Whether you are a savvy real estate investor scouring the market each and every day or a totally non-interested golfer who is enjoying retirement, how many times have you heard the words “pre-construction condos” in the past year? Probably many times. It is the new buzzword in this and many areas of Florida. For many, it has been much more than a buzzword, it has been a tremendously profitable investment vehicle.
Pre-Construction condos are not new to Charlotte County but the volume and demand for them is. Many projects that are announced sell out in days. I recently called on a sign that had just appeared on a piece of waterfront land in PGI. The developer was quite friendly in saying that he would be happy to take a backup reservation agreement to an already existing backup agreement. Basically, I was WAY too late for this project.
Who and what is driving this market? Is it difficult to understand and most importantly, how risky are these ventures? The simple words “pre-construction” can cause an involuntary shake of the head from many.
The first thing to remember about pre-construction condominiums is that each and every project is unique with its own set of advantages and yes, disadvantages. Some are big, some small, some on the water, others off, many have re-sale restrictions, some do not. Each project should be looked at by itself. However, there are many characteristics that a vast majority of these projects share.
The first characteristic of a pre-construction condo is that before a sign is put on the property or an ad put in the paper, many of the units in the complex are already sold. These are the true “pre-construction” sales. Most of the time, the developer does not have the many millions of dollars in the bank required to start a project. In today’s market, just buying marketable multi-family land can pale even the most affluent developers. After the land is purchased, the next step for the developer is usually a trip to the bank to secure millions of dollars to grade the land, build a pool, and build the buildings. This is the point where the investors come in.
The developer typically needs to sell a percentage of the condos to secure the loan. However, they are in a quandary because all they have is a scrubby piece of land, a floorplan and good intentions. It is very difficult to attract end-user buyers with just a colorful floorplan. Most people who are going to spend hundreds of thousands of dollars on their place of residence want to see the view, walk the floorplan, and see the kitchen first hand. Also, many want to move now – not in 12 to 18 months without a guarantee as to date.
This is where the investor comes in. The developer will cater to the real estate investor who is never going to live in the unit. The investor just wants to make money on the project and the developer wants to get the project off of the ground with pre-sales. It is a good match but the developer needs to make it attractive to the investor. To do so, the developer sells the investor the unit at a price much closer to the building cost. The profits will come in the later units that are easily shown. The investor is taking the risk that the floorplan will be fine and that the market will continue upwards. To take this risk, they get a very competitive price.
In an appreciating market or even a flat market, this is a win-win proposition. Once the project gets started, the developer can now start to make his profit. He will put a sign out to advertise and now has months and months to sell the majority of the units. The price will gradually go up so that the last units sell for a lot more than the first. They are not better units but there is much less risk. For the investors who bought a year ago, even in a flat market, the price has gone up. Where the investors really hit a home run is when the market goes up as well as the developers prices. This has been the case over the past few years.
Another positive for the investor is that most of the time, they never actually ”buy“ the unit. When the project is 2 months from completion, they put their unit up for sale. When a buyer appears, they can assign or simultaneously close on that unit. Typically, they have put 10-25% down so they just take the difference between the price that they negotiated a year ago with the developer and what a buyer is currently willing to pay for a done, easy to imagine home.
In both flat and appreciating markets, a good, well-planned pre-construction project is a very strong investment vehicle. However, the risk occurs if the market goes the other way. In a downward market, the developer cannot continue to raise his prices and may have trouble selling the later units. With more competition and falling prices, there may be a negative difference at the simultaneous close or even the scenario where the pre-construction buyer must complete the transaction with a mortgage.
This is a simplified version of a pre-construction sale. There are many variables like non-assignment clauses, reservation agreements, and when the deposits are actually made. The big question to ask before getting into a project like this is: Do you think that people from the north will still be coming down in record numbers a year from the time that you buy into the project? If the answer is yes, let your realtor know that you are interested in pre-construction. Many times, they are the conduit between the developer and the public.