Off-plan vs Ready Investments

“Don’t think of cost. Think of value.”
— John Spence

Is investing in off-plan a much wiser choice than buying a ready unit from the secondary market?

I bet you might have heard that it is way better to invest in off-plan in Dubai. “That’s where the real money is made” some might say.

Others might have claimed that you are “better off gambling your money in Vegas than investing in off-plan”.

What I want to do in this blog post is give you a framework for thinking about the off-plan versus ready decision for an investment.

The key takeaway I hope you get after reading this article is there’s not just a simple right answer.

To answer this question, we are going to study the case of purchasing a 1 bedroom apartment in DSC (Dubai Sports City).

We will look at the option of either buying a ready 1 bed apartment in DSC, or investing in an off-plan 1 bed apartment.

We will then conduct a sensitivity analysis changing multiple inputs and seeing how this will sway the final outcome. In closing we will hopefully have a well-formed idea of how much better or worse it is to invest in off-plan.

To fully understand this analysis however, you will first need to understand the time value of money.

The Time Value of Money

If you have to choose between receiving a 100,000 dollars today versus getting a 100,000 dollars one year from now, what would your choice be?

It is almost so obvious that getting a 100,000 dollars today is a much better decision.

Why is that ? I’ll give you a clue: It is not because you’re impatient. Instead it is for the simple reason that throughout a year you could have invested this 100,000 dollars and made more money.

You could have placed this money in the stock market for instance and made at least 6% returns in one year. This means that I would have to offer you at least 106,000 dollars one year from now to make you an equally attractive offer.

The same applies in real estate: when evaluating an investment’s cash flow you will have to discount each year’s cash flow with your opportunity cost [or discount rate] to come up with the net present value of all the money you would have made.

The Net Present Value (NPV) is the bottom line metric we will need to look at to inform our decision. You would want to know in absolute terms how much money you would be making from this investment in today’s terms.

The investment option with the higher Net Present Value is the more lucrative option. This says nothing about the inherent risk carried by each option however, something we will discuss at the very end of this analysis.

Case Study

For our case study, we will be comparing between the following two options:

Option 1 (Ready):

• Property Type: 1 bedroom apartment in Dubai Sports City
• Price: 800,000 AED
• Size: 1,100 sqft
• Expected Rental Income: 71,600 AED
• Total Operating Expenses: 13,800 AED

Option 2 (off-plan):

• Property Type: 1 bedroom apartment in Dubai Sports City
• Price: 800,000 AED — We will vary the price to see how this influences the outcome
• Size: 1,100 sqft
• Payment Plan: 60 / 40 — We will also vary the payment plan
• Completion Date: 2020

In qualitative terms, here is a brief comparison between the two decisions:

Keeping all the above factors in mind, let’s take a look at the numbers. Below is the projected cash flow of both the ready (Option 1) and
off-plan (Option 2) options.

Option 1: Ready Investment

Option 2: Off-plan Investment — 60/40 payment plan

* a 7% discount rate is used for both calculations — the exact discount rate doesn’t matter as long as we are discounting both cash-flows by the same rate

From the above calculation, you can see that if you are purchasing an off-plan investment for a price that you can readily find on the ready market, the verdict is clear: ready beats off-plan [ an NPV of 81k >>> 20k]

Let’s assume you are purchasing the off-plan property for a 10% discount compared to the ready apartment for a purchase price of 720,000AED instead of 800,000 AED.

This time instead of a 60/40 payment plan, we are going to assume a much more lenient payment plan of 30/70, here is how the new numbers will look:

Option 2: Off-plan Investment — 10% discount and 30/70 payment plan

The numbers now show that the off-plan investment is a more lucrative decision (110k > 81k)

This is mainly due to the fact that cash payments have been pushed further into the future with minimal amounts paid in the first 2 years.

You can achieve a similar tactic when investing in ready units if you choose to make use of debt by leveraging your investment.

Here is how the numbers would then look for the ready apartment if you place a 25% down payment and take a mortgage for the rest of the amount for a loan term of 25 years with an interest rate of 4%

Choosing to finance the ready apartment purchase with a mortgage does increases your net present value from 81k to 104k .

This makes the investment almost as attractive to the off-plan investment from a pure numbers perspective.

A final word

As attractive as 30%[construction phase]/70%[upon handover] plans or 30%[construction phase]/40%[upon handover]/30%[post-handover] or 20%[construction phase]/80%[upon handover] payment plans seem to be there are a couple of things to keep in mind.

• Most probably the developers offering these payment plans are still fresh in the market trying to gain a competitive edge. Mature developers like Emaar do not offer these attractive payment plans, just for the sole reason that they don’t need to do so to attract buyers. Their reputation speaks volumes.
• There is an inherent financial risk in investing in low down-payment plans. A lot of buyers jump in thinking: All I need is to figure out the funding for 20% or 30% of the purchase price and then when the construction is completed I’ll take out a mortgage to fund the rest of the amount.
• But it is quite the common case that a lot of these same buyers might be in a worse financial position 2–3 years from now and might not be eligible for a mortgage, or won’t be willing to plunge further into debt. What happens is a run-on sale where many buyers compete to sell their off-plan investments before the handover payment is due, driving prices down.

Other off-plan risks to keep in mind are scheduling risks. It is very common for projects to get delayed. If a project is delayed for a year, that is one additional year when you could have been generating cash-flow through your ready apartment.

Another thing to note is that in our above calculations, rent was only increased at a 2% rate. If

rents rise faster than this rate then the case for investing in a ready apartment just got stronger.

Same goes for the discount, we only assumed a 10% price advantage over a ready apartment. If, however, you can find an off-plan property that is likely to be 20% or more lower in price than the best deal you might find on the ready market, then the case for investing in off-plan just got stronger.

In conclusion, take the time to properly assess any ready or off-plan investment. Keep in mind the intangible factors at play as well, or try to add this as a contingency in your calculation in some type of way.

Always be conservative in your estimates. Go through the numbers the same way we did, and be ready to analyze many deals before you settle on the right decision.

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