Why should you invest in Preconstruction condos?

When a developer plans a development he usually has a financial hurdle to overcome.  Who ever the developer is, financial backers want to gauge the interest in the project and in many cases require the developer to have reservations on a certain percentage of units before the project is given the green light. This translates into savings for the real estate investor. The developer needs pre-sales to prove his project and secure his financing, so he will give incentives to early buyers.

The Preconstruction Buying Process...

Reservation Phase

In order to obtain financing, developers must prove that a demand exists for the proposed project. They create architectural renderings and floor plans, and begin to pre-sell units at a reduced proposed price. Prospective buyers hold a "reservation" on a particular unit with a token down payment, anywhere from $1000 to $10,000, which is placed in an interest bearing escrow account. The "Reservation Agreement" is revocable at any time for any reason, and upon written notice of cancellation, the investor receives a full refund.

Contract Phase

Once the developer has the required number of presale reservation agreements, "condo docs" are recorded with the county and reservation holders are sent a copy of the docs, along with "hard Contracts" which require a down payment (usually 10-20% of the sale price), which can be made by letter of credit issued by your bank. If you are looking to make a quick profit, you should be sure that the contract that you are about to sign is "assignable". This means you can often assign or sell your right (at a Profit) before you go to closing.

Construction Phase

Construction can take from 6 months to 2 years. Your contract will have an expiration date, upon which you are entitled to a refund of any deposits if the developer has not completed construction. Once you've gone to "hard contract", no additional money is required, (except for upgrades), until completion of your unit. During this period, you will likely see several sales price increases as completion nears. This is how you can make a profit by assigning your contract before you actually own the unit. Suppose you reserved the unit at $299,000 pre-construction. 3 months after construction begins the developer raises the price again to $339,000. 6 months later the developer raises the prices yet again to $359,000. At any point, you can resell your rights to the unit and upon closing, realize the same gains as the developer.

Closing Phase

Once construction is complete and if you have not assigned your contract, you will be expected to close on the unit. If you don't, you forfeit your down payment. For this reason, it is advisable to locate a lender and get pre-qualified prior to completion of your unit. Closing proceeds much like any other real estate purchase. Additional expenses such as association fees are disclosed in a "good faith estimate". At closing depending on your choice in markets, you can actually leave the table owning a condo with significant equity and some money in your pocket. Lets assume the unit above is now priced $379,000 at completion. You put 20% of $299,000 ($59,800) down upon signing the "hard contract" (either by cash or letter of credit). You owe $239,200 + closing costs (approx $5,000). At closing your lender appraises the property at $379,000 and will lend you 80% of that or $303,202. You only owe about $244,200 as stated above, so you receive $59,900 + interest on your down payment.

Risks do exist

As with any investment, risks exist with pre construction purchases. The primary risk is that the developer is unable to complete the project and goes bankrupt. The best way to protect yourself against such risk is by researching the background and completed projects of the developer. Secondly, real estate values may not increase as rapidly as you had hoped. Even if your intention is to sell or re-assign your interest before construction is complete, you should not enter into this sort of investment unless you CAN afford to close.