Happy couple seal a deal with their personal financial advisor at home

We came across this great article by Property Observer about buying properties ‘off the plan’, or purchasing a property before it’s completed. Buying off the plan has many advantages which includes access to properties that could be sold out by completion, customisation options, and the chance of capital gain prior to completion, with minimal initial outlay. However, there are also some risks of buying prior to completion. For example, there has been cases of people paying far more for a property at settlement than they could hope to sell it for in the current market. Below are 14 tips for buying off the plan, extracted from the article which can be downloaded here.
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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? “Banks are strict on who they lend to. Banks also look for a good track record before handing over construction finance,” says Tim Rees, director of CBRE residential projects. The internet is a good tool for research, and look for blogs and newspaper articles. Do not judge a developer solely by its website, and ensure there is an office where you can meet people face to face. It is also a good idea to visit the property site and check the location. You may find other construction in the area, which may affect your view. You should also carefully inspect the display home, models and plans as well as the fixtures and fittings.
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In times past many savvy investors would buy apartments off the plan, leaving only a deposit of 10%, and sell them on before settlement to make a tidy profit. It made many people rich. When the GFC hit these leveraged investments also made many people broke. Some speculators are tied up in court with developers chasing their money on units that have dropped in value to much less than the investor agreed to pay. This investment strategy is only for those who are willing to take big risks witha deep understanding of residential investment. “You don’t see this sort of speculation now, and as a result it is a much more stable and realistic market,” says Rees. Leveraging is simply using other people’s money, either as a mortgage from a lender or sometimes from the developer, to increase the potential gain from a property investment over a fixed period of time. What separates leveraged investment from long-term investment is that it must have an end date that can be calculated. It is the opposite of taking a mortgage out to buy your house, paying it off over 25 years and owning the property. For example, if you buy off the plan and put a $10,000 deposit on a $100,000 property, you would need to borrow $90,000. If the $90,000 borrowed costs you 5% in interest, it would add $4,500 to the entire cost, therefore the $100,000 investment is in fact $104,500, if you sell within that one year period. To make a profit, the property must be sold for more than $104,500. If the property sells for $110,000 you have made of profit of $5,500. The profit is impressive when calculated as a percentage gain on the capital, however take note: if the property sells for $102,000 it will cost you money rather than making it.
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Buying apartments and townhouses off the plan often attracts exemptions or reduced stamp duty for property purchases in states across Australia.Each Australian state and territory has its own concessions and incentives, but if you are a first-home buyer chances are you are eligible for some sort of stamp duty discount or waiver. The schemes mostly provide assistance for individuals buying their first homes, but seniors wishing to downsize might be eligible in some places as well. From time to time, schemes have been unveiled for upgrading buyers aimed at stimulating the construction of new homes. Some schemes have required purchasing off the plan before construction commences, and others subsidise part of the stamp duty after construction commences. The schemes typically have eligibility requirements regarding the top price that precludes consideration. Some governments require stamp duty payments after exchange documents are signed, but others delay the payment of stamp duty until the registration of the strata plan. A useful website for reference is stampdutycalculator.com.au, which calculates 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. Also check state government websites for the latest information in your area.
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It is a good idea to treat rental guarantees with suspicion and do the numbers several times to be sure they really stack up. Buyers’ agent Catherine Cashmore warns against 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”. Cashmore says current rental guarantees are in the order of 5% to 7%. 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 – or $36,800 net – on the sale price.
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All purchasers must define their own needs. Owner-occupiers are different to investors and want very different things from property. Investors who purchase off the plan should be buying for the medium to long term. “Buying short term is risky in the current environment. Look to hold a property for five to 10 years, and that will allow you to ride out any negative movements in the market that could reflect in the value of the property. If you stick with the long term you will end up with solid capital growth,” says Rees. Investors, who accounted for about 70% of sales six years ago, once dominated buying off the plan. But the tide is turning. Rees said that owner-occupiers have become shrewd in buying property off the plan in recent years, and that purchases off the plan have become popular. The tight residential market in Sydney, where owner-occupiers have seemingly embraced buying off the plan or face never getting started on the property ladder, has driven this, Rees says. “In Sydney, there are not many apartment buildings these days that are not already sold when they are finished, so they do not add anything to the available housing stock. “This keeps the market competitive and tight, and owners-occupiers understand that buying off the plan is a reputable way to buy and no longer the domain of investors,” Rees says. However, do not always assume that property prices are going to rise. There have also been cases of people paying far more for a property at settlement than they could hope to sell it for in the current market. When you are considering what might happen to property prices from the time you sign the contract to settlement, you should also research what other projects will be completed over this time frame in the same area. There could, for example, be a glut of apartments being marketed off the plan our due to commence construction, which could create an oversupply rental situation or reduce values.
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Not only can buyers select what they want upfront, they can sometimes make some changes to the floor plans so the property better suits their needs. Almost always the first units to be sold are those in the best positions, such as corners or penthouses. Some ground-floor apartments have courtyards, too. It is first in, best dressed. Investors can be found looking for these units, since they usually bring in a greater rent. Some buyers may pick up two apartments and amalgamate them into a large three-bedroom apartment, while others may turn a two-bedroom unit into a large one-bedroom apartment. Most developers can offer buyers choices of finishes and a variety of upgrades for additional costs. A serious chef might want the dream kitchen with the best appliances and stone benchtops, while an asthmatic would probably opt for a timber or stone floor rather than carpet. Bear in mind, though, that changes to the plan and to fittings and finishes might push up the price, but might not have as great an impact on end value. Also, if it is an investment purchase, consider who is likely to rent it and whether they would pay more for high-quality extras.
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Nothing can be more important than ensuring that the correct research and checks have been conducted and that you are going into the purchase with your eyes wide open. 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 cashflow analysis. It should cover investment and risk. High potential returns often equal greater risk, and vice versa. Take the time to identify the potential risk, and the returns that you have calculated should be acceptably balanced. It is important to settle for a purchase that suits your financial situation and investment targets. “Be vigilant with money, and have your finance lined up when you put down the deposit. Don’t be caught out at settlement by not having finance ready. Something as simple as changing jobs and entering into a probation period can affect your capacity to get finance,” says Carolyn Chudleigh, partner of law firm Holding Redlich. If you are planning to buy off the plan interstate, familiarise yourself with the laws and taxes of that state. And if you have a friend or relative in that location ask him or her to go and physically see the site since there could be any number of factories or other developments nearby that could impact your decision.
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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. If the developer is unable to go ahead for whatever reason buyers will get their money back. Another big issue is often the final product. Chudleigh says the best way to protect yourself from a nasty shock is to check every detail on the sale contract, particularly regarding the finishes. “Most disputes arise from a buyer not being happy with the end product. The best way to avoid this is to be aware of exactly what all of the finishes should be,” she says. “You should look at the schedule of finishes for all parts of the property, including floor coverings, colour schemes and kitchen appliances. Know everything about the interior, down to how many power points there will be in every room. All of this can be negotiated before exchange of contracts and should be included specifically in the contract if you want to be able to enforce performance against the vendor. If a contract is skinny on detail, there may be little room for complain at the end of the day,” she says. Timing of delivery can also be an issue for buyers of property off the plan. “Developers do need flexibility in the sale contract so they can ensure successful delivery of the apartments, and there are many situations that may cause the delivery date to be extended, such as wet weather. “Become familiar with what is on the contract that will allow the ‘sunset’ completion date to be moved. Leave no room for surprises. If you do not understand the contract, take it to a conveyancer and have them read it and explain it to you. Do not cut costs, because with buying off the plan you cannot see exactly what you are signing up for,” Chudleigh says. Purchasers have successfully been awarded large sums of money through the courts where their views have been built out contrary to assurances from marketing agents, so there is recourse. In Victoria, 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. When it comes to signing the contract you should be completely satisfied with all terms. If you are not satisfied by certain clauses, you should ask to have them amended, though the developer may refuse. The bottom line is that if you are not happy with the contract, you should seek legal advice. If the developer adopts a “take it or leave it” approach, your best bet may be to leave it.
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Property investors can use limited recourse borrowing (LBRA) to fund off-the-plan investments using their self-managed super funds. 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.
Under limited recourse borrowing rules SMSFs require a separate lending arrangement for each “single asset”.
In May last year, the ATO clarified what constitutes a single acquirable asset and provided a specific example of what constitutes a single asset in relation to a completed apartment:
“The trustees of an SMSF enter into a contract to purchase a strata-titled apartment off the plan. A deposit is required upon entering into the contract, with the balance to be paid upon settlement for the completed strata-titled apartment.
“A single LRBA can be entered into to fund both the deposit and the balance to be paid under the contract upon settlement. Both the deposit and the settlement payment are applied for the acquisition of a single acquirable asset being the completed strata-titled apartment.”
According to AMP financial planning, the ruling recognises that “generally speaking, under LBRA rules, the single acquirable asset is considered to be the completed strata-titled unit, or land with a completed house on it – despite the fact that the building activity is yet to occur”.
As a result, where a contract is entered into for a unit off the plan or a house and land package, both the initial deposit and the final payment upon settlement can now be funded by a LRBA. Previously, under the draft ruling, it had been suggested that the initial deposit for these types of transactions would need to have been made from existing SMSF assets.
Mortgage Choice broker Michelle Towner, who specialises in helping investors acquire apartments off the plan using SMSF borrowing rules, stresses the importance of these investments being structured correctly and that buyers must engage a qualified financial planner, lawyer or accountant to draft up the contracts. She says the contract needs to be worded correctly so that when the asset is transferred from the bare trust to the super fund, 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. In particular, any off the plan contract must be written to say the deposit is for the acquisition or deferred purchase of the property, not just an option or right to buy the property. Investors will need to work with a professional to ensure the borrowing arrangements are worded and structured correctly.
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Not only can you often get first pick if you get in early, but there can be sound reasons for buying property off the plan. Before a property is constructed developers look for presales to give to the bank so it will provide funding for construction. The GFC has made it hard for developers to get construction finance, and many banks are not willing to part with money unless the majority of the proposed development has been sold. 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 and usually the earlier you are in, the better price you can negotiate. However, you should not rush in to secure an early purchase simply to get a discount until you are satisfied with your investment and the contract you are about to sign.
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As with all investment property, there are some significant tax benefits when you buy an investment property off the plan. These benefits are greater when property is newer because more tax depreciation items are available. Those benefits are best when the property is new, so buying off the plan can maximise your available tax deductions. Be sure to have a schedule of inclusions such as fittings and fixtures on the sale contract, and commission a depreciation schedule from a reputable provider. As an off the plan buyer you may qualify for a 50% CGT discount. The ATO requires that a period of 12 months elapses before the buyer is eligible, but this period begins when the contract has been signed, so provided your settlement period is 12 months or longer (as it will be in most cases) you could in theory sell your recently purchased property the day after settlement and still qualify for the generous tax concession. The catch is that the CGT discount only applies if you are forced to sell the property due to changes in circumstances. If you bought the property with the intention of selling it at a profit as soon as it is completed, it does not qualify as an investment but as part of a profit-making scheme, so normal income tax would apply. Ken Raiss, partner at Chan & Naylor Accountants, points out that if you buy with the intention to sell the sale would still be taxed at marginal tax rates even if you keep it for much longer than 12 months. If you originally intended to keep the property but decide to sell due to unforeseen it is still considered a capital gain but is not subject to the 50% CGT discount. This means you will still be taxed at your marginal tax rate. This could be advantageous if you have capital losses.
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Buying off the plan will require investor 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 cash deposit. A deposit bond is a guarantee that says the insurance provider will pay 10% deposit to the vendor in any of the circumstances where the deposit would ordinarily be forfeited by the vendor. If the settlement does not occur and the deposit forfeited, the deposit bond provider will seek to recover the money from the borrower. There is no exchange of money in 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. The most well-known provider of deposit bonds is Deposit Power, which provides both short-term deposit bonds for settlements of up to six months and long-term deposit bonds for settlements from six months up to four years, tailored for those buying off the plan.
Another provider is Deposit Bonds Australia, which issues deposit guarantees on behalf of QBE insurances. It requires no mortgage documentation, but applicants must prove their ability to fund 105% of the purchase price, not just pay 10% deposit. The bond is provided in exchange for a one-off fee. According to Michelle Towner, a $50,000 deposit bond for a property settling in three years’ time would require the borrower to pay a one-off fee around $3,600. Deposit bonds providers will only provide a deposit bond guarantee to borrowers who satisfy a minimum net equity requirement and tangible worth requirement. First-home buyers (or first-time renter-investors) will be required to provide a guarantor. Deposit Power requires loan approval, but Deposit Bond Australia does not require that borrowers obtain mortgage approval.
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Many off the plan investors will look to take advantage of negative gearing allowances to reduce their annual tax bills. Negative gearing allows investors to deduct losses made on their investment property against their personal taxable income. Losses include costs such as interest on a home loan as well as maintenance and other expenses for an investment property. The most important thing to realise about negative gearing is that it is fundamentally offsetting a loss. Although investors can claim that loss on their tax returns at the end of the year, an investor must carry the cost of that loss throughout the year. Ultimately, when investing, most purchasers would be hoping that rental rates increase over time and result in the asset moving from loss-making to income-producing. While most of the negative gearing benefits will come post-settlement when the 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. Ken Raiss says 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 amortised over five years.
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A contract to purchase an apartment off the plan is a legally binding document. 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. Buyers’ agent Catherine Cashmore says off the plan contracts are “incredibly onerous to the purchaser” and urges buyers to ensure they have contracts explained to them by a qualified solicitor.