Two Sides Of The ‘Pre-Construction’ Coin

After my experience last week at a few new-condo launches, I immediately came back to my office and put on an impromptu real estate seminar for those of my colleagues who were (un)lucky enough to be present.

I ranted and raved, and they sat and listened.

And then one of them played devil’s advocate and raised a very interesting way of looking at things…

turkeycoinflip1.jpg

Yeah, the photo is a little blurry, but football fans will remember what happened during that ill-fated coin-flip on Thanksgiving, 1998, in front of millions and millions of viewers.

It was as simple as “heads” or “tails,” yet a veteran referee managed to screw it all up.

There are to sides to every coin (even if a referee can’t figure it out), and two sides to every equation.

For every argument, there is a counter-argument.

And when it comes to my stance on the fact that “pre-construction in Toronto is dead,” a colleague of mine recently made an interesting argument to the contrary.

Of course, I ultimately rejected the argument, but it’s worth mentioning…

At the risk of repeating myself, I’m going to summarize my thoughts AGAINST pre-construction as quickly as I can, and then follow up with those arguments FOR.

AGAINST

“There has to be an inherent discount on the purchase of future goods relative to those similar goods currently available, otherwise there is no incentive to delay consumption of that good.”

Who said that?

I did, just now.  Sounds fancy, eh?

Seriously – there has to be a discount on the purchase of pre-construction real estate relative to a similar product available on the resale market for purchase and immediate possession, otherwise what is the point?

Why would I put down a deposit on XYZ Condos and wait 3-5 years for it to be built when I can buy a unit at ABC Condos and take possession tomorrow?

The only reason I can think of would be a discount in price.

And this is the way things used to be….before the masses started “investing.”

The masses overheard how to “invest” in pre-construction real estate when they were on the subway one day while reading articles on TMZ.com on their new IPhones…

Once the developers had the masses lured in, they raised prices through the roof.

Now, it actually costs you MORE to buy pre-construction (and wait 3-5 years to take possession) than it does to buy resale.

Oh sure – the developers, marketers, and crack sales-team can put together a shrimp buffet and laser-light-show the likes of which you have never seen!  But don’t believe the hype!

There is no more money to be made in pre-construction in Toronto.  Believe me.

But if you have been brainwashed by the developer you work for, you might actually believe the crap that you are saying….

FOR

Mike and Suzanne are a young couple of 27 and 26 years old respectively, and they are looking to buy their first condo in downtown Toronto.

They spent a couple of months casually browsing on www.realtor.ca, and they started to keep track of properties they liked by saving the photos to their desktop, and scrawling down addresses of cool buildings.

After a while, they found a Realtor who began to help them get more involved in their search.

They went back and looked at some of the properties that interested them, and found that some of these $279,000 condos had sold for $300,000!  Or more!

They started to go out with their Realtor every Saturday and drive around in the car, going into open houses, and battling hoards of other potential buyers just to get in the door.

They found a condo they absolutely LOVED down in Liberty Village, and they waited for the “offer date.”  The condo was listed at $279,000, and with six offers, they offered $279,000.

They never stood a chance.

If they were my clients, I would have refused to submit the offer.  Why bother offering if you’re not going to put forth a realistic offer?  You’re just driving up the price!  You may as well have offered $150,000.  Or $10, for that matter.

But they aren’t my clients; they’re a fictitious couple that I’ve invented to illustrate my point.

Mike and Suzanne eventually became wise to the game, and a month later, they offered $305,000 on a condo at Electra Lofts, listed at $289,000.  The condo sold for $315,000.

Every weekend, they would get in the car with their Realtor, and every weekend, they would go and look at more and more condos.

Every Sunday night, they would contemplate making yet another offer on another condo.

And after five failed offer attempts, they lost all interest.

One day, Mike and Suzanne were walking along Driggs Avenue in the west end, and they saw a throng of balloons tied to the roof of this old warehouse.  There was a huge neon sign out front, and some trendy electronic music coming from inside.

The sign read “MAJESTIC LOFTS – ONE DAY PREVIEW.”

Mike and Suzanne went inside, and they were welcomed by some of the smiliest, happiest (sales)people they’d ever seen!

A gorgeous brunette with a beaming grin came up to Mike when Suzanne’s back was turned and said, “So nice to see you!  Let me know if I can help!”

And then a cross between Johnny Depp and Brad Pitt looked over at Suzanne and actually made his left eye gleam like in a cartoon!/

They were immediately offered complimentary glasses of Merlot, and when Mike accepted and Suzanne said, “I actually only drink white,” somebody magically appeared with a glass of Pinot Griggio.

Mike and Suzanne mulled about the room and looked at what was for sale.  “Majestic Lofts” would be a hard-loft conversion from an industrial space that was built in 1909 and was used as a shoelace factory until the mid 1970’s when velcro straps drove the company out of business.  The conversion would begin in May of 2010, and occupancy was expected quickly – by early 2011!

The model suite was gorgeous and the finishes were much better than anything Mike and Suzanne had seen during their forays into the resale real estate market.

Mike was scarfing down crab cakes like there was no tomorrow, and Suzanne was licking her fingers from all the chocolate-covered strawberries.

But the best part about the whole experience was that they could buy a condo today, right here, right now, and they wouldn’t have to be in multiple offers and cross their fingers that they “won.”

They could buy a condo today if they wanted to!

And they got ten days to change their mind; something called a “rescission period.”

Sure, it would take a year until the condo was ready, but they were on a month-to-month lease, and for the right property, they were willing to stick it out.

Imagine: no more having to wait by the phone to hear if you “won” in multiple offers.  All this could be over with the simple stroke of a pen!

Mike’s belly was full of lobster, and Suzanne was a little tipsy from the “vintage” 2009 vino…

The deal was done, and they lived happily ever after.

BUT IN REALITY…

This was simply a “devil’s advocate” approach to the situation.

I understand that some people are frustrated with multiple offers, but that’s just the market we’re in.  It’s been like this for the last six or seven years, albeit with a few breaks in between.

Over-paying for pre-construction is not the answer.

Paying tomorrow’s prices today is not the answer.

Being lured in by ridiculous promises from utterly evil developers is no way to go.

The pre-construction industry in Ontario is a mess right now, with developers doing whatever they bloody well please.

Now that the prices have shot past the moon and are on their way to the cold, dark recesses of Pluto, there’s just no incentive to consider pre-construction anymore.

So who is buying it?

13 Comments

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  1. George says:

    I think Geoff’s comment is an excellent one. Anticipating what you need and where you need to be a few years down the road is very difficult. Even 12 months is a long enough time frame for a person’s situation to change so much that their residential purchase is no longer a wise one.

  2. Andy says:

    I think the answer to this question is pretty simple. It boils down to two things: the author is not young and he is not familiar with the concept “I need my place later”.

    OK, let me describe my friend. Let’s call him Victor and let’s say that he works in software industry and makes something like 60-70k a year. He’s, say, 26, has a few dozen grand and is either living with his parents or rents on the cheap. Victor doesn’t have a girlfriend – currently.

    Of course, he plans to have a girlfriend. He’s young, eligible, and dating, or is dating, but is not quite ready to settle down just yet. Or he and his girlfriend are dating but don’t plan to really start a family because they’re early in a career.

    So, Victor doesn’t really need a condo now. But he’s pretty sure he’ll need it in 3 or 4 years. And, yes, he lived through the price increases of the decade. Thus, Victor would really hate to see himself outpriced out of a particular neighbourhood.

    Let’s safely assume that Victor has his eye on something around 280k (he can afford it). He has two choices: either buy an existing condo now or get himself a preconstruct. If he buys now, he’s immediately looking at at least 5k/year in maintenance fees, another 2k in taxes, and that’s before we factored in interest rates. Yes, Victor can probably rent it out, but he’s bad at renting out and don’t have the experience, plus he’d have to renovate, and, no, he will have to hire someone anyways.

    Anyways, Victor decides to go with the pre-construction. This way he’ll get the brand new condo he wants in 3-5 years when he thinks he’ll need it. If he’s really lucky, he can even skip the condo step altogether, resel the unit at a profit and go for the house.

    Can you point at an obvious flaw in this logic? There are a lot of Victors in Toronto; I know four and all of them are happy.

  3. matt says:

    I bought a pre-construction in mid summer before prices began their climb. I agree that pre-construction has major drawbacks. However, I got free parking in my unit (2 bedroom plus a small room called a den), and no multiple bids (which just the idea of seriously bothers me as in such situations, price can be driven by emotion and not fundamentals).

    I saw comparable units almost finished that were going for $45K more and no free parking (so add $20-30K).

    My plan is, I’m not getting any superficial upgrades when colour selection comes around. On move-in day, if I like the unit I’ll upgrade it myself with custom materials. If I hate it, I’ll leave it as is and rent it out. I believe my price per square foot was $486 (with free parking spot it’s more like $455). The sales rep did tell me that the same units were selling for ‘more’ about 2 months after I bought mine. Who knows though, I never trust the sales reps anyway.

  4. Geoff says:

    I think the other factor that should come into play at some point on the pre vs resale question is the human factor. A lot (A LOT) can happen in four years. I went from single to married to a father in 4 years. So if you’re going to tie your money up for that kind of time, be sure that you’re very confident that your life won’t change – to the best of your abilities.

  5. MattO says:

    @Ryan
    If you’re purchasing for investment purposes, then I would assume that the resale condo you bought today for $1M would have a positive capitalization rate, so that not only would you be making the 10% on the condo value, but also whatever capitalization rate you have over those 4 years.

    If you’re purchasing to live in the condo, then, during those 4 years of waiting for the condo to be finished, you’d still have to pay mortgage/maintenance fees/taxes on the place you’re currently living in. It would all depend on what the carrying costs are of the place you’re currently living in. If they’re higher than the carrying costs of the $1M resale condo you’re looking at (not likely, but possible), then of course it makes sense to buy that $1M resale condo now. Otherwise (you’re looking to upgrade, the more likely situation), the prudent financial move would be to stay in the place you’re living at now, and wait for the $1M preconstruction condo to be finished. However, if you are looking to live in the condo, then it’s human nature to want to have it right away, and that is the major incentive to buy the readily available condo (I’m assuming that if you were looking to make money on the condo, you’d fall into the first case, buying for investment purposes).

  6. Carl says:

    Ryan,

    I think the point being made is that the price of the pre-construction is not the same.

    Using your case above, it would be akin to having the pre-construction price (now) of 1.1mm…and that is the argument David contends for why it doesn’t make sense.

    Your point though does have merit in that the principle of leverage may make for a better return on the investment in pre-construction.

    That in itself could be a market equilibrium force behind the higher prices for pre-con.

  7. dogbiskit says:

    Well all I can tell you is pre-con made sense for me. I was tired of living in an older building with small windows surrounded left, right and centre by 7am new condo construction noise and more and more congestion. So I bought my pre-con last summer because I liked the unit, the building and the location and I plan to live there. I sold the old place and scored a great deal on an assignment at East Lofts. The interim condo is teeny tiny but brand new and awesome.

    It’s not just investors that buy pre-con!

  8. Ryan says:

    Fidel is right that it does not make sense to pay the future value of something today when you won’t get it for several years. However, in a pre-construction transaction you’re not asked to pay the for the condo today, you only agree to pay for it in the future when you do get it.

    Suppose a condo that there is a condo already built and one that will be exactly the same when it is built 4 years from now. You can purchase them each for the same price of $1mm, and you put down 10% for each. Now 4 years from now both condos are identical and are selling for $1.1mm, so you sell them to make a $100,000 profit on each. But wait a second, the condo that was already built required a mortgage, and you had to pay interest on the $0.9mm loan, not to mention maintenance and taxes, so your net profit is less than $100,000. On the other hand, money you have been saving by NOT pay a mortgage on the pre-construction could be invested in one of our Canadian banks at a poor interest rate of .015% but none the less better than paying it to the bank.

    Given this, what incentive is there to buy a condo now that is price as one not built yet?

  9. earth mother says:

    C’mon Dave — who can resist a little vino & some yummy treats & some good-looking salespeople….

  10. David I really loved this piece.

    Like you said it’s tough, frustrating and disheartening to be beat out time and again on places that you become emotionally attached to.

    And who doesn’t get the emotions pumping when they find “THE” house.

    Coming back to fundamentals of staying on budget and not becoming house poor may be creeping into the subconscious of buyers minds once again.

    Time will tell.

    Ian

  11. LC says:

    Developers are in business to make money. If anything, pre-con pricing spoiled a lot of us purchasers in the past (to the point where some projects collapsed as they simply weren’t feasible anymore). The game has changed, developers are wiser now and keeping that extra profit for themselves. And what’s wrong with that? It just makes you work harder to find value. Welcome to capitalism. You didn’t think it would always be so easy as writing a few cheques now and then, did you? 😉

  12. Geoff says:

    As a ref I have to defend my colleague in arms – the ref didn’t mess up, the player did. Player said “hea tails”, and ref took that to mean heads, a reasonable position. It came up tails, and the player then insisted he said tails. Kind of like that monty python bit… whats your favourite colour… “red.. no blue!… aaaaaaaaaaaaaaaaahh!”

    http://en.wikipedia.org/wiki/Phil_Luckett#Thanksgiving.2C_1998

  13. fidel says:

    I’m with you on this one D, it does not make sense to pay the future value of a property now. And if the only argument for doing so is to avoid multiple offer situations, well that has to be the lamest justification I’ve ever heard.

    But how much longer can these multiple offer situations continue? Come spring there will be a lot more inventory on the market.

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