How an off-the-plan apartment can instantly lose value even in a healthy market
The value of an off-the-plan apartment can drop instantly, even without dramatic changes to the overall market. But how?
There are many reasons why an owner-occupier may be attracted to apartments that are being sold off-the-plan. They may desire, for instance, to choose a preferred position in the building and have an influence over the interior fit-out.
Off-the-plan apartments can also be enticing to investors looking to sell for a profit. The idea is that the value of the property will hopefully increase in the time it takes to complete the development, which could be several years. By selling the apartment after settlement, the investor can turn a relatively small deposit into a substantial profit, all while avoiding those nasty holding costs.
Of course, there are many potential pitfalls when buying off-the-plan, but I want to focus on what can cause the value of a recently completed apartment to seemingly drop in an instant. I’m not talking about a decline in the overall market but rather the things that can play havoc with the value of a property even when the market is healthy.
An overcrowded market
Generally speaking, the more supply there is of a particular product, relative to demand, the lower the price will be. When it comes to apartments, excess supply can certainly drive down values by increasing the competition amongst sellers. For an investor looking to sell a recently completed apartment, competition can come from three areas.
Firstly, there is a good chance that other investors who purchased in the same complex have had a similar idea to buy off-the-plan and then sell for a profit on completion. This means a number of almost identical properties would come onto the market at the same time.
Secondly, even if a large proportion of the development was sold off-the-plan, the investor’s property may still be competing against the remaining developer’s stock, which is probably untenanted.
Thirdly, depending on the location, there is a chance that other apartment complexes may have been built nearby, which only adds to the glut of properties and drives down prices. A classic example of oversupply happened in the Docklands area of Melbourne, where apartment values were significantly less than what investors paid at settlement.
With Australia’s growing population, strong economy and robust property ownership laws, Australian real estate is well regarded on the international scene.
Foreign investment regulations in Australia say that foreign buyers can only invest in Australian real estate if that investment adds to the housing stock. In other words, they can only buy new or off-the-plan properties. This is why apartment developers and marketers like to specifically target foreign buyers, particularly those in China and other parts of Asia.
Many foreign buyers have plenty of money to invest but not a lot of knowledge about the local market they are entering. Relying on advice from salespeople, these buyers can easily pay too much for their off-the-plan apartment.
Furthermore, foreign buyers may have unique motivations for buying property in Australia, such as a desire to emigrate in the future, help out a relative or get their money out of an unstable country. Again, this extra motivation can lead to overpaying.
Sales to foreign buyers at inflated prices can have a knock-on effect for local buyers, as the sales become a precedent for the remaining properties. Buyers naturally feel more confident with a purchase knowing that others have paid a similar price.
Valuers may also use sales to foreigners to justify the valuations required by lenders, further compounding the problem by giving buyers a false sense of security that the value ‘stacks up’.
But it’s not just misleading sales evidence that can hurt investors of off-the- plan apartments. There is also the fact that cashed-up foreign buyers are not permitted to buy established dwellings, so the ‘resale’ market comprises only of local buyers.
With weaker demand and potentially excess supply, properties will inevitably adjust to real market value and this could be significantly less than what investors paid.
Where’s the incentive?
It’s common for off-the-plan apartments to be sold with some sort of incentive, such as a rental guarantee or furniture package. These bonuses can be used to justify a high price, or they actually inflate the price by adding additional costs.
The problem is that these incentives are no longer there when the apartment is resold by the original purchaser.
Subsequent purchasers don’t have the same incentives attached to the purchase and this will be reflected in the price they are willing to pay.
It’s easy to see how the value of a recently completed apartment could drop, seemingly instantly, to the shock of the investor who made the off-the-plan purchase. Even without any dramatic changes to the overall market, a newly purchased property can appear to lose its value either because the investor overpaid to begin with or because of different market dynamics.
For investors who plan to buy and hold an off-the-plan apartment, the damage can still be significant. A poor valuation after completion can affect the investor’s ability to access equity, which could halt the wealth creation process and take many years to recover.