Buying new builds: Key risks and benefits of turnkey and land and build - Nadine Higgins

Buying off the plans can be good, but the risks should not be ignored. Photo / 123rf

When the Labour Government abruptly announced investment property tax changes in 2021, it exempted “new builds”, which prompted many investors to shift their focus, as was the intention.

While the current Government has since rolled back those changes, there remain compelling reasons why you would buy new – the ability to use a 20% deposit instead of 30%, lower repair and maintenance costs, fulfilling Healthy Homes requirements, and, altruistically, adding to the country’s housing supply.

But buying new comes in more guises than simply browsing One Roof new builds - you can also buy off the plans, where the property doesn’t exist yet.

Some people shun from the idea, worried it’s fraught with risk – and it’s true there are things you need to understand. To start with, there are typically two types of contracts: turnkey, and land and build, each with differing benefits and risks.

Turnkey involving paying your deposit, then just waiting for settlement. You don’t pay the balance until you get the keys (hence the name).

Land and build involves settling on the land, then paying for construction generally based on milestones, for example, when the roof goes on.

I’m not a lawyer (and always suggest you consult one) but I’ve bought properties utilising both types of contracts, and guided clients through the process, too. The differences aren’t solely financial (for example, a land and build contract requires a lot more paperwork) but let’s focus on the numbers.

Generally, a land and build contract will have a lower price tag, so might seem more attractive. But bear in mind developers can afford to offer a lower price because they don’t own the land, you do. They’re not borrowing to finance the build, you are.

Therefore, you need to understand those costs, as they may offset some of your savings. Plus, you need to determine how you’ll pay them, as they’ll hit long before you get any rental income – which also introduces something else to be wary of. If completion is delayed, you’re paying interest while you wait, whereas with a turnkey contract, your only exposure is your deposit.

However, (for what it’s worth) the land and build agreement I signed had a clause stipulating that if construction took longer than X number of weeks, they would cover the interest until completion. I’m not sure how common that is but, given that clause was indeed triggered, I’d say it’s worth requesting it! (and is evidence of why you should always involve a lawyer, ideally one with experience of off-the-plan contracts).

I’d argue the incentives for a developer to get things completed on time are more financially compelling with a turnkey contract, however, occasionally the reverse is true. During Covid some developers invoked the “sunset” clause on turnkey properties, cancelled the contract and sold the property to another buyer (for a higher price.) With a land and build contract you are less exposed to that risk, because you own the land and have been billed for everything to date (although the developer may be able to pass on build-cost inflation, depending on the terms of contract).

There are also lending considerations to factor in with both types of contracts.

Senior financial adviser and director at The Loan Market Cameron Marcroft says banks favour turnkey contracts, and will often factor in a contingency of up to 20% for land and build contracts.

“This is part of the borrowing assessment, meaning it can reduce the amount of borrowing capacity for what you can actually get approval to use for a build,” he says.

There are other lending risks to consider with turnkey properties too – for example, when you sign the contract and pay your deposit, the property could be a year away from completion. Some banks will offer a 12-month approval, but others will only grant 3 months, which they may roll over once, but will then require a whole new application.

Marcroft says that introduces risks: “Such as if your financial position changes negatively or assessment policy changes between when you buy the property and when you settle, meaning the previous approvals may be null and void.”

I’ve seen this happen – sometimes it’s outside of anyone’s control, for example when interest rates shot up, but some purchasers sign the contract then decide to quit their job and start a business, or extend their home mortgage, which fundamentally changes their borrowing proposition.

There’s a bit to get your head around, to ensure you’re forewarned and forearmed. My rules of thumb would include: ensure you’ve factored in all costs, not just the purchase price (like interest during the build); use the time between unconditional and settlement to strengthen your financial position (access to more equity or other funds can solve a variety of issues); delay (where you can) major life changes until after settlement; use a lawyer with experience of off-the-plan contracts; test the affordability of lending at higher interest rates (I’d suggest higher than current test rates, because if interest rates were higher, test rates would be, too); aim for a 12-month pre-approval or stay in close communication with broker to keep your approval up to date; and buy from a reputable, experienced, well-financed developer.

None of this is to say that buying off the plans is a bad way to go – it can work brilliantly - but the risks should not be ignored. Clock them, and where possible, mitigate them.