You know how the saying goes “if it’s too good to be true, then it most likely is”? Well in most cases that is correct, however many property developers who put these “two good to be true” concepts together are making investors a fortune if taken advantage of. How? Because the developers are simply selling their off plan property far below current market value.
Before going any further, it’s important to know what off plan property even is. Off plan property is a property that is either currently under construction or has not begun construction yet. At some point or another, every single property in the world went through its off plan phase. When a developer decides to build in a certain area, he or she first needs to obtain planning (building) permission from the state or government before allowed to begin construction. The developer can still buy the land and hold on to it while planning permission is pending, and in some countries the developer can even start pre-selling units before planning permission is even granted. This is of course very risky to the investor as permission has not been granted but is done quite often. Because the risk is far greater before planning permission is granted, the developer decides to incentive property investors with a discount that rewards them for taking on such risk. Often times, the developer will state in the contract that if for any reason planning permission is not granted that the investor will receive a full refund plus a certain percentage of interest for tying up their capital. (Don’t ever invest in to an off plan property unless this is clearly stated in the contract between you and the developer).
So let’s consider the fact that you, the investor were looking for a heavy discount in the market and decided to contact developers or investment firms that were recommending off plan property as an investment. Take the price of a one bedroom apartment for example in North West London that costs on average £204,000. If you were to purchase this apartment at market value, you are not leaving yourself with very much upside potential, unless of course you wanted to wait for the markets to appreciate over the next 7-10 years to see a sizable return. To most aggressive investors, this is NOT an exciting investment strategy. So you decide to look at off plan property as an option and you are told of a property that is currently being sold for only £170,000, but has not yet begun construction. How can this be? This is a 20% instant savings on a 1 bedroom unit very similar to the completed properties you have been looking at. Because the developer is still obtaining planning permission, but is very confident that they will be granted rights, they decide to start selling units at a very heavy discount. Remember, at this time the developer and his team have everything in place including renderings of the development, but are just waiting for the planning committee to give them the green light. With a completion date set for two years out, you only need to put down 30% and nothing further due until the property is finished. Depending on the location, a mortgage is not required until the property is built which gives you more time to build up your savings and borrow even less when it comes time to apply for a mortgage. In many cases, by the time the property is complete, you may not even need to apply for a mortgage because you have saved enough funds to go ahead without it. So with a property price of £170,000 and only 30% needed to lock in this transaction, you only need to come up with £51,000. And it’s get better…
Once planning permission is approved, the investment case dramatically changes because now the property is guaranteed to be built. This gives the developers the confidence to ask for more money on each unit. It also gives the banks the confidence they need to finance the development in line with the developers needs. Immediately the developers raise the prices on each one bedroom unit to £185,000 giving you an instant unrealized gain of 8.8% in just a matter of months. Typically at this time, there is a rush of investors to get in on this new build, and if there’s enough hype you may even be able to sell your property to the next investor which would give you a profit of £15,000 or a 29% realized capital gain on your initial 30% deposit. Because you only invested £51,000 and your take home is £66,000, you genuinely are able to see big returns in a very short period of time.
Now let’s imagine that you decided to hold on to your property or there wasn’t enough hype in the market for you to be able to sell just yet. You now wait until the second phase in the property investment which typically occurs when the developers break ground. At this time, you can expect the prices to go up again, but not by as much as they will when the property is completed. On average you may expect the price of the property to rise roughly 5-10 percent and in some cases maybe 15%. Let’s be ultra conservative in this case and say that the property only went up another 5%. The value of your property is now worth £194,250 and the developers begin to list the investment at this price therefore giving you another opportunity to make even a bigger gain on your 30% deposit. If at this time you were able to sell your property you would now be taking home £24,250 which increases your gross capital gain on cash employed to 47.55% in just one year.
Finally when construction is complete, the developers officially launch the development to the public and sell each unit at market value. By this time, you have two options. One, take out a mortgage and continue to wait for the property to appreciate to a price that you would be happy with. Two, sell the property to a new investor that is happy to purchase this completed property at market value which in this case is £204,000. Let’s say that everything worked out perfectly and you were able to sell the property immediately before applying for a mortgage. You would now be taking home £34,000 (£204,000 – £170,000) giving you a realized capital gain of 66.67% increase in just two years.
This aggressive property strategy is known to many savvy investors as “flipping” and must be done in line with your financial situation. If you cannot afford to hold on to the property when it comes time to apply for a mortgage, then you should not enter this strategy with the intentions of flipping it before completion. You may get caught out not being able to sell which then forces you to take out a mortgage, therefore generating a massive burden on your financial situation if the mortgage payments are not in line with your financial budget. On the other hand, for investors looking for “a quick buck” (or pound in this case) can absolutely do so through the use of off plan property. It doesn’t always work out this way of course and more times often then others will you need to hang on to your property for a little bit longer then you originally planned, but if your financial situation permits it and your financial advisor highly recommends the investment, then go for it! It’s OK to take on little bit of risk every once and a while in order to see the potential big rewards.
So now that you understand how the strategy works, how do you know which off plan property to select? You should always speak to an investment advisor regarding the purchase of off plan property. Real estate agents aren’t qualified to give you the investment advice needed, and if you want the real story it’s best you speak to a financial advisory firm.