How to mitigate risks when buying off-the-plan

Expert Advice with Doron Peleg 12/06/2017

When you buy an OTP property you commit to buying a promise from a developer that a property that hasn’t yet been built will be completed to the expected specification and quality, within the agreed timeframe, and will deliver capital growth and solid rental return.

While you make a deposit of 10 per cent of the agreed purchase price, one of the risks is that it's only when the property has been completed that the bank will complete a valuation either to approve, or sometimes deny, your loan.

Therefore, it is absolutely critical that the value of the property does not decrease between when the contract is signed and the actual bank valuation.

 

What are the major risks of buying OTP?

There are number of major risks associated with buying OTP properties compared to when you buy an existing one.

Firstly, there are a variety of financial risks, including:

Settlement risk – the value of an OTP property may decrease between the original contract date and settlement;
Equity risk  – the price may reduce or the property may deliver poor capital growth; and
Cash flow risk – the actual rental return may be poor and the landlord has to cover a significant shortfall between the rental income and the ongoing costs.

There are also legal and other types of risks which are driven by five risk factors. So, to help mitigate them, it's vitally important to consider the following:

Investment strategy

You must set your investment strategy around what you're planning to do with the property, how long you're planning to hold it, and how it aligns with your overall investment strategy (e.g. retirement plans).
 

Where you buy

The property's location can reduce your risk and deliver better capital growth, which is why we've created our Best and Worst Off-The-Plan Areas report.            Our research found that lower risk OTP properties are generally located in suburbs that:
Are within a region with sustainable economic growth;
Have a low proportion of new dwellings;
Have a relatively higher median price;
Are located in the middle-ring; and
Have a lower renter ratio.

You must seek independent advice about the area, the property type, and its configuration. Bear in mind that any person who get a commission or "kickbacks" from a developer is not independent.

 

What you buy

Our research found that OTP houses outperformed OTP units in the same area. Also, overall, across our four major capital cities, houses significantly and consistently outperformed units.
In addition, the property configuration (the number of bedrooms, bathrooms and   parking, etc.) has a significant impact on risk. Larger units, generally, carry a lower risk than smaller units, as they appeal to owner-occupiers.
Generally, the highest level of risk are studio apartments and one-bedroom apartments. If the property size is less than 50 square metres, the risk is very high, as many lenders restrict lending on these properties.

 

Who you buy from

The developer and the contract you sign carry significant risks, so you need to check:
The developer’s financial stability, e.g. low risk for bankruptcy
Legal matters – it's absolutely crucial that you use the services of a solicitor or conveyancer.
Completion period, quality, and specifications.
 

The deal

Since you're buying a promise that carries significant risks, you need to find an attractive deal.
The most critical step here is that you, the buyer, do your research first on the suburb, the preferred property type, and the price range.

 

The RiskWise Property Review's best and worst Off-The-Plan suburbs reports are available at: www.otp.riskwiseproperty.com.au

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Doron Peleg is the CEO/Founder of RiskWise Property Review, a Co-Founder and Managing Partner of 'PELEG, KESSEL & CO' and a former Executive Manager at Westpac.
Utilizing 20 years of experience in risk management, Doron has Co-developed RiskWise's property risk rating algorithm. This smart algorithm enables potential property investors to better access and mitigate risks for individual propertues in Australia.


Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.

 

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