By guest contributor Calvin Yeo (reproduced with permission from his blog www.investinpassiveincome.com)
A constantly debated topic in Real Estate has always been whether one should buy completed or under development properties. The answer is: it depends on your need and situation. I for one have done both and I would like to share my experience. Frankly, I dislike buying under construction properties nowadays as I hate waiting a long time before I start seeing any Real Returns. However, I will still go through the Pros and Cons of each.
Pros of Buying Underdevelopment Properties
1. Developer Freebies
Developers often give freebies like Free Stamp Duty, Free Legal Fees, Rebates and others. There are also developments where the Developer absorbs the interest during the construction period, known as Interest Absorption Scheme/Deferred Payment Scheme. In some lesser known developments, Developers may also give out Rental Guarantees for a number of years to attract investors. However, the Developers normally have already priced these incentives into the pricing, so it’s not usually that great a deal after all.
2. Ease of Financing
Developers usually work with Panel Banks to secure financing for their buyers. As such, valuation is usually not required for these properties as the banks have already accepted the valuation of the developers’ pricing. Banks may also come up with innovative schemes like No Payment Down or minimal down payment required for certain developments.
3. Low Payment Upfront
As described earlier, a combination of Free Stamp Duty and Legal Fees basically reduce transaction costs. Coupled with low down payment schemes, the down payment can be pretty low. It’s one of the cheapest options to purchase a property.
4. Brand New
Buying an under development project means getting a brand new property when you receive the keys. For some people, it’s a psychological comfort that the house is brand new and much cleaner than one which has been lived in before. There will also be minimal hassles with repairs and maintenance since it would be covered by the developer during the Defects Free period.
Cons of Buying Under Development Properties
1. Risk of Abandoned Projects and Delays
The most basic risk is that the development gets delayed or worse still never gets completed. It’s a real risk in countries such as Malaysia where any Tom, Dick and Harry can become a developer. For larger, well known developers the risk of the project getting abandoned is less likely. In this case, the risk may be delays in delivering the completed property.
2. Unable to See the Final Product
Developers are known to furnish showrooms with the most expensive materials, furniture and fixtures which may not be in the actual unit. Showrooms also employ many visual tricks like walls of mirrors, breaking down doors and divisions to make the space appear larger than it actually is. The site plan may also be somewhat different, so the layout of certain rooms may not be as ideal as you expected. Also, standing at the ground floor of the showroom, it’s difficult to imagine what your view would look like; the last thing you want is to see a cemetery right from your living room (it happened to a friend of mine before).
3. Long Waiting Time
The standard length of time to completion is anywhere from 2 years to 4 years, so it’s a long wait. If your development does not offer a Deferred Payment Scheme, you will have to make interest payments for the Progressive Payments of the project. In addition to the opportunity costs of the downpayment locked in during those years, the holding costs could be quite sizeable. The money could have been invested in low risk stocks/bonds for 3-4% return per year.
4. Market Uncertainty
For investors, the market can be very unpredictable. 2 to 4 years is a long time and anything can happen when you get the keys. Should there be a downturn during that time, you could be in for a tough time. Those who are hit particularly hard by this are speculators who just buy with the aim of flipping for a gain upon completion. A hot market inevitably draws in a lot of speculators who do not have the ability to hold the units and they may be forced to sell at low prices, lowering market values for the property.
5. Higher Prices Than Resale Properties
In recent years, new properties are almost always priced above currently available resale properties in the same area. I am sure you have heard all the factors, inflation, rise in construction costs, rise in material costs, higher land cost, new design blah blah blah. There may be some truth in them, but it’s up to you to decide if the developers are overpricing their projects.
6. Rental Yields Uncertain
Sales people will always quote unreasonably high rental yields and always boast the rentability of the project to expats or students. Investors for some reason have a constant fascination with either expats or the student rental market so the sales people will always try to touch on these factors. It is important to note that half of the things sales people say are exaggerations so I would never take them too seriously. Do your own research on how certain these units are likely to rent and the probable rental rate.
Pros of Buying Completed Properties
1. What You See Is What You Get
You will be able to see the actual unit before you commit to purchasing it – the exact layout, quality of furnishing, view, who the neighbours are, occupants of the development, surrounding amenities and more. All these factors are critical factors to the rentability of your unit, so it’s great to be able to see them, reducing your risk considerably.
2. Cheaper than New Properties
Resales properties are not always old and dilapidated. In fact, some are newly completed! In my opinion, those new completed properties usually represent a good buy especially if the price is still below the launch prices of new projects.
3. Instant Rental
Once the transaction is completed, you will be able to rent out the unit for income instantly. Better yet, if the purchase comes with a rental agreement, it saves you the agent costs and searching costs. This is another very important factor, getting Instant Returns once you actually own the unit instead of having to wait.
4. Ability to Calculate Rental Yield
Even if the actual unit is not rented out, it is quite easy to derive an approximate rental based on other units rented in the same project. The ability to calculate rental yield is an important determinant of whether the price you are paying for the property is reasonable. The higher the rental yield, the better the price is.
Cons of Buying Completed Properties
1. Higher Transaction Costs and Cash Outlay
In a resale, the buyer often has to pay for all the transaction costs upfront such as Stamp Duty, Legal Fees, Financing Fees, Valuation etc. and more. Furthermore, the downpayment will have to be paid in full in a relatively short timeframe of 3 to 6 months. The cash outlay is normally much higher when you buy a completed property.
2. Difficulty In Getting Valuations
In some cases of hot properties, it may be difficult to get banks to match current asking prices since valuation prices are normally based on historical. If you believe in the potential of the property, you have to either shop around, push banks to increase their valuations or even top up the difference in cash. Again, having the cash on hand is critical in such situations. You can always refinance the property to get the cash out after the valuers have caught up with the new valuation.
3. Repair and Renovation Costs
Buying a resale property normally means having to do some repairs and renovations. Depending on the state of the property and age of the furnishings, the costs can be either minor cosmetic touch ups or astronomical for those with structural defects. It is therefore important to get an expert to check on potential defects especially if you are buying an old house. Then again, there are many who have made good money by buying old houses, renovating them and flipping for a good profit.
After going through all the Pros and Cons, you should have a good idea of the differences between both options. I personally prefer buying Completed Properties, but for some people Under Development Properties may be a better choice.
Guest contributor Calvin Yeo is the founder of the Making Passive Income blog. He graduated with a Business Major in Finance and Accounting and spent a few years working in an investment bank. The knowledge from his studies and working experience serve as a good base for him to grasp the ideas for passive income generation.