as many apartments on the site as the council regulations permit. That reduces the portion of land to a minimum and is exactly the opposite investors are looking for. In this way larger developments produce an over supply of properties for sale at completion. That results in reduced scarcity value and lower rents.
Another problem often overlooked by investors is the quality of appliances. Developers normally purchase in bulk with discounts and conditions far before installation. That has two fatal implications; the standard warranty for appliances elapsed after 12 months before the end of the first year of ownership, and for some imports it is hard to find appliances repair service.
But the real annoying experience has been that the first year budget has been tempered by the body-corp manager (engaged by the developer). Expenses for building defects have not been claimed under warranty and shortfalls in the budget were passed on to apartment owners.
Probably you got an idea why buying “off the plan” sucks. When dealing with a two or more year time-frame for the completion, there is a slim chance to predict what the future value will be. I feel you should receive a sizeable discount for all the uncertainty if you decided to buy off the plan. Good luck.
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Klauster Blogs lead to a real person, IT professional, investor, landlord and business owner with interests in technologies, properties and trading.
His passion, making experiences available and helping people like you, comes from extensive travelling and the principles of life—how to avoid pitfalls in unfamiliar territory when investing or forming relationships.
The philosophy to treat life, partnerships and hobbies as an investment has helped people in his circle. Life is a dream with a deadline, happiness comes from making the right choices and having realistic expectations.
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