FALLING DOMINOES IN OFF-THE-PLAN PROPERTY

The Danger of buying property off-the-plan.

Article originally published DECEMBER 23, 2003 –Reviewed and approved.

NOTE: Although written in 2003, the dangers of buying apartments off-the-plan with the expectation of making a profit, are just as prevalent today. Indeed, today, with higher prices, the danger is more acute. And yes, prices have risen a great deal in the past 17 years, but please remember, property is cyclical. If you buy at a high point and must sell at a low point in the cycle, you may lose money. OFF-THE-PLAN IS ALWAYS HIGH RISK!

By Neil Jenman

The front-page story in today’s Australian may seem sensational, but if it’s half true, it will mean huge consequences. And remember, the authors of this story, Robert Gottliebsen, Geoff Elliott, and Elizabeth Colman, are respected commentators. This is not a media beat up, it is a story with an ominous ring of truth.

According to The Australian, Melbourne and Sydney are about to face the “biggest residential crisis in a decade”.

It’s all about those off-the-plan sales that are due for settlement next year. Today’s report says thousands of investors will be unable to complete their purchases. Of course, many of these investors had no intention of ever completing the sale. It was their intention, in a rising market, to on-sell their apartment and walk away with a tidy profit.

Expecting to ride the ever-increasing wave of rising prices, investors paid ten per cent deposit on apartments that were not yet built. All they saw was an architect’s plan.

Now, back in 2001, with prices rising daily, it was easy for salespeople to convince buyers that by the time the apartment was built it would be worth a lot more. And, according to the common sales spiel, the best way to make money in property is to use what’s called “leverage”. If you pay ten per cent deposit and the price of the property goes up by ten per cent, you have doubled your money.

It sounds great – in theory.

However, just as leverage is an advantage when prices are climbing it becomes a disaster when prices are falling. If a property is bought for $400,000 and then, when it is completed, its value turns out to be $360,000, the buyers can be in real trouble. Especially if the banks tighten their lending criteria.

And that’s exactly what’s happening now.

Two years ago, property prices were going up by 15 or 20 per cent a year – and banks were falling over themselves to lend up to 90 per cent of the purchase price. It seemed like a no-lose deal.

But how things change.

Today, many of the unbuilt apartments that were sold off-the-plan for say $400,000 are worth $360,000, at best. Often much less – try as low as $300,000.

And now, instead of the banks being prepared to lend 90 per cent of the value (not the purchase price), many have now reduced the percentage of value upon which they will lend.

Some banks will only lend 50 per cent of the value of city apartments. So, if the buyers paid $400,000 and the completed apartment is now worth $360,000, the maximum loan available will be $180,000.

Suddenly, instead of pocketing a profit of at least $40,000 (had the apartment increased by ten per cent to $440,000) the buyers now must reach into their pockets and find anything up to $220,000.

Of course, many of these now hapless buyers throw up their hands and walk away in despair. They will lose their deposits.

But not so fast. It gets worse.

The developers will then sell the apartment and SUE THE INVESTORS FOR ANY LOSSES.

For example, if the apartment sells for $300,000, the investors will lose $100,000 ($400,000 less $300,000). These investors will be faced with two choices – sell at a loss or borrow against other assets to complete the sale.

Some investors – especially those whose assets are not solid – face a far uglier choice. They will have to sell their family homes to cover the shortfalls.

This is why today’s report is so frightening. It is no exaggeration to say that the apartment crisis will lead to “much wider ramifications including a further fall in the overall real estate market.”

Those commentators who say that real estate markets differ from area to area have failed to see an obvious point in the real estate world. All markets are linked.

A crisis in one segment of the market is a sign to what will happen in other segments of the market. It happens when prices go up and it happens when prices go down.

It’s like a domino effect.

When one starts to fall, it causes another to fall and so on.

Finally, it all dominoes fall.

The warnings have been clear for at least two years – real estate prices have risen too far. They will fall. For investors who bought off-the-plan, it is probably too late to escape unscathed. For those in other areas, here’s some advice. Check your financial position. The falling dominoes are heading your way.

If you can sell now for a good price – even a small profit – it might be worth considering selling.

After all, you never go broke making a profit.

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