Time For A Refund?

I’ve received this phone call a dozen times so far this year: “I bought a pre-construction condo two years ago, and I’m worried I’m not going to make money when I close.”

Realization is a good first step.  Second: ask for a refund…

Yeah, I already know that the pre-construction salespeople aren’t going to like this post.

Ask me if I care…

After last Friday’s blog video on “E Condos” and how utterly insane it is to spend $700 per square foot on a condo with no parking or locker, that may or may not be built, there was some Twitter buzz flying around.

Theoretically, I could be accused of “interference” with listings (something RECO oversees), but since these condos aren’t actually built, and they’re not really selling an actual piece of real estate, perhaps we fall into a grey area.  In any event, the day that I come under fire by a regulatory body for speaking the truth about real estate will be the day our industry is no longer looking out for the consumer…

So with that disclaimer out of the way, let me pile-on pre-construction yet again.

As I said at the onset, I’ve received the same call a few times in the past two months, essentially boiling down to this: a purchaser of a pre-construction condo is asking what the likely sale price would be for the product, which is only weeks from occupancy, only to find that this likely sale price is barely what they paid for the unit in the first place.

It makes sense, right?

Over the past two years, developers have raised pre-construction condo prices to the point where they’re equal with resale, and in some cases, the actually exceed what comparable resale condos would sell for!  How can you make money on an “investment” when you’re paying a price that already has a built-in profit going to the person who sold it to you?

Here’s a real example from a conversation I had on Saturday afternoon.

“Ben” has bought into a development (I don’t want to name names here) in the downtown core which is about three weeks from occupancy, and he called me to ask what I thought the selling price of his unit might be.

The unit is a small 1-bedroom, 443 square feet, on the 9th floor with a nice north-view that is unobstructed.

The development is well-done, there’s no doubting that.  But how much can you expect to get for what is essentially a junior-one-bedroom unit, no parking, no locker, that is 443 square feet?

Starting at the absolute maximum, I told Ben, “Even at $600 per square foot, which I don’t think is achievable, you’d be looking at $265,800 for your unit.”

Laying on the possible worst-case scenario, I said, “If the market was flooded with units once the building registers, and you had to let yours go for $525 per square foot, you’d be priced around $232,575.”

I told Ben to consider the costs associated the purchase/sale.

He’d probably be looking at around $4,000 in land transfer tax, $1,500 in legal fees (or $3,000 to buy and sell the same unit), and then a 5% commission to sell the condo down the road.

But I also told him to consider that the building might not register for 6-8 months, or perhaps 12+ the way things are going in Toronto, and that he would either have to eat the monthly occupancy cost of $900, or rent it out to a tenant, and suffer the GST consequences down the road.

So with that out of the way, I asked the million-dollar question: “How much did you pay for the unit?”

Would you believe that he paid over $240,000 for it?  I think you would…

And how long ago was this?  2-3 years?

Prices simply can’t rise enough in today’s market to justify the high prices that developers charge in pre-construction.

Even if Ben was able to sell this condo for $250,000 ($564/sqft), he would have close to $20,000 in transfer costs, and thus he would net out at a $10,000 loss.

And if he carried the unit for twelve months during occupancy, and ate the $900 per month cost, he’d be out a further $10,800.

Hardly seems like an “investment” does it?

On the downside, if Ben sold this condo for $230,000, he would be looking at upwards of a $40,000 loss!

Tell me again, usual pre-construction suspects who read my blog and hate what I write: where is the money to be made in pre-construction?

There are things that Ben could do in order to cap his losses.

Let’s say that he was able to rent the unit out for $1,500 per month, and thus he was cash flow positive for 12 months during occupancy, to the tune of $600 per month, or $7,200.  Of course, if the unit was leased out, and it was considered an “investment property,” Ben would have to pay about $2-3K in GST (or rather he would not be eligible for the rebate).

So he’s up about $4,000, but still looking at $20K in transfer cots, for a unit that will sell between $230,000 and $260,000.

So I asked Ben point-blank, “Where is your upside here?”

Even if he sold it at $600 per square foot – $265,800, he’s looking at the original $4,250 for land transfer tax, $3,000 in legal fees for the 2012 closing and the likely 2013 sale, $15,017.70 to sell through a Realtor (5% plus HST), probably $90 per month in heat/hydro (another $1,080), and thus a net price of $242,453.

So add in the $4,000 he could net by renting the unit out and he’s sitting pretty at $246,453 – or just $6,453 above what he paid.

It hardly seems worth it for three years’ work, does it?

I did all this on the phone with Ben while shopping at Loblaw’s, where I purchased $105 worth of chicken because it was on sale for half-price.  I went home and opened up all the packages, trimmed off the fat, and put five chicken breasts into each ZipLoc freezer bag, for a total of eight bags for eight meals!  My point?  If you plan ahead, and spot deals when they come along, you can save money in the future by being smart and cautious in the present.

A lot of people have got in over their heads by purchasing pre-construction condos, with no analysis of what the future holds, or could hold.

Many of today’s buyers simply go in blind, and assume that because a friend-of-a-friend made money buying a pre-construction condo years back, that they will too.  But these people don’t stop to ask, “How reasonable is paying $600 per square foot today in pre-construction for something I’ll get in 3-4 years?  What would I have to sell the unit for in 3-4 years to make money, and how much profit is worth the associated risk?”

Few people do this, and it truly worries me.

The good news, for Ben at least, is that he has an “out,” if you will.

He did his pre-delivery inspection (PDI) last week, and he noted several deficiencies and deviations from the original floor plan.  He approached the developer about these differences, and the developer balked at his request to correct them.

He threatened to take legal action, file a complaint, get TARION involved – whatever he had to do, and guess what?  The developer offered to let him out of the agreement, and provide his full deposit back, with interest!

“It’s a no-brainer,” I told Ben while walking down aisle seven at Loblaw’s, trying to find fat-free Miracle Whip, which seems to have gone out of production.

“Your upside is limited to about $5,000, and your downside is potentially a $35-40K loss.  There’s nothing in this for you.  Get out, and move on.”

And so, he did.

There’s that saying in sports, “Sometimes, the best trade is the one you never made.”

Well just because you bought into a pre-construction development, doesn’t mean you have to see it through to the end in search of profits that are unattainable.  Sure, your co-workers, friends, and others might say, “Geez, that’s too bad! What a waste of time!  You mean you’re not making any money on this?”  But if you bought a stock at $80 per share, and you could sell it at $70, why would you hang on for it to hit $40 just because people with absolutely no knowledge of the situation might make a backhanded remark at a dinner party?

Everybody in Toronto thinks it is their God-given right to make money in real estate, and in today’s climate, there’s no guarantee.  You have to be smart, and you have to be willing to listen to reason.  That means not listening to all the fluff that you hear, especially in regards to pre-construction condo “investing.”

Ben is out of the game, and he’s keeping his money.

The same can’t be said for so many others…

12 Comments

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  1. BEN says:

    I’m the one who David is speaking of here. Im’ Ben LOL.

    I bought a unit at the Market Wharf Phase 2 for 239,000. 1 bed 443sq with a 100sq balcony. INCLUDED LOCKER It was great floor plan and when inside the unit, it really did feel much bigger than it was. the Finishes were great as well. David is right. There was no way, i was going to make any money on this. I have heard through the grapevine the developer sold it for 265. So that’s the true test, at that amount i would have just broken even after occupnacey and realtor fee etc.

    There were no deficiencies. The unit was near perfect. The clause that rescued me was this. “There will be no roof equipment in the immediate vicinity of this unit and will have no impact on
    the view, sound or smell.” Turned out there was roof equipment from the podium.

    Also, I did not have an assignment clause. I asked the developer for one AFTER about year, and they said the would allow me one for 5000. They said, find your buyer first and we’ll go from there. So I did find a buyer for 270 (Through Assign it.ca), and then they back out of letting me assign it. Pricks!!!

    You can see images of the place and floor plan here…

    http://urbantoronto.ca/forum/showthread.php/10862-Market-Wharf-Condos-(Context-Developement)-Real-Estate/page9?highlight=wharf

  2. IanC says:

    Hmm… I thought $1,500 was generous for a bachelor… I wanted to look further.

    I just realized that you can’t search 0 bedrooms on mls.

    Why not?

    0 bathrooms would be silly…. but I think 0 bedrooms should be a valid search.

    1. @ IanC

      I agree. I also wish you could search for “0” parking spaces, but you can’t do that.

      In fact, there are about a hundred things about MLS/realtor.ca we’d like to change, but there’s more red tape than a Christmas party…

  3. Sage Advice says:

    Real estate investment strategy aside. When you purchase a residence as your place to call home it is exactly that. You need a roof over your head. Everybody needs to understand the difference. Real estate is not a liquid asset and looked upon as such increases the risk. The higher the expectation for a higher than average rate of return the greater the risk. If you have a low tolerance to risk the only way to mitigate this risk is to treat real estate as a place to hang your hat and call home not an investment. If treated as investment the strategy that has less risk is to treat it for what it’s primary purpose is and that is a long term investment intended to complement the diversification of your overall portfolio. As an investment and treated as buy and hold there is much less risk than purchase and sold. Sure there are many examples of people making a fortune by churning, flipping, assigning of real estate. For every example of someone making money, there as many for those individuals that get caught up in the frenzy and herd mentality and get busted for a loss. Some advice for those of you out there that have bought with the intention of churning a few dollars on your pre-construction condo. If you have to sell for a loss. Don’t. It does not make any sense. As long as you have completed a thorough financial analysis and you have the financical capability to carry the debt load, with or without a tenant, hold on and ride it out. As David has suggested, if the builder is handing out gifts and you are able to get out and you know the return would be in the red territory, that is a deal that makes a lot of sense. Especially if the market has gone static with limited expectation of an upside in the near term and it was going to expose you to financial duress trying to carry the property without tenancy.

  4. AsianSensation says:

    Excellent post. I was in a similar situation and I got my deposit back plus 2% interest. There’s a push to throw more ‘upgrades’ into sales than I’ve ever seen on pre-construction.

    Sorry ‘Garrison’, but I’d rather have 15K off the list rather than an island and a microwave!!

  5. Devore says:

    Brad Lamb’s development company has produced earlier this year an “investment guide” for some of their new properties, one of which was in Calgary. It basically outlined how you can make 100s of percent on your investment by buying pre-construction, using highly questionable practices, funny accounting, and massively optimistic assumptions, designed to make their product look like the no-brainer investment opportunity of the decade. Plenty of people use this kind of information to guide their actions or justify their decisions post-fact.

    1. Joe Q. says:

      The Calgary ad you refer to was particularly egregious. As I read it, I couldn’t help but think about how claims like those would get just about any other investment broker into a world of trouble. But in the RE world, it’s A-OK.

  6. George says:

    Buyers could use a dose of skepticism. If someone is trying to sell you something then you are probably not getting a deal. Deals happen when there is desperation or misinformation on one side. In pre-construction, the buyer is generally the misinformed party, with a far too optimistic view of the construction process. The sellers are getting the deal.

  7. Darren says:

    Wow. I’m shocked that they would offer his money back. That’s almost as rare as rocking horse shit. Particularly in this market.
    What were the deficiencies?

    1. Horrido says:

      It isn’t that rare to get money back offers. My builder offered me the opportunity to get out prior to inspection. Why not? If I got out, they could resell my unit for a much higher price! Fortunately, I stuck with it and I am very happy with my West Harbour City 2 unit, for which I made a tidy precon profit! David is right, however. There’s no money to be made in precon **today**…

      1. @ Horrido

        Different situation though. You may have paid $300K in pre-construction, knowing your unit was worth $400K when you took possession, so of course the developer would offer you a refund!

        But many of today’s buyers are under water. Many people paid $400,000 for units in 2010 that are going to be ready in January, and are worth…..$400,000.

        1. lui says:

          or less………I seen many units that people are willing to break even just to get out of the market these days….

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