,If you want to sell a property before it’s been built, it’s known as selling off the plan.
This means instead of doing a walk-through of an existing property, buyers will make a decision to buy based on documentation you provide prior to construction. The documentation might include floorplans, architectural drawings, artist renders and legal paperwork.
Once you’re a more established property developer, you might set up a display suite to show off the fixtures and finishes using mood boards or you might even build an entire kitchen and bathroom.
But because property investors can’t see and touch the actual, final built product, some don’t like the idea of buying off the plan. Other buyers expect to buy at a substantial discount on what we consider the perceived completed value to be. And there are some people who buy and then pull out of their contract.
So why would a property developer choose to sell off the plan?
Isn’t it better to wait until you have some shiny new apartments or townhouses ready to show buyers?
Clearly there must be some pretty compelling reasons to choose this sales avenue when it comes with some significant drawbacks.
Show me the money
To put it bluntly, sometimes there’s no other way to get finance approval for your property development project.
If you want to use one of the big four banks, they’re quite stringent on their finance requirements. They’ll typically ask you to get what they call debt coverage for your project. And that debt coverage can be anywhere between 80% all the way up to 120%.
So if you've got a project that has a total development cost of $4 million, you’ll get debt coverage by selling enough of the project dwellings off the plan to generate $4 million worth of sales.
This means you’ll probably only have one or maybe two of your dwellings left to sell as the finished product. And as a general rule, the finished product will attract a higher price point than selling off the plan. This is because you’ve taken most of the guess work out of the purchase – buyers can see exactly what they’re buying and are more confident making a decision.
But what happens if you use non-bank or second-tier banks or people who specialise in development funding? Well, they tend to have higher interest rates but they’re less stringent on their finance requirements. You may be able to commence construction and sell off the plan while the development progresses.
So how do you choose between the big banks and a second-tier lender?
As a property developer, you first have to weigh up the allure of low interest rates and the perception of the savings that creates with the actual real world costs of selling most of your project off the plan.
To secure the low rate it’s likely you’ll have to sell at a discount.
When you sell off the plan the bank valuer is always conservative, so straight away they’re shaving a little bit off the price. Then you’ve got a buyer who is concerned that what they’re buying off the plan may not necessarily be what they get, so they’re wanting to get a discount.
Then you’re typically selling through a project marketer, who specialises in off the plan sales and commands higher commissions than their real estate counterparts.
That, and you’re trying to sell a dream. You’re asking buyers to sign up on the promise of what’s to come, which may mean the sales process takes longer, which in turn means your holding costs go up. The big four banks won’t let you start constructing until you have all the required presales.
This means buyer number one is not really motivated to get in because he doesn’t know how long it’s going to take you to sell the remaining dwellings. So getting the first few sales is really hard off the plan because nobody knows if the project will definitely go ahead.
Then there are the pre-sales that the bank won’t qualify as a pre-sale. Say what?
Well, the valuer and the bank stipulate that pre-sales should be made to an “informed buyer”. Their definition of an informed buyer is a local buyer familiar with the local market. So if your off the plan sales are to interstate or overseas purchasers, they might not count!
Typically the bank will limit the amount of out of area sales, so your focus will need to be on local buyers, and these are not always the buyers targeted by project marketers.
So while low interest rates are appealing, you have to factor all of this in when you’re deciding on the best finance option for your property development.
Let’s compare that to paying higher interest rates with a second-tier lender.
There’s a good chance you can get started on construction which means people can see what’s actually being built. Selling once construction is underway is usually much easier, even if you’re selling off the plan.
But there’s a flipside here too. If you hang on to the majority of your dwellings until completion, hoping to sell for the best possible price, you’ll reach what we call peak debt.
You’ve already incurred all of your costs, from DA approvals to construction to marketing and you’ve got a huge outstanding loan. And this starts to put pressure on the sales themselves. If the sales don't turn over in a short period of time, then the holding costs of that finished product escalate. That pressure can actually force you to start discounting from the get-go, because you’ve got legitimate concerns about blowing out your holding costs.
Risk reduction
Another reason to sell off the plan is to lock in a high price if the market is falling or likely to head south in the near future. Obviously we want to maximise our sale price, and we know it's going to take some time to move through the construction process to create a finished product.
Let’s say the market has been booming for 12 months but the media is starting to talk about a slow-down. You’ve got a project ready to go that’s going to take at least 18 months to complete. There’s every chance that by the time our project gets to lock up stage the property market is in decline. To avoid the possibility of the market dropping off, we sell off the plan at today’s prices. Assuming our construction prices remain stable, and we’ve built in appropriate buffers for unexpected challenges, our deal is done and dusted from a profitability perspective.
Not only have you removed one of the variables in the current project, you’ve also got some certainty around what funds you have to roll into the next project.
This is a risk reduction strategy, and if you don’t need presales to get finance approval, risk reduction is the other key motivator to sell off the plan.
So folks, this is just the tip of the iceberg when it comes to selling off the plan, but it gives you an introduction to why you might need to tread this path as a property developer. Keep your eyes peeled for my intel on off the plan sales contracts coming up in a future Property Pulse blog post.
This means instead of doing a walk-through of an existing property, buyers will make a decision to buy based on documentation you provide prior to construction. The documentation might include floorplans, architectural drawings, artist renders and legal paperwork.
Once you’re a more established property developer, you might set up a display suite to show off the fixtures and finishes using mood boards or you might even build an entire kitchen and bathroom.
But because property investors can’t see and touch the actual, final built product, some don’t like the idea of buying off the plan. Other buyers expect to buy at a substantial discount on what we consider the perceived completed value to be. And there are some people who buy and then pull out of their contract.
So why would a property developer choose to sell off the plan?
Isn’t it better to wait until you have some shiny new apartments or townhouses ready to show buyers?
Clearly there must be some pretty compelling reasons to choose this sales avenue when it comes with some significant drawbacks.
Show me the money
To put it bluntly, sometimes there’s no other way to get finance approval for your property development project.
If you want to use one of the big four banks, they’re quite stringent on their finance requirements. They’ll typically ask you to get what they call debt coverage for your project. And that debt coverage can be anywhere between 80% all the way up to 120%.
So if you've got a project that has a total development cost of $4 million, you’ll get debt coverage by selling enough of the project dwellings off the plan to generate $4 million worth of sales.
This means you’ll probably only have one or maybe two of your dwellings left to sell as the finished product. And as a general rule, the finished product will attract a higher price point than selling off the plan. This is because you’ve taken most of the guess work out of the purchase – buyers can see exactly what they’re buying and are more confident making a decision.
But what happens if you use non-bank or second-tier banks or people who specialise in development funding? Well, they tend to have higher interest rates but they’re less stringent on their finance requirements. You may be able to commence construction and sell off the plan while the development progresses.
So how do you choose between the big banks and a second-tier lender?As a property developer, you first have to weigh up the allure of low interest rates and the perception of the savings that creates with the actual real world costs of selling most of your project off the plan.
To secure the low rate it’s likely you’ll have to sell at a discount.
When you sell off the plan the bank valuer is always conservative, so straight away they’re shaving a little bit off the price. Then you’ve got a buyer who is concerned that what they’re buying off the plan may not necessarily be what they get, so they’re wanting to get a discount.
Then you’re typically selling through a project marketer, who specialises in off the plan sales and commands higher commissions than their real estate counterparts.
That, and you’re trying to sell a dream. You’re asking buyers to sign up on the promise of what’s to come, which may mean the sales process takes longer, which in turn means your holding costs go up. The big four banks won’t let you start constructing until you have all the required presales.
This means buyer number one is not really motivated to get in because he doesn’t know how long it’s going to take you to sell the remaining dwellings. So getting the first few sales is really hard off the plan because nobody knows if the project will definitely go ahead.
Then there are the pre-sales that the bank won’t qualify as a pre-sale. Say what?
Well, the valuer and the bank stipulate that pre-sales should be made to an “informed buyer”. Their definition of an informed buyer is a local buyer familiar with the local market. So if your off the plan sales are to interstate or overseas purchasers, they might not count!
Typically the bank will limit the amount of out of area sales, so your focus will need to be on local buyers, and these are not always the buyers targeted by project marketers.
So while low interest rates are appealing, you have to factor all of this in when you’re deciding on the best finance option for your property development.
Let’s compare that to paying higher interest rates with a second-tier lender.
There’s a good chance you can get started on construction which means people can see what’s actually being built. Selling once construction is underway is usually much easier, even if you’re selling off the plan.But there’s a flipside here too. If you hang on to the majority of your dwellings until completion, hoping to sell for the best possible price, you’ll reach what we call peak debt.
You’ve already incurred all of your costs, from DA approvals to construction to marketing and you’ve got a huge outstanding loan. And this starts to put pressure on the sales themselves. If the sales don't turn over in a short period of time, then the holding costs of that finished product escalate. That pressure can actually force you to start discounting from the get-go, because you’ve got legitimate concerns about blowing out your holding costs.
Risk reduction
Another reason to sell off the plan is to lock in a high price if the market is falling or likely to head south in the near future. Obviously we want to maximise our sale price, and we know it's going to take some time to move through the construction process to create a finished product.
Let’s say the market has been booming for 12 months but the media is starting to talk about a slow-down. You’ve got a project ready to go that’s going to take at least 18 months to complete. There’s every chance that by the time our project gets to lock up stage the property market is in decline. To avoid the possibility of the market dropping off, we sell off the plan at today’s prices. Assuming our construction prices remain stable, and we’ve built in appropriate buffers for unexpected challenges, our deal is done and dusted from a profitability perspective.
Not only have you removed one of the variables in the current project, you’ve also got some certainty around what funds you have to roll into the next project.
This is a risk reduction strategy, and if you don’t need presales to get finance approval, risk reduction is the other key motivator to sell off the plan.
So folks, this is just the tip of the iceberg when it comes to selling off the plan, but it gives you an introduction to why you might need to tread this path as a property developer. Keep your eyes peeled for my intel on off the plan sales contracts coming up in a future Property Pulse blog post.
