Risks Of Buying A Turn-Key New Build

The risks of buying offplan/Turnkey

Mark Zuckerberg said “The biggest risk is not taking any risk. In a world that’s changing quickly, the only strategy that is guaranteed to fail is not taking any risks”.

What a way to start this article and I should follow that by saying that I am in no way encouraging the taking of blind risks without understanding the potential outcomes.

In particular, the potential downsides.

Like a lot of things in life, buying a property comes with risks.

Buying a new build – whether it be off-plan or turn-key – comes with a few more.

This doesn’t mean it’s “risky” but does mean you should be aware of those risks and how to mitigate them. This article will set that out.

Firstly, what is a turn-key or off-plan property?

The definition of the two is important because it can affect the ability to get a bank approval.

What’s a Turn-key property?

Taking a main bank definition, a turn-key property is a new build which is due for completion within the next 12 months.

This could be a stand-alone house or a townhouse and some of the banks will say that it’s only defined as a turn-key if there are less than 10 townhouses on the building consent.Otherwise, it’s defined as off-plan.

This is different to a land and build contract where you take possession of the land first and then enter into a separate progress payment build contract.

Banks are able to issue 12-month approvals for a turn-key property provided there is confirmation that the completion is expected within that timeframe.

What’s an off-plan property?

An off-plan purchase is similar to turnkey, except the completion of the development is more than 12 months away.

This can also be a town house but if more often where you buy in an apartment complex.

Banks are not able to issue approvals for longer than 12 months and therefore in this case, the immediate risk is that you are entering into a purchase without a formal bank approval.

In both the off-plan and turn-key situations, you will enter into a sales and purchase agreement with the developer of that property.

Upon going unconditional, you’ll pay a deposit (typically 10% of the purchase price) and that deposit will sit in the solicitors trust account.

You’ll then pay nothing until the property is completed (has CCC and title).

So, what are the risks?

I’ll outline these in no particular order.

Pre-approval is not indefinite

When you sign up to purchase your new-build, you will get a pre-approval for the finance.Your pre-approval will be valid for a specified time.

Depending on the lender, this pre-approval will be for between 3 months and 12 months.Once confirmed this will be communicated to you by your adviser.

The risk here is the build taking longer than you are approved for.i.e., if you have a 12-month approval in place but the build takes 15 months.

Should the specified time frame expire prior to the build settling, a brand-new application will need to be completed to renew that approval.

Any new application will then be subject to the respective lender and their policies at that time of application.

Given that, there is no guarantee that you will get that approval renewed.

There are ways to mitigate this risk and help ensure that you are protected so the best thing to do would be to speak to your mortgage adviser.

Change in your financial position

When you get an approval for your new-build – regardless of whether it is a 3 month or 12-month approval – the lender requires you to notify them if your position changes during your turnkey build period.

Common changes include:

- Change of employer or becoming self-employed

- New consumer debt (hire purchase or credit cards etc)

- Pregnancy, birth of new child

- Childcare expenses

- Change of circumstances that the lender considers may affect your ability to service the mortgage

If there are changes that occur that negatively impact your approval, then the risk is the bank may withdraw their approval or not renew the current approval.

If you know these changes are likely or possible at the time of applying for your lending, then talk to your mortgage adviser about how to manage this.

Interest rates can’t be locked in

Whenever you’re buying a property, you need to meet all approval conditions before you can lock in interest rates with your bank.

With a new-build, those approval conditions will include things like title being issued, Code of Compliance (CCC) and a valuer completion certificate.

These are things that can’t be provided until the build is complete.

What this means is that you cannot lock in a fixed interest rate until the end of the build.

This means that you won’t know for certain what your rates are when you sign up for the property.

Once you have the conditions met, you/your mortgage adviser can arrange for the interest rate fix, and any cash contributions (if applicable).

You should be using a mortgage adviser or financial adviser that helps you understand the impact of rates increasing or decreasing during the time of the build.

This will help ensure you make an informed decision when buying and don’t freak out if they do increase.

The value may drop

The value of your property at settlement may be more or less than what you agreed to pay under the Sale and Purchase Agreement.

A risk of buying a new-build is that property is coming in “under value.

Let’s say a purchaser signs up to buy a property for a price e.g., $800,000 and the expected completion of that property is 12 months away.

However, during that 12 months build time, the value of that property falls below the initial price paid.

As part of the loan approval with the bank, you need to go and get a registered valuation to see what the property is worth.

If the registered valuer says the property is now worth $750,000, it has come in “under value”. This is because the registered valuation ($750k) is lower than the purchase price $800k).

The most significant thing you need to look out for is how you pay for the property.

The big issue when your property falls in value is that the bank will often not lend you as much money as you thought.

This is largely due to loan-to-value ratio restrictions (LVRs).

These requirements from the Reserve Bank say that banks can only lend up to a certain percentage of the value of a property.

The specific percentage depends on whether it is an owner-occupied or investment property.

They can lend 80% on own occupied and 60% on an investment property.

The bank will always lend on the lower of either the purchase price, or the registered valuation at the time of completion.

If the value of your property goes up (above the purchase price), there’s no impact; the bank will lend to you based on the purchase price (less of the two).

For example, if your property was bought for $800k, and it’s now worth $850k - the bank will still lend to you based on the purchase price of $800k.

There are lots of ways to mitigate this risk so speak to your Mortgage adviser about the options.

Getting a registered valuation

There are a few different ways to determine the value of a property:

- Government valuation (rateable value)

- Sales and Purchase agreement

- Desktop valuation

- Registered valuation

When buying a new build, the lender will almost always require a registered valuation.

This is where a qualified valuer will go out to the site of the build, take pictures, measurements and then do a formal assessment of what the property is worth.

With a new build that hasn’t been completed, they will use the plans and specifications to help predict what the property will be worth when it’s completed.

One strong recommendation would be that you obtain a registered valuation on your new property purchase prior to going unconditional on the sale and purchase agreement.

The valuation can assist in obtaining any lending approval for the full amount prior to going unconditional.

This will help in a couple of ways:

- It will help give you the confidence that you aren’t overpaying for the property

- It will help mitigate the risk of the value decreasing prior to settlement as the lender (in most cases) won’t require a new valuation at settlement – unless the build has gone beyond 12 months and you need to re-apply for lending

LVR rules may change

Current LVR rules allow for 80% lending on new build investment properties.

This means you will need to obtain 20% from other assets, such as cash, other investment assets or equity held in other property assets.

If those LVR rules were to change and meant that a bigger deposit was needed for the investment property, then this this would mean either:

You would need to put in more cash

Or, you would need to have more equity in your existing property

I would say that, of all the risks we have noted, this is probably the least likely to occur.Throughout the whole time that the Reserve Bank have implemented LVR restrictions, new builds have been exempt.

Do I need 10% or 20% Deposit upfront?

This is a bit more of a contentious one in that not everyone agrees with our view.

But in all honesty, our process has been created through seeing the downside of not doing it.

When you purchase a new build investment property, you will be required to pay 10% upon going unconditional, and then the remaining 90% on completion of the new build.

At Catalyst, we will look to ensure we borrow the full 20% deposit at the start rather than only the 10%.

Why would we do that?

When you borrow that initial deposit, you’re using existing equity in your property (or properties) and that is based on the value of your properties at the time of application.

Should you choose to borrow only 10% of the deposit at the start from current equity (e.g. from your owner occupier or other existing investment properties) prior to confirming the sale and purchase agreement, there is a risk that movements in future value could result in the 10% balance remaining on settlement no longer being available due to your assets decreasing in value.

In this instance, you wouldn’t have the available equity in your property to be able to settle the new build – which you are unconditional on.

Getting 90% lending against the new build is by no means a certainty.

To mitigate that, we borrow the 20% up front while we know what the value of your property is.

Now, because you only need to pay 10% upfront, we then structure your lending in a way that ensures you only pay interest on the funds you have used.

The other 10% will be set up in a revolving credit or offset so that you don’t pay interest on it until it’s needed.

Which brings us to another risk…

Should you choose to borrow 20% prior to going unconditional on the sale and purchase agreement, 10% will become payable to the developer to be held on trust until settlement.The remaining 10% would be retained by you until settlement (as outlined above).

The downside of this is that those funds are available to you and what that means is you can spend them.

If you spend the 10% on anything other than to complete the sale on settlement you risk having insufficient funds available to settle the property.

Interest only terms

It’s highly likely that you’ll be wanting your new investment property lending to be on interest only.

If you still have lending against your owner-occupied property – and especially if you’re buying a new build investment property – then it’s more efficient from a tax perspective to pay down your own home first.

Therefore, you’d put the investment lending on interest only.

However, the banks don’t approve interest only loans indefinitely.

Typically, interest only is limited to between 1 – 5 years only, depending on the lender and their policies at that time.

This means that for the entirety of your interest only term, you will not be contributing any principal repayments towards your loan.

What is also means is that once your interest only term expires, you will have the remaining loan term to repay the principal amount borrowed.

For example, if your loan is approved over 30 years with 5 years interest only, then once the interest only term is finished, you will need to repay your loan over 25 years.

Renewing the interest only term is possible, but not guaranteed.

As with anything, buying a new build isn’t without risks.

What’s important though, is that understanding these risks and having financial advisers who also understands them, gives you substantially more confidence in mitigating them. Swinging the risks in your favour will ensure your well set up to continue growing without the fear of things going wrong.