As asset classes go, property is the smart choice, but investors who have bought property through these two vehicles, in most cases, have had to wave their healthy bank balances a tearful goodbye
Few things could sound more attractive in theory than a rent guarantee – where a seller or developer guarantees a certain rental for a period of time. For some people they can provide comfort and security, especially among investors concerned with vacancies.
The problem is that the guarantee comes at a cost. It is usually factored into the purchase price – you pay the developer upfront for the rent he will repay you over the next few years.
In some cases, it can land an investor in downright trouble.
Here’s an all-too-typical scenario of how many investors get played:
A developer has 100 units and needs to sell them for $400,000, but the market is performing badly and their true value is closer to $350,000. The rental market will pay only $350 a week, which means that, for the $400,000 price, the investor’s return is 4.5%. Developers realise these numbers won’t attract investors – at least not in a hurry – so they put in place a rental guarantee.
They price the units at $400,000 with a rental guarantee of $450 a week for two years. This pushes the yield to 5.9% and suddenly investors are interested. To finance the guarantee, it costs the developer $100 a week to foot the difference between the guaranteed rent and what the market will actually pay. This totals $10,400 over two years, which would seem a lot except that, since the developer was paid $400,000 for a property worth only $350,000, he is still some $40k ahead.
The headache comes after the two years are up. When the guarantee expires, the investor has to find tenants in the open market. Upon realising that the market will only pay $350 a week, the investor’s returns fall from 5.9% to 4.5% in the blink of an eye.
There is nothing inherently wrong about off-the-plan purchasing.
The traditional concept is that brave early bird investors obtain a property below its potential sales value by purchasing a property when it is nothing more than a contract and a couple of sketches. Part of the payback is that the investor only needs to put down a deposit of a few thousand dollars for accepting some of the risk – allowing him to sell for a killer profit a few years down the line.
It’s a strategy that works for a handful of experienced investors, who generate considerable profits, but the majority of investors get it wrong.
One of the big issues of buying off-the-plan is finance. Banks are often very nervous when it comes to granting approval for off-the-plan purchases, and getting a loan can be difficult. In addition, since loan approvals are only current for three months, getting formal pre-approval is impossible. This means that when the project is completed, some purchasers will be unable to obtain finance and are forced to sell. Others go in never planning to settle and only want to flip their property for a profit.
All of this adds up to a group of desperate vendors who lower their prices to sell at whatever the market offers. If you are one of those who were successful in settling your purchase, the banks are likely to only lend against the prevailing market price of your property, which will be the lowest price achieved by one of the desperate vendors, instead of the price you paid.
Another thing to consider is the unknowns that accompany an off-the-plan purchase – such as what the property will really look like outside of a sketch or model. A good off-the-plan development is one where developers sell at sensible figures that recognise the risk you will be taking.
When assessing an off-the-plan development, look at other similar developments around it that are a few years old and take note of the prices they are selling for. Also consider whether there will be much competition for rents or resales when the development is finished, because this will impact your cash flow or sales price.
What do you think is the easiest way to lose money through property? Have you made a profit by buying off-the-plan? Join the debate in our comments section below
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