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Why buying off-plans may put property buyers off

Summary

  • Off plan still very popular. 55% of all real estate transactions were off-plan

  • Historically, only 40% of projects are delivered on time

  • Investors are expected to pay for the property for many years even after handover before generating returns

  • In off-plan you are reliant on price appreciation to make a decent return

Purchasing off-plan properties is still a very popular way to jump into the real estate market, particularly in Dubai. Already in 2019, over half – 55 per cent – of all real estate transactions have been off plan. Investors are eager to be involved in the real estate market, and many first timers are using off-plan purchases as an affordable way to get on the property ladder.

While purchasing an off-plan property may seem like a low-cost way to enter the property market, there are a number of variables that you have no control over that will affect your return on investment.

With so many unknowns, purchasing properties off-plan can turn from an investment to speculation.

Hoping that once the property is handed over it will be worth more than when you purchased it is nothing short of a roll of the dice. Most off-plan properties have an expected handover period of 3 to 5 years, but unfortunately the industry has a bad track record.

Only 40 per cent of projects in Dubai get delivered on time, meaning an off-plan buyer would have to wait even longer to see any return on investment.

During this time, the money that was invested is totally inaccessible in case of a major life change such as a job loss, or a drastic change in the real estate market itself. This puts all of the risk on the shoulders of the buyer.

If you do manage to make it through the nearly six years it might take to receive your property, your return on investment may still not be all that you had hoped. In the current market, off-plan properties are selling at nearly the same price per square foot than the existing or “ready” market. It may be worth more in the future, but then again, maybe it won’t – that is the risk that off-plan buyers take on.

Now with post-handover payment plans, purchasing off-plan can seem even more attractive upfront – but buyer beware. Developers and brokers can be misleading when they claim that buyers will see great returns on a four or eight year post-handover payment plan. They calculate returns based on only what has been paid until the date of the handover, and then determine the rent on that money, ignoring the fact that the buyer will have to pay the remaining 40 to 50 per cent over eight years. Factoring in the cost of the service charges, many times buyers end up paying out of pocket as their returns don’t cover costs.

Let’s take an example of a AED 1 million property that is expected to be handed over on 4 years with 5 year post hand over payment plan. Let’s assume you are required to pay 30% until the handover and the remaining 70% during the 5-year post hand over plan. For simplicity we will assume all payments are paid on a linear fashion. In the first 4 years to handover you will be obliged to invest approximately AED 75,000 per year. Remember this is money being paid to the developer and you are not earning anything on it yet. Once the property is handed over and lets assume you can rent it out for AED 80,000. Lot of agents and developers sell the idea that you have only put in AED 300,000 (AED 75,000  x 4) and are earning AED 80,000 in rent and that is 26% ROI. This is extremely misleading as they forget to mention that you still have 70% of the property value to pay.

On a 5 year post hand over payment plan that equates to AED 140,000 per year. Even if we don’t assume service charges, property management or any other fees you are still required to pay an additional AED 60,000 out of your pocket for another 5 years (AED 140,000 less rent AED 80,000). So for the next 9 years you will only be paying and not earning any return on your money. The post hand over payment plan is good as you got your renter to pay for part of the property purchase. The AED 1 million property only costed you AD 600,000 as the renter paid AED 80,000 per year for 5 years. Now let’s assume the property is worth AED 1.3 million at the end of these 9 years your total return will be an impressive AED 700,000 on your AED 600,000. Not bad at all but it took you 9 years to earn that. However, we have not assumed any delays, any service charges or other costs. If the property prices don’t increase or your rent is less than the returns will be much lower. You need a lot of things to go right your way for you to make money on an investment like this over a long period of time. It could work out or it could not.

You as an investor should be rewarded for the risk you take. Now assume a similar property can be purchased on day one that is rented at the same price. You would buy that for AED 1 million and collect AED 80,000 rent per year and after 9 years that property is worth AED 1.3 million.  In the 9 years you would have earned AED 720,000 in rental income and AED 300,000 in gain on the property for a total of AED 1,020,000.  Keep in mind you did have to park AED 1 million in this case, but you started earning right away and had more control on your investment. If you look at the returns in % terms, there is not much difference.  If you factor in the time value of money the off-plan might have a slight advantage. Total returns are not too dissimilar, but the risk levels are very different. Off-plan is much riskier than buying something that is ready, and you can start earning right away. For higher risk your return should be higher than the alternative. If that is the case and you are getting rewarded more for the level of risk, you are taking than it might make sense to go down that route but if you are getting the same return then why would you take on additional risk. 

Thankfully, there is more than one way to buy into the real estate market without emptying your bank account with a huge upfront purchase cost. Crowd-sourcing platforms like Smart Crowd bring the same affordability that off-plan purchasers are looking for to the ready market by allowing buyers to invest in a fraction of the total property.

With crowd-sourcing investment platforms, buyers don't have to wait years to see returns on their investments. They can start seeing rental income from day one.

In the long-term, crowd-sourcing also protects your investment, as you won’t need prices to increase substantially for you to make high returns. A steady rental income releases you from the ebb and flow of a volatile market. Real estate investment may feel like a gamble, particularly when purchasing off-plan properties. Savvy investors who want to buy into the real estate market without throwing the dice look to group investment platforms to provide a low cost to entry, immediate returns and less risk.

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