The Pros and Cons of Buying a Pre-Construction Condo Unit

While there can be some very real benefits to buying pre-construction condo units as an investment, one must be aware of the dangers and pitfalls which exist in this special Real Estate category. Before we look at the pros and cons, it is important to know that buying a pre-construction condo unit is more convoluted and confusing than buying any other type of Real Estate. Developers likely keep it this way so that buyers don’t have full access to the information, and will thus be forced to rely on messages which the developers can control, such as ads, brochures, investment projections, etc.

The main benefits of buying a pro-construction condo unit are:

-         Some projects allow for small deposits (5%, 10%, or 20%), which are often spread over time.

-         Your ROI (Return on Investment) can be quite high, because of the small deposit size, and the length of time the property has to appreciate. For example, if you buy a $500,000 condo pre-construction, and put a 10% deposit, and you close on the purchase four years later, the property might have appreciated by 20% per year. So the property might be worth $900,000, which represents an increase in value of 80%, but the return on your 10% ($50,000) deposit, is 800% (of course, closing costs must be factored into this calculation to achieve exact numbers).

-         If you get into a project early enough (Platinum phase, or VIP), you can benefit very quickly from an increase in value, since the developer usually increases prices as time goes on.

-         If demand is high enough, you can assign your contract to buy the unit, to a new buyer, and profit from the difference between how much you agreed to buy the unit from the developer for, and the amount the new buyer is willing to pay for it now.

The potential negatives to watch out for:

-         Most developers do not allow buyers to advertise their unit for (assignment) sale, especially not on the MLS (which is the best marketing tool to achieve maximum price). This means that if your exit strategy is to sell before you have to close on the purchase with the developer, you have to be very confident that there will be buyers who will pay you more than what you bought the unit for from the developer.

-         The contracts a buyer signs with a developer, favour the developer in the extreme. For example, if the developer does not end up constructing the building, he can return the buyers’ deposits, and walk away. This is a disaster for anyone who was relying on a return on the deposit monies they submitted.

-         It is very difficult to know what one is buying. Even if you think you’re buying a condo unit on the 28 floor with unobstructed, floor-to-ceiling, views of the city, the developer could decide that structurally, he needs to put a massive column inside your unit, right in the middle of the perfect view you thought you would be buying. You also have little control over which parking space and locker you will receive.

-         This type of investing is extremely speculative in nature. In fact, I sometimes call it the Real Estate casino. NOBODY knows for sure that a market will continue to increase. And if it decreases, how do you exit your investment and recover your equity? In pre-construction condos, that is virtually impossible, because the only exit strategy you can employ is to try and assign your unit to a new buyer, and which buyer is going to want to pay much more than what you paid, if she knows that that unit, that project, or the general market is losing value?

-         Realtors are incentivized to push clients into buying pre-construction condo units, even if this is not the appropriate investment for a specific client’s personal or financial situation. This is done by the high commissions they are offered (usually, between 3% and 5%), and with special prizes such as a luxury car or watch for the Agent who sells the most units in a project or building. Since the amount of cash outlay required is relatively low (in some projects, you can buy $2,000,000 of condo units with only a $100,000 deposit), sometimes buyers are encouraged to buy multiple units at the same time. While this is fine for some buyers, for buyers who cannot qualify for the financing required to close on the units in a few years, this is a big gamble – basically assuming that the price can only increase, and that it will be easy to find buyers for the contract, before the official closing with the developer.

-         When you or a tenant moves into the unit, you don’t even own the unit! This is the part that most first time pre-construction condo buyers have the biggest issue with, and which they are most surprised to learn about. Because developers are eager to stop paying interest on the huge development and construction loans they took for the project (as a business person, I can’t blame them to want to stop paying interest), they want to start charging buyers carrying costs as soon as possible. This is done by announcing to buyers that their units are ready for occupancy (even though the building amenities, hallways and other common areas, are not at all finished or useable yet), and that they will start paying “interim occupancy fees” as of a specific date. Otherwise known as “phantom rent”, these fees are calculated by applying an interest rate to the amount of each buyer’s purchase price which is outstanding (purchase price minus all deposits made so far).

-         Most condos are finished to a standard which the developer feels is acceptable and appropriate. Any upgrades which a buyer would like (and which often need to be done by the developer, since they might be more costly to have done after closing – such as installing electrical wiring through concrete floors or ceilings) must be paid for, often at a higher than reasonable price (or at least higher than what seems reasonable – many builders’ and developers’ workers are unionized). Many items which buyers might feel are basics items, may not be provided by the developer unless an upgrade is purchased, such a ceiling lights in bedrooms, sufficient lighting in washrooms, good quality appliances, smooth ceilings throughout, etc.