Does the NSW stamp duty saving mean I should buy off the plan?

By now most property investors would have learned that the NSW Government is waiving or discounting stamp duty on certain property purchases and this is making some wonder if it is time to buy off the plan properties.

The initiative is aimed at addressing the severe housing shortage in NSW and giving a boost to the construction industry and I applaud this. Clearly the Government’s intention is to increase the supply of properties by cutting stamp duty to zero for people who buy off the plan.

But what does this really mean for investors?

Firstly, let’s look at what the Government is proposing…

Stamp duty will be waived on a new property purchase priced below $600,000 for a home (including apartments, units, etc) and below $400,000 for vacant land where construction has NOT commenced. To qualify for zero stamp duty, you will have to purchase a property before the foundations are laid. This would translate into a maximum saving of $22,490 for a home and $13,490 for vacant land.

If construction has commenced, purchasers will receive a 25% discount on the stamp duty payable. This is a maximum saving of $5,622 for a home and $3,372 for vacant land.

While I agree with any government help in boosting housing supply and making property more affordable; on the face of it, these measures won’t actually increase supply. They will only increase the demand side of the supply and demand equation and could have the unintended consequence of pushing up property prices even further, much like the first home owner’s boost did.

The new concessions apply for contracts entered into between July 1, 2010 and July 1, 2012, and the development must be completed by December 2012 or December 2013 in some cases. If you buy vacant land, you must start building within six months of exchange of contracts for the land component.

While these measures will definitely help first home buyers by making house and land packages cheaper, I’m a little concerned some investors may be led down the wrong path with these incentives.

Let me explain why…

While new homes can be built quickly, for these concessions to apply to high-rise buildings only those that already have Development Approval could potentially be built within the timeframes. This means the availability of stock will be limited if you want to buy off the plan before construction starts. As I said, these measures may push up demand and not supply with a subsequent rise in prices.

But the big problem for investors is that neither a new home built on land in the outer suburbs or a new apartment bought in a high rise building makes a good investment – no matter how big the stamp duty savings.

Remember, investors should be looking for asset growth and we know that in general it’s the land component of a property that appreciates. This means for an investor who is looking for capital growth, they want the land to asset ratio to be as high as possible.

Think about it…

When you buy a new house on a block of land in one of the new outer suburbs, you may be paying $450,000, of which the land, the bit that goes up in value, could be worth around $200,000. This is a very low land to asset ratio indeed.

Of course there are other reasons we don’t buy houses in the new estates for investors. While they may be great places to live and bring up your family, in general, capital growth will be subdued in these suburbs. Firstly new homeowners in these “mortgage belt” suburbs are more interest rate sensitive, as they tend to have less disposable income than people who live in more affluent suburbs.

Secondly, there is rarely a scarcity factor about properties in these locations. Many properties look the same and there is always another estate with more similar houses and more land just across the road. Of course, scarcity is one of the major reasons properties increase in value.

Another reason we avoid buying in these areas is the demographics. While they make good areas for young families and new home owners, there is not the same demand from a diversity of tenants as there is in the inner and middle ring suburbs.

Okay, well if taking advantage of the stamp duty savings on new homes isn’t going to work for investors, what about saving the stamp duty on new high-rise developments?

Let’s look at a few reasons I would avoid high rise apartments at present.

Firstly, let’s look at the land to asset ratio. Remember investors want the land to asset ratio to be as high as possible – they want to own as much valuable land under their apartments as they can. They know it’s the land that appreciates.

On the other hand when a developer chooses a development site they focus on getting the land to asset ratio down as low as possible – they want to build as many apartments as possible on that block of land.

Essentially the interests of the developer and the investor are opposed to each other.

But there are many other reasons we avoid buying off the plan.

In the current climate one of the big issues with buying off the plan is finance.

And I’m not talking about developers having difficulty getting finance and therefore having to charge above market rates to get their developments across the line. I’m talking about the finance an investor needs to complete the purchase.

Since most loan approvals are only current for three months, obtaining a formal pre-approval for an off the plan purchase is often a waste of time. The problem is, currently we have four big banks in Australia and they each have a policy restricting their exposure to any one building. Most won’t lend to more than 15% of the properties in a building. This means that if there are 100 apartments in the building and you are the 16th person to approach the bank when the building is completed, they may decline your loan application.

Another concern is that most off the plan developments are sold to investors and we like buying properties in buildings that have a good proportion of owner-occupiers. We find they tend to look after the buildings better and this enhances your long-term capital appreciation.

The other big problem is that some of these investors will want to sell, and others will have to sell when the building is completed. Having a whole lot of properties for sale, dragging down the value of your property when you want the bank to lend you money to settle means that often the banks will lend on the new lower valuation price than what you paid.

The other thing many investors forget is that even if the banks will lend for your new high rise purchase, they will usually only lend at much lower loan to value ratios than for other types of properties, meaning you need a bigger deposit. And this could easily wipe out any stamp duty savings.

There are lots of other reasons I would avoid off the plan purchases, including the uncertainty of completion dates, finishes and the market conditions when you eventually take possession.

Finally, if you want further proof that the stamp duty savings on new homes or high rise apartments does not make up for the deficiencies in these as good investments you just need to look across the border.

Victoria already has a stamp duty system like this and while it has encouraged the building of new homes, in fact they build about 20,000 more homes per year than we do in NSW, new properties have underperformed as investments.

Our Melbourne research shows that buying investments in better suburbs and in established buildings with an element of scarcity and particularly buying properties which have the potential for added value through renovations, gives much, much better capital growth.

In summary the NSW Government has moved in the right direction and encouraged buyers to purchase new properties because it will stimulate new construction and this has a huge flow-on effect in the economy. While this will be good for home buyers, the types of property these measures will produce don’t make good investments.

What do you think the NSW budget is going to do to the property market? Has it made you consider buying off the plan?

Michael Yardney is the director of Metropole Property Investment Strategists, a best-selling author and one of Australia’s leading experts in wealth creation through property. For more information about Michael visit www.metropole.com.au and www.PropertyUpdate.com.au.