As an adviser, I was often introduced to what seemed like an endless array of client investment proclivities. I lost count of the various agricultural, real estate and share investment schemes that were “run past me” over the years. There was even one that required purchasing unhatched ostrich eggs ready for incubation!
And, as was my custom, I always spent time looking over each and every proposal in order to provide the client with both an educated and honest opinion. Alas, in every case, the advertising promises never lived up to the reality of the underlying investment.
What I usually discovered was a complex network of cross-holdings between the promoters of the product and the managers of the same. All of them hidden via various corporate identities. These cross holdings were used to siphon a steady flow of fees from the investor’s account into the numer- ous administrative and management subsidiaries of the promoter. I was often surprised that any funds actually made into the investment assets!
For a good example of what I’m talking about, read this story from the Australian Financial Review of 20/7/19. It discusses Listed Investment Companies (LIC) and the risk factors faced by investors. In doing so it cites a particular example of a financial planning practice creating a LIC devoted to US residential property investment.
The article goes into detail about the many business relationships shared within the fund. It makes for some very interesting reading and will certainly open your eyes to not only the exorbitant fees but also the inherent risks not often thought of by investors.
By the way, I do like the concept of LIC’s, even writing a post about them. I do however warn in the post that the new wave of LIC’s and the web of fees that they have built into them. Therefore I much prefer the older ones such as AFIC.
Sadly though, it is often the risky nature of many investment vehicles that will escape an investor. When something is wrapped up in a glossy brochure and surrounded by slick advertising, it can be terribly hard to look past the promises and dig deep into reality.
Thankfully, one great advantage of any new investment scheme is the Government legislation that surrounds them. Australian Legislation requires a Product Disclosure Statement or PDS to be is- sued with any new financial products. And it is within this document that everything required for investors to make informed decisions is detailed.
And it was this very document that I always would refer to, allowing me to examine the many ‘wondrous’ investment schemes shown to me by clients. And it didn’t take too long to discover what machinations lay within the investment fine print. Although the ‘marketing whiz kids’ at financial institutions did appear to have utilised the services of a 16th-century monk when writing the document as evidenced by both the wordy and quasi-scientific examples illustrating the risks!
But a bit of experience and a pen and paper was all it took to be able to show a client just how much the promoters were dragging out as fees. But it wasn’t only the costs the document revealed, but all the other ‘surprises’ built into the investment which would often leave the investor ‘holding the bag’ should even the slightest thing go wrong.
But, in saying that, there is, however, an investment that doesn’t carry one ounce of new investment protective legislation. There’s no PDS for this ‘bad boy’. Just a shiny sales brochure, possibly a ‘free’ seminar and above all else, the glowing promises of the promoter. And oddly enough, this investment is probably the most popular I ever came across! In fact, it’s probably one of the most popular methods of investment ever for the average investor!
So what exactly is this investing enigma? Well, quite simply, it’s purchasing an apartment off-the-plan prior to construction. Yes, you read it right, actually buying a property before it’s been built. For
the best part of 30 years as a financial adviser, I have witnessed both the undying adoration and blind faith the investing public hold for investment properties.
And for whatever reason, mostly spurious and based on hearsay1 rather than facts, their first foray into the world of investment is purchasing property in preference to anything else. And more than likely, a debut investor would be stimulated into action as a result of a prevailing property boom.
A time where the investing public usually forms into lines of ‘lemmings’, blindly following each other as they eventually fall into the ‘abyss’ of the inevitable market crash. OMG, I know, that’s tantamount to heresy! Actually accusing the ‘safest investment known to mankind’ i.e. property, of luring unsuspecting investors to their financial doom! Never! But sadly, it’s true.
And ‘off- the- plan’ purchasing was tailor-made for investment ‘newbie’s’. No physical dwelling to inspect and discover being too small, or in poor repair. Nope, none of that stuff to get in the way. For ‘off -the- plan’ buyers they buy a beautiful package of architectural drawings, artist’s impressions and flowery sales speak, all delivered in a glossy brochure. And not by a licensed investment adviser, but by a real estate salesperson – Egad!
This surely must take blind faith to another level. In exchange for a presentation folder, an investor actually gives a contractually binding commitment to part with lots of money for something totally unseen. In fact, depending on when the purchase details were arranged, it could take up to five years before an owner even sets eye’s on their investment.
Now, on the surface, who would do this? Think about it. Here is someone, making a solid commitment for hundreds of thousands of dollars, in exchange for what is a promise that everything will turn out as described. And that promise is actually coming from a real-estate salesperson! This is crazy in the extreme.
But the investing public seems to lap up this type of investment, and particularly when you add that oft-misunderstood concept of negative gearing into the mix. In fact, construction of unit blocks rarely takes place until at least two-thirds of the units have been pre-sold, guaranteeing the builder of recouping their money.
This, of course, leaves the risk solely with the purchaser. But in the heady atmosphere of a boom, investment risk becomes a mere detail totally overshadowed by the perceived potential profits. (And as I have quoted in previous posts, investors always rank real estate investment as a 3/10 for risk.)
So, as a result of the inherent risks, I have been, for many years, detailing them through my capa- city as a financial advisor. But certainly not to dissuade potential investors, rather as an attempt to open their eyes to the many and varied risks they were exposing themselves too. But alas, it was done mostly to no avail, and more often than not exposed myself to tirades of abuse and accusations of favouring my own investment wares (managed funds). Oh well, I tried.
But now, there’s a totally new type of risk suddenly raising its ugly head. A risk factor I must admit, I would never have thought could mutate into such a serious issue. And the new risk? A failure of builders to perform their construction duties to the quality required. Put simply, shoddy workmanship.
Now don’t get me wrong. Shoddy workmanship has been synonymous with the building industry since man first inhabited caves. And I’ve always recommended to anyone taking possession of a ‘just built’ property to always obtain an independent building inspection in order to reveal the inevitable issues inherent with all new structures.
However, examples coming to light recently have elevated what was in the past mainly nuisance value into the realms of actual structural safety issues. Multi-story buildings with dodgy foundations, inadequate internal supporting beams, and unsafe balconies to name a few! In fact, a number of newly built complexes have actually been evacuated and remain uninhabitable until the issues have been rectified. Oh, and it’s at the cost of the owner, not the builder.
And the examples being reported in the media are no doubt only the newsworthy ones; the multi- story, million-dollar-plus dwellings. What about the many others that were constructed during the recent boom. I can well imagine that if shoddy workmanship became a feature of such sophisticated builds then a first-time developer must have really cut some corners!
Now, attributing responsibility for these major building problems has become a real minefield of ‘tit for tat’ between developers, structural engineers, and building certifiers. Each one blaming the other and anyone else they can find.
Unfortunately, it’s the investor (or owner occupier) who’s left holding the bag for the cost of repair with costs in some instances running into hundreds of thousands of dollars per apartment. Some owners have even had to declare bankruptcy as their only solution as their banks have refused to in- crease borrowings to fund the repairs.
And it seems the issue of compensation is further complicated with the process known as ‘pheonixing‘. Were a builder folds the $2 company used for the development and then reopens un- der a new name to continue their shabby construction.
Investment outcomes
I have always advocated to never, buy an off-the-plan apartment, simple. Now, this is not to say they are a totally bad investment, but rather there are far too many hidden (or not apparent until completion) risks associated with them. And this new issue of dangerous build quality is just another reason to avoid them.
Historically, they have been heavily marketed during booms, which allow property developers of all levels of experience to extract sale guarantees prior to them having to commit any money. Thus transferring all risk from themselves directly to the new owner. And because their ‘parachute has opened’ the commitment to an acceptable standard of construction seems to diminish rapidly.
Often it’s usually the final stages of a boom that provides the fertile hunting grounds for a property developer/promoter. The very time uneducated and novice investors start to feel the FOMO (fear of missing out) effect, falling over each other to hop on the ‘gravy train’. And sadly spending little or no time actually examining what exactly they are signing up for.
So unless you are an experienced investor, think long and hard about entering into this type of property purchase. At the very least, go into the investment with your eyes open to all the risks, rather than just the promised profits. And the current crop of build quality issues should certainly be taken on board as a major potential risk factor.
But, if you do believe that there’s good potential in a given off- the- plan purchase, then ensure you manage and minimize as many of the risks as is possible. Here is a link on how this can be done. At the very least, employ an authorized building inspection immediately on completion. As any faults and issues located remain the builder’s problem under the terms of the statutory warranty.
Property investment is just as risky as share investment and off-the-plan purchases take that risk to an even greater height. Committing to purchase something sight unseen is the ultimate act of faith and puts the transaction into the realms of gambling rather than that of investing.
Thanks for reading, hope to see you soon. Homepage
1. Footnote. This is my opinion, but it’s certainly been crafted over countless (and I do mean count- less) exposures to past, prospective and current property investors. This heavy exposure was no doubt a result of being employed by a bank whose major ‘raison d’être’ was, of course, lending for property purchase so I saw plenty of examples!
