09 Sep 2013
Words Tim Admin

Tips for Buying Off the Plan

There are a number of reasons why people want to buy management rights off-the-plan. It is often perceived as an opportunity as there is an expectation that:

• the multiplier will be lower when buying from the developer; and
• the profit could ultimately be a lot higher than that projected by the developer (especially for short term accommodation).

It is also important that there is no stamp duty on the initial grant of the management rights, although there is still duty on the unit. Although there is GST on an off-the-plan management rights acquisition that is eventually remitted back to the buyer as an input tax credit. While the legal fees and general delays can be much greater than a normal purchase, the duty saving more than makes up for that as the duty can be over 5% of the price! Of course there are also risks of buying off the plan. But, if the items in this article are considered and acted upon, the risks can be substantially minimised. Tip Number 1. Deal with competent and respected people and get good advice early. Importantly, the first person you need to check out is yourself! Do you have the skills to bring this kind of business together? Permanent complexes are fairly straightforward. Many of my existing clients hear about a holiday building years before it is completed. Developers often approach experienced managers directly. Warning bells should ring if you have no experience and come across a major holiday or short term building six weeks before it is to be finished! Never sign an off-the-plan management rights contract without expert legal and accounting advice. These contracts are never standard. Tip Number 2. Trust but verify. The agent and the developer can be an excellent source of information. But, it is critical to distinguish between information and ‘blue sky’. Information can be verified, blue sky cannot be. Blue sky includes, for example, unsupported estimates about likely rental or occupancy rates. It is important to identify, check, and verify any important assumptions about the business. Get good advice form an accountant with expertise in management rights to help with the verification. Your accountant will assist to establish price calculation and related assumptions. What is the breakdown between body corporate remuneration and letting income? What expenses have been allowed for? What is the expected occupancy? What are the other income sources (electricity supply, internet services, parking fees)? Is it appropriate that those Income sources be included in the projections for sale purposes? Remember that projected profit does not equal cash flow! Depending on the size of the complex, nett cash flow (before interest) could be 10% or more below projected nett profit. Consider preparing separate cash flow forecasts. Again get your accountant to assist in this regard. Tip Number 3. Get good advice from an experienced lawyer on how to structure the clawback arrangements and deal with these issues up front so that agreement in principal can be reached with the developer. A critical question that is often ignored is, “How many units do I need in the letting pool to settle?” You can have the best clawback clause but if there are not enough sales to investors, the business might not stack up even with a major price reduction. In a holiday complex, consider if you require a minimum number of units to be fully furnished. One of the things that you need to determine is how much each unit is worth in the letting pool. For example, if the projected letting income from a unit is (say) $6,000 and the multiplier on your purchase is 4.5, then that unit alone is worth $27,000 to your letting pool. Examples of the features of clawback clauses include: not paying for units retained by the developer or its associates, only paying on receipt of a signed PAMD Form 20a Letting Appointment from an owner who has completed the unit purchase, and only paying for completed, furnished units (if applicable). These are just a few examples of the many factors we look at in calculating clawback provisions. We have a comprehensive checklist that we use for working out a clawback/clawforward arrangement. Working these out at the beginning of the matter as part of reaching in principal agreement with the developer can save time, money and angst. Tip Number 4. The developer and its selling agents – ideally, the developer will have a good track record – find out about the developer’s other complexes. Speak to the managers of those buildings. What support will the developer offer you? This could include marketing support for websites and advertising, and assistance with identifying and rectifying building defects. Managers often need to spend significant time and money setting up the business and fitting out the office in the months leading up to settlement. Who are the agents selling units in the complex? What have they promised the buyers? Obtain copies of marketing material. Tip Number 5. Make sure that you are using a lawyer with extensive experience in off the plan management rights transactions. There will be items of critical importance that need to be resolved before and after the contract can be signed. Your lawyer should identify any immediately obvious issues in the agreements but also conduct a thorough review of the agreements and the by-laws in the due diligence period. Developer’s solicitors frequently use ‘off the shelf’ caretaking and letting agreements. Often, we see permanent townhouse complexes with agreements that seem drafted for a high rise holiday building and vice versa. High risk items that might need to be considered include, for example, strict office hours, or being required to carry out duties that are way beyond the expertise of a manager and more properly the responsibility of a specialist contractor. These are but a few of the issues that an experienced lawyer will be able to identify and address.