Careful contract consideration key when buying off the plans
As residential housing stocks remain low and tax exemptions come into play for investors buying new builds, we are finding more purchasers entering into ‘turn-key’ contracts to purchase property or buying houses ‘off the plans’.
Agreements of this type allow parties to agree upon a fixed purchase price for a house that hasn’t been built yet.
While the vendor takes on the risk of costs to complete the dwelling potentially increasing after signing up the agreement, they also have the benefit of locking in a purchaser at a fixed price before work has started. By doing this, the vendor can forecast costs reasonably accurately prior to starting the development, and satisfy their funder that the development is economically viable, thus securing their finance.
For this reason, a vendor will often need to obtain a certain number of pre-sales at the early stages of the development. In doing this, the vendor can provide the funders of the development with sufficient comfort that, upon completion, the houses will be sold at that fixed price and the lending will be repaid at the conclusion.
The purchaser, on the other hand, shoulders the risk that the dwelling may take longer to complete than expected, leaving their deposit tied up for this period. They also have the benefit, however, of entering the market at the current price point – and when they finally move in, the property will, hopefully, have gone up in value.
It may seem like a ‘win-win’ for both parties, but it is important to know where you stand as a purchaser when things don’t go as smoothly as you might have hoped.
Sailing off into the sunset
A common clause found in agreements of these types is a sunset clause.
The purpose of this clause is to provide the parties with certainty that the agreement can be brought to an end should the building not be completed within a certain timeframe.
A recent scare mongering article suggested that an un-named developer supposedly delayed their progress so they could invoke the sunset clause and cancel the agreement. This was apparently done with the intention of then on-selling the property to a third party for a higher purchase price, as the market had increased since the agreement was initially signed up.
In our opinion and based on our experience with agreements of this type, we believe that this is an unlikely and unrealistic reason as to why a sunset clause would be included in an agreement and exercised by a vendor.
A more likely reason why a vendor might want a sunset clause inserted is because they may need to obtain a resource or building consent on terms acceptable to the vendor in order to complete the development. Unfortunately, consents are not always granted on the terms the vendor wants which is why this clause is key.
Alternatively, the cost of complying with the consent or the costs to build may increase to the point that the development is no longer economically viable. In both these situations the sunset clause would allow the vendor to exit the agreement after the sunset date has passed thus avoiding bankruptcy or liquidation, or avoiding the parties being subject to an agreement that can never actually be settled.
A common example of why a purchaser, on the other hand, might want a sunset clause included is that if the vendor has not made sufficient progress in obtaining a Code Compliance Certificate by a certain date (being the sunset date) the purchaser may cancel the agreement and acquire another property that might be available now.
Can the vendor really cancel?
A vendor may only cancel the agreement on the sunset date if the agreement gives them the right to do so under the sunset clause. Accordingly, if the clause is drafted so that only the purchaser has the right to cancel then the vendor will not be able to cancel and will be required to complete the development.
If the vendor insists on having this clause in the contract, you could consider making it available for them to exercise within a certain period, such as within 20 working days of the sunset date passing, so that it doesn’t go on indefinitely.
To avoid the vendor simply delaying the work indefinitely and forcing the purchaser to cancel the agreement under the sunset date, the purchaser can also look at having a liquidated damages clause inserted. This clause asserts that the purchaser will receive the benefit of the purchase price reducing by a set amount for every day, or week, that the build is delayed after a specified settling date. This will incentivise the builder to complete the development as soon as possible.
It is complex, which means it is key to have an experienced property solicitor review the agreement before entering into it. In our experience, during negotiations it is not unusual for the vendor to agree that only the purchaser shall have the benefit of the sunset clause.
But what if the vendor won’t agree to this change? Or what if you have already signed up to an agreement which includes a sunset date allowing the vendor to cancel?
While it might seem like all is lost, and that the risk is high, the practical reality is that if you are using a well-known and trusted developer or builder then the risk to their reputation in cancelling and selling to a third party is far likely to outweigh any increase in price they might obtain.
We also note that in most cases a developer’s funder will want their money repaid as soon as possible and would therefore not be prepared to allow the vendor to cancel the agreement under a sunset clause and risk not getting another sale. There is no benefit to the funder in allowing the vendor to do this.
If the vendor did do this, it could risk them breaching a condition of their funding, like having a certain number of pre-sales, so again, the risk simply doesn’t warrant the potential reward.
Increase in costs
The cost of construction has increased significantly in the past year fueled by labour and building material shortages due to the pandemic.
With these increasing costs, can the builder pass these costs on to the purchaser?
The answer will be found in the specific terms of the agreement signed with the vendor. These agreements are often long and contain a number of clauses which dictate what can be done, and when, by either party.
It is recommended an experienced property solicitor reviews the agreement to identify and advise you of any possible pitfalls, such as the right of the vendor to increase the purchase price if the cost of materials increases during the build.
While the agreement may have been sold to you as a ‘fixed price contract’, it is important to check the agreement to ensure no clauses have been inserted which allow the vendor to:
- Increase the price in certain circumstances;
- Change the materials without agreement; or
- Change the materials to use items of lesser value and / or decrease the value of the house.
In Haigh Lyon’s experience, we have been successful negotiating the deletion of such clauses to ensure these fixed price contracts are just that, and don’t allow for any increases to be passed on to the purchaser. It is essential this is done before signing any agreement.
Risk should equal reward
The bottom line is that purchasing a property off the plans is a great way to lock in an affordable price, pick up the capital gains on the house simply for the cost of the deposit, and to enjoy the tax benefits when investing.
It is important, however, to know that there may be some risk involved when purchasing a property in this way (as there is when purchasing any property). The best chance a buyer has of ensuring any risks are minimised is to employ the services of an experienced property solicitor as early as possible in the process and to buy from a reputable developer who builds quality houses.
Haigh Lyon can provide advice on sale and purchase agreements, ‘turn-key’ contracts, what to do when purchasing ‘off the plans’, and wider property issues. Contact Shaun McGivern on [email protected] or Petrea Parkhill on 09 306 0621 or [email protected]