Settlement Risk When Buying Off-the-plan Properties

By Justin Wang

While buying off-the-plan properties has a number of benefits for an investor, there are many hidden aspects that you need to be aware of before you sign a contract, especially when settlement of the property may not occur for a number of years.

At present, the Sydney housing market is hot and sales are going crazy. But you and I both know that the property market is ever-changing and tends to move in cycles. So while Sydney as a whole is progressing, and is in a fast-paced cycle, there are many projects that are on the go that may never be completed, or they may take years longer than anticipated to be built.

New developments are being planned daily, and contracts are being exchanged between banks and developers, developers and buyers, as well as buyers and agents, and buyers and banks. Everyone is excited by the opportunities and the possible profit, but how many of us think about the risks associated with buying off-the-plan? Risks that include, but are not limited to, the following:

• A delay in settlement due to the developer encountering building or financial issues,
• Property designs being altered with the finished building not looking the same as the original design,
• Paying for the property as its being built, then getting the property valued after completion to find that you’ve lost money.

What Is Settlement Risk?

All development risks that can possibly happen at the time of settlement are called “settlement risks”. These risks can affect many people, such as buyers, developers and agents, as well as banks.

The risks caused by developers are vast, especially if a developer is new to the industry or to the Australian market. Some of the most common settlement risks include the following:

• Developers who lack experience may not be familiar with construction legislation.
• The developer may not know how to deal with certain organisations, such as transport services, water suppliers and banks.
• Developers may have also miscalculated their budget.

All of these factors contribute to a delay in construction, and in some cases, the development may never be completed. As a result, some buyers may find that their contract expires before their property is built. Even if the 10 percent deposit is refunded to the buyers, the loss of opportunities, time and energy are still massive.

Many agents made fake promises about property value increases, and they misled clients.

Can Real Estate Agents Be Held Accountable for Settlement Risk?

While many buyers would like the real estate agent who sold them their off-the-plan property to be held accountable when the settlement of their property fails, most agents are only responsible for selling properties and are not responsible for the settlement. When you buy an off-the-plan property, a real estate agent typically gets their commission from the developer as soon as the contract is exchanged. Therefore, they do not need to keep in-touch or carry out a follow-up throughout the rest of the process. Thus, real estate agent is long gone when construction takes place, so they do not need to worry about how long construction takes or whether the buyer is happy when settlement occurs.

Some real estate agents don’t even care about their reputation in the industry. When the market was at its highest selling point, many new agents emerged. These agents are what many refer to as “opportunists”, where they enter to the market to make a quick buck, and then move on. 

Thankfully not all real estate agents are the same.

How To Avoid Settlement Risk?

When the Property Investors Alliance (PIA) was founded, it was a tough time in the Sydney property market. When we first entered the market, people were extra cautious about real estate agents, this was mostly due to settlement issues, and in some cases, even settlement crises. Real estate agents at this time, would encourage buyers to look for short-term investments in order to earn an instant profit. Many agents made fake promises about property value increases, and they misled clients.

The consequences of these actions were disastrous for a number of developments. Many buyers had to sell their properties due to poorly written contracts and not getting full loan approval before settlement, while others sold their properties below market value to remove the financial burden of their property from their shoulders. This pushed the value of these developments down, due to many of them being on the market at the same time. So some buyers who made a late purchase then found that the asking prices of these properties was above bank evaluation. As a result, the price the bank had valued their property at was a lot lower than the advertised price. It was an absolute nightmare. Developers who were caught in the settlement crisis lost a great deal of capital. They could not pay back their bank loans and in the end had to auction off the whole project for as much as they could get, and in many cases, declare bankruptcy.

Having witnessed this, PIA decided to introduce measures into its company procedures that reduce settlement risks. In addition, we keep examining and building on this model of responsibility, which aims to act in the best interests of all parties, including allies and developers. This measure was not as easy as it sounds to put in place. We deal only with reputable developers and only instruct allies to sign a contract after we have evaluated the building costs of a development and any possible issues that might be encountered. If, unfortunately, a settlement date has to be delayed we also retain the capacity to negotiate with developers to mitigate any loss.

On the other hand, we also wish to create a stronger relationship with our developers. As a result, PIA only accept their commission after the settlement date. All actions we carry out before the settlement date ensure that the rapport between the developer and buyer remains sound and that the building of the property flows smoothly. If a buyer encounters problems with their finances, which may prevent them from going ahead with settlement, then we can assist these allies to find a solution. If this proves to not be possible, then we look for another buyer in advance so that the whole development is not disrupted. This process allows PIA to monitor the process to ensure that it is relatively straight forward. This, in turn, guarantees a better financial result for developers.

How PIA Ensure Settlement Risk is Avoided

PIA firmly believe that to avoid settlement risk and to gain financial freedom, our allies need to learn how to sail their own financial ship. Therefore, to avoid issues when sailing, all allies must learn emergency training procedures. This then prevents unnecessary accidents. To do this PIA prepare allies for the purchase of long-term investment, and we check their financial status in advance.

When compared to a lot of real estate agents, PIA might appear to have strict guidelines, and terms and conditions, such as:

• We don’t accept a 5 percent deposit.
• We don’t promote short-term investment.
• We don’t allow option buyers.

But we do this because we are taking on responsibilities that other agents don’t want to be burdened with. Plus, we want to ensure the success of our allies when they sail their financial ships through rough waters.

Over time, PIA are beginning to see that their vigilant efforts and development of a sounder settlement process is starting to pay-off. This is a direct result of the company carefully selecting its buyers and developers, and aiming to deliver greater satisfaction by building rapport. So that everyone on the property investment ship has a safe and enjoyable journey.