Why off the plan apartments are riskier than ever

It’s no secret that I’m not a fan of buying off the plan apartments.

For many, many years, I’ve talked openly (and written extensively) about what I believe to be the high risks associated with these types of properties, from an investment point of view.

In my opinion these risks have only become greater since the onset of the pandemic, yet I’m still seeing naïve investors considering buying this type of property.

Why am I so against off the plan properties?

Well…there are a number of reasons why these types of property represent a riskier proposition from an investment perspective – including a lack of scarcity factor, building quality issues, a lack of demand from owner occupiers, a very low land to asset ratio and a mountain expenses when it comes to ongoing costs and maintenance.

One thing that they often don’t lack is a profit margin for developers.

There are many reports showing buyers of new and off the plan properties see little or no capital growth for up to a decade after they purchase their property.

One of the reasons is they pay too much in the first place.

Don’t believe me?

In a report called The Apartment Shortage, the Reserve Bank of Australia’s (RBA) Keaton Jenner and Peter Tulip suggest that buyers continue to pay a premium for new property stock in high-demand, inner city areas.

The problem, of course, is that the growth drivers to move these values even higher are few and far between – so those investors who do pay a premium for these types of properties are often waiting years to see any kind of capital appreciation.

“We estimate that home buyers will pay an average of $873,000 for a new apartment in Sydney, though it only costs $519,000 to supply – a gap of $355,000,” they report.

This represents some very big profits for developers.

In general, developers expect to make around a 20 percent profit margin for their risk and the banks also require them to make a profit.

This profit, plus the expenses involved in marketing, is built into the price that the apartments are sold for.

However, this new research from the RBA suggests that a much bigger margin of 68 percent is achievable – far in excess of the industry standard 20 percent – particularly in areas where “the shortage of apartments is most severe: in the inner suburbs of Sydney, where height limits prevent more construction”.

“Australian cities face a shortage of apartments. The severity of this shortage can be gauged by the difference between what homebuyers will pay for an apartment and what it costs to supply,” Jenner and Tulip explain in their report.

While they estimate that the average new apartment in Sydney sells for around $355,000 more than it costs to supply, or 68 per cent of costs, they say the margin is closer 20 per cent of costs in Melbourne, and 2 per cent in Brisbane.

With such massive profits on offer in Sydney, why don’t even more builders and developers exploit these profitable opportunities, by constructing more apartments?

“The standard answer,” argues Jenner and Tulip, “is that planning regulations stop them.”

Urban Taskforce CEO Tom Forrest says the bloated and expensive planning system in NSW “had slowed the planning approval process even before COVID-19 hit”, but that since the pandemic, “planning approvals, particularly for apartments, have now fallen off a cliff”.

“Given the economic shock created by COVID-19, the RBA's independent confirmation of the excessive costs associated with the NSW planning system presents an opportunity for the NSW Government to cut housing prices by approving more supply and allowing for more height,” he says.

"This important piece of independent research cannot be ignored by policy makers in NSW.”

With so much uncertainty brought about by the pandemic, investors are already questioning whether property is still a worthwhile investment.

So with that in mind, does it make sense to flirt with a property investment option that is already mired in big risks and even greater uncertainty?

Not in my view – especially when there are huge amounts of money on the line.

It’s not just the financial risk that the asset won’t grow in value, either.

There are a number of safety risks that have been highlighted in the last couple of year, since the real cost and depth of the cladding crisis has become even clearer.

Why do off the plan properties make “bad investments”?

With off the plan apartment investments, as the property owner, you have to let go of many aspects of “control”.

You can’t control what other owners are like, how they upkeep their homes, or what type of environment they create.

You can’t control the potential to add value through renovation, as there are often strict rules around what you can and can’t do.

You definitely can’t control the outcome when someone else in your building experiences financial distress and has to offload their property for a “fire sale” price – thereby dragging down the rest of the values of similar properties.

Add in the fact that local investors are fewer in number and there’s a flight to quality; that foreign investors are completely out of the market at present; and that fewer owner occupiers are likely to want to live in towers in close proximity to others due to COVID-19, and it’s becoming increasingly clear that off the plan apartments are not the ideal investment opportunity in 2020.

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Michael Yardney is CEO of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.

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