Buying off-the-plan: tempting tax benefits but loaded with risk

Every property cycle upturn is accompanied by developers marketing planned new apartments and units as a great opportunity to benefit from the property tax system.

At first glance, it looks like a compelling concept. Buying before construction is complete allows purchasers to avoid a substantial proportion of stamp duty.

Stamp duty can be a weighty cost.

On an established $600,000 property, an investor would pay $32,695 in Victoria, $21,872 in NSW, $22,813 in Queensland and $23,045 in Western Australia.

When buying a property off-the-plan, stamp duty in most jurisdictions is calculated by subtracting the construction cost incurred from the contract date from the overall purchase price.

For an investor, buying a $600,000 apartment off-the-plan before construction starts, if $400,000 will be spent building the apartment, the dutiable value stamp duty (plus a few smaller fees) will be charged on $200,000.

In Victoria for instance, that amounts to a significant saving of $24,917.

Buying off-the-plan loaded with risks

On paper, these cost savings make buying off-the-plan look like a winning proposition. Yet it’s the riskiest way of buying property.

Perhaps the most insidious aspect is that many of the risks in newly built property aren’t apparent when the keys are handed over.

I was reminded of this recently when chatting to a young owner of a nine-year-old building. He told me he was moving out thanks to owners corporation (strata) fees, which for his one-bedroom apartment in inner Melbourne had escalated to $11,500 a year.

Why so expensive? Like many recently built complexes, this one started having engineering issues a couple of years after completion.

That is not that unusual. Placing a new building weighing thousands of tonnes on a plot of land will mean that building and the earth underneath it can take a few years to settle.

For instance, hairline cracks can be common in new foundations and appear due to the building settling and fluctuations in soil moisture.

The settling process may lead to expensive rectification works and the need for these won’t typically show themselves for anything from a year to five years.

But the most common problem is water leaks through the structure due to faulty plumbing, poor waterproofing or external damage.

Structural faults in the foundations, load-bearing walls, beams or roofs are the most concerning and they can be expensive to fix.

Any of these expenses can lead owners corporations to refinance the sinking fund by escalating their fees to owners and that cost can also deter prospective buyers for years.

Building problems

Since most states moved away from government certification of buildings, reports of construction issues have accelerated.

A NSW government survey found more than half of apartments registered between 2016 and 2022 had at least one serious defect.

Now with governments at all levels under pressure to increase new home building, many in the industry are warning that a “forced construction boom” could lead to a wave of building defects.

Don’t believe the display home

For many investors, the game plan when buy the property off-the-plan is to take advantage of stamp duty reductions and hope market growth will fill any gaps.

With this approach the purchaser needs to understand the different risks at play.

Large developers have teams of project managers and building supervisors but some of the smaller players may only have a small number of staff overseeing the project.

But all developers will be under pressure to meet cost guidelines.

That means the finish in the display apartment may not match the final product, with builders substituting lower priced appliances, fittings and materials if permitted by the contract.

Investors should take the time to understand the contract, history of the developer and how many of their projects they finished successfully.

Most developers contract a builder to conduct and oversee construction. For smaller developers, it’s actually the proficiency of the main contractor and their sub-contractors that is most important.

A power imbalance or dispute between the parties can develop, which in the worst cases, can lead to the builder being sacked.

Where structural issues exhibit themselves after completion, that can lead to the question of who is actually legally liable.

Projects where the developer has their own team supervising all aspects tend to be more secure.

Timing and delay risks

Another common problem for investors is where the project runs behind time, leaving purchasers months behind their proposed settlement date.

That means new landlords will find themselves months behind receiving the rental income many were counting on.

It also brings into play the sunset clause in their contract. In most jurisdictions, governments have moved to prevent developers from relying on sunset clauses to purposely delay residential projects to the detriment of the buyer.

Nonetheless, delays can play out badly for buyers in changed financial circumstances. When the times comes to settle, the purchaser will need to come up with the funds or the developer will take them to court.

That change in circumstances may see buyers scrambling to find a new mortgage, often at a higher interest rates, or resort to the developer selling the unit for them and incurring more costs. 

Established homes better bet for investors

It’s the accumulation of risks that leads most buyers agents to steer clients away from newly built projects and buying off-the-plan.

The potential losses simply outweigh the benefit of the tax saving.

In many ways, that’s a pity as the construction industry is, for the most part, designing and building better homes.

For investors determined to buy new, I would advise them to consider properties built around a decade ago instead.

Most of the issues with new buildings make themselves apparent within a few years of construction. More astute buyers target complexes that have a clean engineering scorecard or where issues have been rectified at least five years ago.