Tips for buying off-plan in the current market
Buying a home off-plan involves more risk in the current market of late 2022.
Buying a home off the plan has been a popular choice in the past few years, locking in a home at a price before it goes higher and giving yourself time to keep saving. But it’s worth taking another look at the pros and cons of this way of securing a home in the tougher housing market of late 2022. This route to home owning always comes with risks but there are more downsides in the current economic climate, say experts.
What you’ll learn:
- Doing your due diligence before signing is even more important than usual.
- Choosing between a turn key and progressive payment schedule.
- Falling house values may affect your financing when it comes to settlement time.
- If you can’t get your house finance the developer will keep your deposit and possibly sue.
- Checking on your developer’s financial strength is even more vital than usual.
- Buying off-plan is easier for downsizers than first home buyers.
When buying a home off-plan, you’re going to rely very heavily on your team of experts – namely, your lawyer and your mortgage adviser – who will take you through all the risks involved. Read on to learn all the great questions to ask in your due diligence.
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What your lawyer will want to know
You’ll want your lawyer involved early on before signing anything on an off-plan purchase. They’ll be assessing the sale and purchase agreement or contract and will do the due diligence on your behalf.
Fintan Devine, from Devine Law says off-plan contracts can be up to 60-70 pages long, compared with the usual 12 page sale and purchase agreement.
As part of the due diligence, your lawyer will look at the sunset clause, the clause that gives the date when the home is meant to be finished. Sometimes, these will give the developer an automatic right to extend the contract. Fintan says he’ll also look at whether the developer can change the specifications of the build, and any way an increase in price might happen if values go up.
Developers will reserve the right to substitute materials, which could well happen in the current market with supply delays. To protect the purchaser, clauses in their contract will need to say that any variations won’t materially affect the value of the property, says Fintan. If they do there will be a right to compensation.
The Wellington lawyer warns that with a planned new build you won’t get a LIM report so it’s good to have “ears to the ground” on any neighbourhood expansion plans the council might have in the area.
What’s the difference between turnkey and progressive payment contracts?
There are two ways to set up payments for your off-plan property purchase. Progressive payment contracts are where you pay along the journey of the build as certain important construction achievements happen, such as when the roof goes on.
In this financial climate, a progress payment schedule puts you at risk because what happens if the builder crashes during the course of construction, warns Fintan.
With the turnkey purchase, you put a deposit down at the beginning and then make the rest of the payment at settlement. You’ll usually agree to pay a fixed price although that hasn’t stopped developers coming back to buyers because of escalating building costs, says Fintan.
There will often be a condition in the agreement that says it’s also subject to the developer meeting resource consents. At any time before the contract goes unconditional, the developer can say you need to increase the price for us to be able to go ahead, says Fintan.
In the current market, where house prices may still be falling, he’ll always warn clients that they won’t know what the market will be like when the home is completed in 18 months or two years’ time.
“The property at completion may not “value up” to what you agreed to pay for it,” says Fintan. And if the bank lending criteria differs, you may not get finance when the time comes to settle.
“We’ve had clients in that position who’ve really struggled to settle and had to borrow to be able to complete settlement,” he explains.
If you can’t settle because the banking conditions have changed, then after the vendor (the developer) has given you 2.5 weeks’ notice, they can cancel the contract and keep the deposit, adds the Devine Law principal. Meanwhile, if they on-sell the property at a loss and the money that they got out of the deposit (on top of this) is less than the initial agreed price, then they could sue you for the loss incurred on the resale.
What mortgage advisers say about buying off-plan
Why might it be hard to get the finance to settle when the time comes? Because the lending environment has changed, explains Loan Market Capital & Coast mortgage adviser, Clifford Lawson.
For the past six or eight years Kiwis have been able to buy off-plan and get great capital gain, but those days are over. “Buying off-plan now, the concern is not so much developers completing the project but it’s people being able to get finance,” says the mortgage adviser.
“Whereas the bank test rate (on a new mortgage) might have been 6.5% when you first got pre-approval 12 months ago, now it’s up to 8.5% and you’ve also got CCCFA restrictions around debt servicing,” explains Clifford.
On top of this, most banks will only give pre-approval on mortgages for 12 months and most developers take longer than 12 months from the time of signing the contract.
It’s not all bad, says Clifford: “I’ve got clients who aren’t worried. They’re saying:”I’m just going to continue to pay down our debt and when we’re needing to borrow, we won’t need to borrow as much.””
Buying off-plan is good if you’re downsizing, adds the mortgage adviser. If you don’t need a mortgage it’s fine, you’ve got some time to sell your own home in the run up to settling on the new property.
The Loan Market mortgage adviser’s main concern with buying off-plan at the moment is there are so many variables in the equation.
“There’s no control over physical labour, the market, valuations going up and down, finance, and all of those then lead to how watertight is the contract?”
Clifford can’t stress enough to clients the need to find a quality solicitor and not to cut corners on legal advice.
How escalation clauses can scupper your prepared finance
If you only have a low deposit, then be very careful about buying off-plan, says Loan Market’s Bruce Patten in Auckland. Escalation clauses mean the developer can come back and ask for more money, as was the case with a client recently.
Their home finished a year after the expected date, and the developer asked for $60,000 more at settlement. “They didn’t have a choice, they had to pay it, they had enough equity and income to borrow the extra. You have to understand if you have an escalation clause, how much is it limited by and do you have the resources?” says Bruce.
The senior mortgage adviser points out there are so many developments completed with homes for sale, so it’s a really good market to buy a brand new home, you don’t have to buy off the plans.
The reason so many were selling off-plan in recent years was because there weren’t many finished new developments, he notes.
What happens if the valuation of your off-plan property falls?
Typically, says Loan Market mortgage adviser, Mikey Smith, you should expect there to be two valuations on the off-plan home – one at the beginning of the process and one at the end once the Code Compliance Certificate (CCC) is passed. You’ll be asked to pay for this by the bank and it’ll cost around $1,000 each time.
A big concern in the current market and in the future, is that the property value at the time of completion is less than the purchase price, says Mortgage Lab’s Christiana Pollock. “If the lender has requested a property valuation be completed before the mortgage is drawn down then the lender has the right to lend less to the client, based on the lower value. This means the client may need to find the extra funds themselves or risk losing their deposit,” she explains.
The majority of lenders require the approval for a turnkey property to be renewed every 90 days until settlement. If the client’s situation changes, the approval could be withdrawn, says Christiana.
Make sure you know what you’re signing up for, she adds. Look at appropriate plans and drawings at the initial stage and ideally a show home that shows the materials, appliances and so on, so you know what to expect. Then, draw from these details when doing the pre-settlement inspection near completion.
The mortgage adviser notes there are some key benefits in terms of finance with off-plan as for new builds.
- New builds are exempt from the RBNZ LVR restrictions
- Kāinga Ora's 'First Home Partner' scheme is only available for newly built properties
- Check what the homestar rating of the property will be because there can be benefits
How financially sound is your home’s developer?
More crucially than ever, you and your lawyer will be examing the liquidity of your house developer, when looking at an off-plan purchase, says Devine Law’s Fintan Devine. Your lawyer will always check that your deposit on the off-plan home is going into the developer’s lawyer’s trust fund. And, if they go under, that the deposit money will come back to you.
Another thing to check is which builder the developer is using, says mortgage adviser, Clifford Lawson, who expects some developers to “tip over” in the next six to nine months. The risk with buying off-plan has gone from a 20% chance of it going wrong to an 80% chance, he says.
Typically, if you buy off-plan and the developer goes bankrupt, the receiver tries to finish the project and on-sell it.
Always work with a developer with a proven track record, says Tim Clark from Tommy’s Real Estate. In Wellington, a construction company went under on a central city project and the developer stepped in to make sure the project was finished and everyone was paid, he says
“A bigger, better developer will always have a contract that’s a bit more friendly and not too heavily weighted in their favour,” he adds.
In the current market, it’s not just about individuals struggling to get finance, it’s also about the developer having the ability to fund their next projects, he comments.
Tim says the amount of off-plan opportunities will be relatively limited until the uncertainty about the economy subsides.
“Most of the developers aren’t releasing new product at the moment,” he says.
Sam Newble, a Tommy’s Real Estate agent, currently selling a townhouse off-plan in Mt Victoria, says it’s a good idea to see finished properties that the developer has undertaken. If they were built by the same developer and architect, they’ll have the same look and feel. “Not many people can read a floor plan,” he explains.
He suggests driving past the site with the floor plans so you can see what the outlook is, and when the sun hits the property.
To lessen the risk make sure it’s a good home for resale
A key way to lessen the risk of buying off-plan is to make sure that your future home has all the characteristics of a saleable home. It should be in a handy location with good transport links and close to amenities so that you’ll always find a buyer for it when you’re ready to move on.
“Go in with your eyes wide open,” says Clifford Lawson. If it says 60 sq m with three bedrooms, does that work, could you live there in 60 sqm?
And when you go to negotiate the deal, negotiate hard, says Mikey Smith, who says developers are having to meet the market.
”I’d be negotiating on any purchase right now as hard as I could. If interest rates go up another 1% it will be more difficult so you want to be buying at the most competitive price you can,” he says.
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