Finance risks when buying off-the-plan

Since 2009, there have been around 165,200 apartments completed in metro Melbourne, and there are currently around 24,430 apartments combined - under construction and being marketed (source: Australian Property Journal).

Melbourne's population is forecasted to reach 7.9 million people by 2050, a 52% increase from the current levels of 5.2 million (source: Australian Property Journal).

Competition amongst developers and builders has always been fierce, and with such an expected surge in population growth in Melbourne, such competition will only intensify. In recent times some developers and builders have been driven to the brink in light of rising labor and material costs, however this issue is expected to abate at some future point as a new norm returns - driven by strong demand for new housing.

Traditionally, apartment developers have offered all sorts of promotional deals to lure buyers into purchasing off the plan.  In most instances, developers are required to have a large percentage of apartments sold off the plan in order to obtain the funding and take the project from concept to construction.

There has always been a degree of risk associated with purchasing off the plan residential apartments, as this type of housing seldom performs when it comes to future capital growth - generally speaking.

Today I wanted to share with you the finance risks associated with buying off the plan apartments, as finance is key - and usually a necessity - when it comes to buying property. These risks are real and you should therefore take great care when making an off the plan purchase so that you are not caught out.

If I had to come up with one reason why buying an off the plan apartment may be an attractive option, I would struggle. In some instances, buyers have been able to lock in today's price and enjoy a capital gain once the project is complete at a future point. But of course, this perceived gain is only on paper and doesn't mean much until the gain is realised from a sale.

From experience, this has been the exception and not the rule as some buyers have bought in a rising market - although developers are usually savvy business people and tend to factor in future price growth into the purchase price and will sell you a story around this perceived promise. And there lies one of the finance risks!

So, what are the main risks when buying an off the plan apartment?

Usually settlement is a long time away, 18 to 36 months is very common.  The bigger the project, the longer the settlement period.

Whilst you wait in anticipation for the settlement date, the property market will move up, down or sideways. Your bank/lender will conduct a valuation of the property near completion (usually within the last month or two) as they want to verify that the purchase price is still aligned with the current market value - at that future point in time.

If the market value (near completion) is less than what you paid for the property, this will result in a higher Loan to Valuation Ratio (LVR) which may cost you more in Lenders Mortgage Insurance (LMI).  Or if the market value is significantly less, then you will have to come up with the cash for the shortfall as the bank will cap their lending to the maximum LVR against the current market value (not against the purchase price).  I have known people to lose their deposit over this issue, as well as be sued by the developer for marketing costs having to re-sell the property, as coming up with more cash is problematic in most instances!

Does a finance pre-approval remove this risk?

Contrary to popular belief, a home loan pre-approval is only valid for 3 months. Furthermore, a pre-approval is 'subject to satisfactory bank valuation', which means the lender will always value the property near completion and they will base their lending ratio against the current market value (as explained above).

The risk with a pre-approval, apart from having it lapse, is that the lender will want to see updated payslips from you prior to formally approving your loan. Therefore, if your personal circumstances have changed, or if lending policies have changed, you may not be approved for the finance.

Here are some examples which will impact your ability to obtain finance once the project is complete...

• Loss of job and currently looking for work - with no payslips you won't be approved for a home loan
• Your salary has reduced due to less overtime - which means your borrowing capacity is reduced
• You're currently on probation as you changed jobs - only a handful of lenders that "may" include your probation income for servicing purposes
• You changed employers and industries - most lenders won't accept your new employment salary as they want to see you in your new chosen industry for a period before including your income
• You took on new loans/commitments - which now means that your borrowing power is reduced
• You have a credit blemish on your credit file which you weren't aware of and are trying to get it removed, which takes time... a long time in fact
• Lending policies have changed and the LVR is now restricted further, which means you need a bigger deposit in order to settle the purchase
• Interest rates have risen and the qualifying rate is higher - so now your borrowing power is much less
• Lenders have reduced their lending appetite against the property you purchased off the plan - this is a result of a saturation of apartments in the block/suburb/area where you purchased

Off the plan purchases "may" be a sound investment, but in my experience these are usually limited to boutique type developments with up to 8 apartments or townhouses - where the land to asset ratio is higher.  In these cases, off the plan purchases have their place in a sound investment portfolio and the finance risks (above) are less likely.  However, when it comes to buying into large apartment blocks which are high density projects, and come with a low land to asset ratio, there are many risks that one has to be aware of to ensure their investment is protected.

If you are considering buying off the plan, whether that's a place to call home or to buy your next investment property, please feel free to tap into our years of experience and property success so that you buy your next property with more certainty and with calculated risk.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.