31 Oct 2016
Words John Mahoney

Off The Plan or Off The Planet

There is no doubt that the past couple of years have been very bullish for off the plan management rights sales. Until recently rental demand for new product has been strong and rents had held quite steady, at least in the case of new permanent rental apartments.

We have all read recently about the softening rental market, increasing vacancy levels and an oversupply of apartments, particularly around the Brisbane CBD. As usual there are a number of commentators predicting all sorts of problems but it is funny how the market tends to correct itself pretty quickly. Nevertheless anyone contemplating buying management rights of the plan in the current economic cycle needs to be cautious.

Whilst I will not attempt in this article to cover all of the things that such buyers should be looking for, I will highlight some of the traps that buyers should avoid falling into.

The first trap is the acceptance of the developer’s “blue sky projections of profit. It is not uncommon to see such projections based on the full body corporate remuneration, close to 100% of the units in the letting pool, 100% occupancy over 52 weeks of the year, no allowance for wages and little if any allowance for expenses.

In one set of projections I saw recently, the body corporate remuneration was around $260,000 a year and letting income over $500,000 yet there was no allowance at all for wages in the minimal expenses shown the projections. So a 2 person management team is supposed to perform all of the caretaking duties, which for the remuneration being paid the body corporate might reasonably expect about 130 hours of work per week, and run a letting business generating half a million dollars in annual profit! Some 2 person team.

Apart from getting an experienced and independent accountant to assist with determining appropriate expenses of operating the business, buyers should also look carefully at the rental projections which unsurprisingly are often inflated. Whilst there is no doubt that new apartments will attract a premium over older apartments, caution is still warranted particularly in the current climate.

Then there are the various issues that need to be properly addressed in a well drafted contract for the acquisition of the rights. Whilst up until now developers have largely had the upper hand in negotiating these contracts, there are some particular traps that buyers should avoid.

I am of the firm view that a manager should only pay for letting appointments from unit buyers who have actually completed the purchase of their unit and not for appointments where the purchase contract has not yet settled. There is no certainty that all such contracts will settle.

Buyers should also be wary of situations where one person, whether that be the developer, associates of the developer or some third party, owns multiple units. Valuers will discount or in some cases attribute no value to these appointments, and for good reason. There are different ways that these can be dealt with in the purchase contract to protect the manager.       

Clawbacks and clawforward provisions in off the plan contracts take on a variety of styles and meanings. It would be foolish to accept the typically simple provisions that benefit the developer and move all the risk to the manager. Our comprehensive checklist helps us and our clients to identify and minimise or remove these risks in a way that is fair to both the developer and the manager.

With historically low interest rates, no stamp duty on the acquisition, opportunities to establish and sell a new management rights business for a healthy profit, I do not expect to see too much slowing down of these transactions in the marketplace. However I do expect to see buyers becoming more cautious with a little less appetite for risk.