Australia: Buying off the plan? Be aware of the pitfalls and do your due diligence

It is no secret that the Sydney real estate market has been experiencing a boom since 2013. While this is considered good news by existing property owners, today's market prices are a cause of great concern for aspiring home owners who are increasingly asking themselves "will I ever be able to afford a home?" It is therefore understandable that many of today's first home buyers find themselves buying homes off the plan.

Off-the-plan property purchases appeal to first home buyers

Off-the-plan home and land packages have been marketed to appeal to first home buyers. This, in combination with government incentives and the fact that the buyer, in a sense, does not have to pay anything aside from the deposit until later, makes it the perfect choice for many first home buyers who cannot really afford to buy anything else.

Just as it is easy to see the appeal of off-the-plan purchases, it is also just as easy to overlook the risks associated with such a purchase and the importance of having a good lawyer review the contract for sale before signing on the dotted line.

Contracts typically skewed in developer's favour

The first thing to remember about an off-the-plan contract is that you are not dealing with your usual home owner. Rather, you are dealing with a developer. A developer's very business is to buy land, develop it and sell it.

Developers, in instructing their solicitors to draft an off-the-plan contract, are ensuring that the terms of the contract are going to be of benefit to the developer and going to protect their interests and their business. It is very easy for unfair terms to be concealed in an off-the-plan contract, especially in the case of an excited buyer who is solely focused on the fact that they may be purchasing a property.

This article is intended to make you aware of the risks involved in buying off the plan, so that when the time comes for you to make the choice, you know what to look for in your contract to make sure that you and your family are financially protected.

Preparation and approval of development application can cause delays

If you are buying off the plan, essentially you are buying something that does not yet exist. Construction of the property cannot commence until the plan itself has been approved by the relevant council. The developer has to lodge a development application with the council and await its approval before it can commence construction.

A number of parties may be involved in the preparation of the development application, such as valuers, building surveyors and strata certifiers – it is not handled solely by the developer. The involvement of so many parties can cause delays in finalising the development application.

Then, the actual processing time of the council can take anywhere between four weeks to a number of months, and this is assuming they do not identify any problems which require rectification. If the council does identify such problems, this will cause further delays, because the developer will then need to lodge one or more modification applications, modifying the plan to respond to the council's concerns.

All of these factors, along with wet weather conditions once construction itself has commenced, can cause significant delays. If you are planning to purchase off the plan, and are being told that it will take six months to a year to have the home in liveable condition, you should double that figure and ask yourself if you would be happy potentially to wait that long for the home to be ready. If you are not, then it may not be the right purchase for you.

Safeguarding your deposit and your right to terminate or rescind the contract

If you do not have a clause in your contract giving you the right to terminate and/or rescind the contract and receive your deposit back in certain circumstances, you could find yourself stuck in a contract where it may take years for the property to be ready. It is important that you ensure you have a clause to this effect in your contract to safeguard your deposit and to give yourself a way out. Examples of appropriate exit conditions that you could include are:

• if the development application is not lodged within six weeks of the date of exchange
• if the development application is not approved within six months of the date of exchange
• if construction has not commenced within nine months of the date of exchange
• if the home has not been completed within one and a half years of the date of exchange

It is preferable to specify dates, rather than stating "within six weeks". This ensures clarity regarding deadlines.

The developer may not agree to all of the above terms, especially if the term relates to something outside of the developer's control, such as receiving council approval. However, you should still negotiate the terms and ensure that whatever agreement you come to, your interests are well protected and you are comfortable with proceeding with the purchase.

What happens if the developer becomes bankrupt or insolvent?

You need to safeguard yourself from a situation where the developer becomes bankrupt or insolvent. If the developer falls into financial strife while your property is still being built, then your property is at risk of being incomplete and you could be faced with the decision of either losing your deposit or having to hire a different developer to complete the project.

It becomes a very costly exercise. To safeguard yourself, you should do your due diligence before signing any off-the-plan contract. This includes researching the developer.

If the developer is a company, have your solicitor run a company search. This will reveal who the directors and owners of the company are and the company's credit rating. You can also have your solicitor run a bankruptcy check on the directors and shareholders (or on the developer personally if the developer is an individual).

Your solicitor can also use this information to see if there are any court proceedings currently underway against that developer. You might be surprised how many class actions and disputes are currently listed in the Supreme Court where buyers have been defrauded by developers. You should also ensure that you are informed of who the actual builders contracted to do the building work are, and that they have current licences.

You should also consider incorporating a clause in the contract that states that if you as the buyer become aware that the company may be experiencing financial difficulty (for example, by conducting a company search and seeing that a creditor has petitioned the winding up of the company), you have the right to terminate or rescind and get your deposit back.

Statutory warranties and warranty deed with construction contractor

The law sets out a number of statutory warranties which apply to your home. This means that even if they are not written into the contract you sign, the law states that they still apply to the work you are having done on your home.

These warranties are detailed in Part 2C of the Home Building Act 1989 (NSW) and include the fact that the work must be performed with due care and skill, be done in accordance with any plans and specifications as laid out by the contract and that all materials that are supplied are suited for the purpose for which they are to be used. (Similar legislation exists in the other Australian states.)

In addition to statutory warranties, you can request additional clauses to be included in your contract to protect you in the case of any defects to the home, and you can also seek to enter into a warranty deed directly with the construction contractor. The benefit of this is that, should there be a problem in the future that requires litigation to resolve, instead of you suing the developer and the developer then suing the contractor, you can sue the contractor directly.

This would save time and costs in undertaking any such legal proceedings. Such a deed would require the construction contractor to provide all warranties that it gives the developer in its construction contract, to you directly.

Determining the market value of the property

You should do your due diligence and organise a valuation of the property to ensure that the price you are paying is in line with the current market. Too often, developers advertise a high purchase price and this can be a significant disadvantage if the market drops during the time between the exchange of contracts and the date of completion. If this occurs, you may experience difficulty in securing finance for the balance.

Finance approval will depend on your circumstances at the time

Carefully consider your position in the future with respect to finance approval. Just because you are able to obtain conditional approval at the time of signing the contract, does not mean that you will be approved at the time of completion. Most banks do conditional approvals, but the condition is that your circumstances must not have drastically changed by the time of completion. If they have, you might not be able to borrow as much as you initially anticipated and it could mean losing your deposit.

If you enter into an off-the-plan contract, and anticipate that it will be ready for completion in two years, consider where you will be – will you still have your job, or be in a job that pays as much or more? Will you have started a family? Will you have sufficient funds saved by then as a backup, in case lending has tightened and interest rates have gone up? These are all things to consider carefully.

Ensure you have insurance to protect your property before signing the contract

You should ensure that you have a clause in your contract requiring that the developer has adequate insurance to protect your property. The developer needs to have arranged insurance under the Home Building Compensation Fund before they contract any builders to do the work. The developer needs to be providing a copy of the certificate of insurance to you.

You should make sure you have been given a copy of the certificate before signing the contract, so that you have peace of mind that your property is covered. You should also require the developer to have insurance to cover the following circumstances: death of the developer, bankruptcy or insolvency of the developer and disappearance of the developer.

Market out clause to allow you to cancel the contract

You should incorporate a clause allowing you to cancel the contract in circumstances where there has been a substantial change to the market. For example, if you purchase a property for $600,000 in 2017 and the market subsequently crashes at the time of settling and your property has dropped in value to $300,000, it would allow you to opt out of the deal.

However, the developer would be unlikely to agree to refund your deposit under such circumstances, as agreeing to such a clause would already mean a potentially significant loss to the developer.

Ensure the list of inclusions is as specific as possible

Make sure you are getting what you pay for. Triple check the list of inclusions and make sure it is as specific as possible. Be wary of clauses that the developer might include in the contract that would give them the right to substitute certain inclusions for other inclusions, or for the same inclusion but of lesser quality.

Make sure the shrinkage clause has a clearly defined limit

A shrinkage clause allows the developer the right to vary the size of the property. A developer's power to "shrink" the size of your property can have significant implications for the future value of your property.

A developer is unlikely to agree to removing the shrinkage clause completely, but you should negotiate and agree on a limit to how much they can shrink the property to only 3% of the overall size.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.