Business | August 26, 2008

Hindsight is a funny thing.

Because now it all makes sense!  I mean at the time, I didn’t have a second thought in the world about telling my girlfriend, “I think that dress makes you look really fat.”

It’s a little tougher to look back on the woulda-coulda-shoulda’s of real estate investing…


It’s amazing how much useless crap you accumulate when you have your very own three-drawer file-cabinet that is really intended for everybody in the office to share!  I decided to clean this puppy out last week, and I found a bunch of old brochures for condominium developments in downtown Toronto.

It was interesting to see these sales pamphlets for existing buildings from before they were ever constructed—kind of like a step back in time.  I liken this to my 1986 Donruss Jose Canseco rookie card where he has the really bad teen-moustache.  If only he knew then what lay ahead…….

As I pawed through them, I was astounded, and equally sickened by the low prices of some of these projects from “back in the day.”

“Why the heck didn’t I put all my money into 66 Portland Street?” I wondered aloud.

“Why the heck didn’t I short-sell shares of Nortel at $124.50 on August 27th, 2000?”

“Why the heck didn’t I know it was a bad idea to date all those girls I worked with?”

Hindsight is a funny thing.

No matter how many times we experience it, we still continue to kick ourselves down the road for something we think we should have seen coming.

It’s no secret that lots of money has been made in the real estate market over the past decade, but more specifically, very high returns have come in the form of pre-construction condominiums.

The inherent difference is with respect to the deposit or downpayment required to hold the property while it’s being built.

If you were to buy 123 Jones Street and hold on to it for three years before selling it, you would be responsible for the downpayment (usually 20%), and you would also make monthly payments to the mortgage company, about 70% of which is interest in the first three years.

But with pre-construction, you’re putting down 10% of the sales price and THAT’S IT!   That tiny amount of money holds your property until it’s built, after which you close the deal, and put it on the market while only throwing away a few thousand dollars in closing costs.

One of the old brochures I found in my file cabinet was for 66 Portland Street, and my jaw hung open as I compared the pre-construction prices to those prices found on the resale market.

These units were first offered for sale in 2003, and initial possession was given in the Fall of 2006.

Let’s look at the 1-bedroom-plus-den model of 644 square feet.  This unit was priced at $209,900, thus the deposit needed back in 2003 was only $20,990.  The first recorded resale for this model was for $275,000 in October of 2006, followed by a sale of $283,000 in January of 2007.

Let’s assume for a moment that this purchaser set down his downpayment exactly three years before he sold the condo.  Using the $209,900 initial price and the $283,000 resale price, we arrive at a gross-profit of $73,100 over 36 months.  Subtract $14,150 for sales commissions and $6,000 for initial occupancy fees, property taxes, and closing costs, and we get a net-profit of $52,950.

Now if this were a typical resale property, we’d calculate that return out of the entire $209,900 purchase price and arrive at 25.2% over three years.  Not too shabby!  Almost 9% per year!

But since the buyer only put down 10% on the property ($20,990), the return is calculated from that amount, meaning a whopping 252% over three years!

Show me one other investment vehicle that will net you 84% per year!

How did the more expensive units fare?  Take the 2-bedroom, 2-bathroom model of 1035 square feet that was sold for $355,900 in pre-construction.  This unit was first sold on the resale market for $464,900 in late 2006.

Downpayment (10%): $35,590
Gross Profit: $109,000
Net Profit: $79,755

With the more expensive unit, the overall profit drops to only 224% over the course of the three years it took to build the project and subsequently sell the condo.

So what about those people that purchased their condominiums at 66 Portland Street and hung on to the unit a little longer?  Well, they made more money overall, but their returns were smaller.

Take that same 1035 square foot, 2-bedroom, 2-bathroom unit used in the example above.  This model recently sold for $537,000, which is two full years later than the one above.

Downpayment: $35,590
Gross Profit: $181,000
Net Profit: $148,250

But hold the phone—what about all the other costs?

Assume that the buyer had to put down yet another 10% when he arranged his mortgage to avoid being in the high-ratio bracket.  This means his downpayment is $71,180 overall, with $35,590 being paid in 2003 and $35,590 being paid in 2006.  For simplicity, consider the downpayment to be a “weighted average” of $49,826 per year over the five year period.

If his total mortgage amount is 80% of the $355,900 purchase price ($284,720), then his monthly mortgage payment is approximately $1690 per month.  In the two additional years he is holding the property, he’ll pay $40,845 in mortgage payments, of which $28,668 comes in the form of interest and only $11,817 is returned to him in the form of principal.

So by holding on to the property for two more years, the property continues to appreciate, but the buyer/investor loses almost $17,000 in mortgage liabilities (interest minus principal), not to mention about $2000 per year in property taxes, and $400/month in maintenance fees over two years.

So with the additional expenses AND the additional downpayment he required in 2006, his overall return on investment shrinks to 47.3% per year over the five year period—a far cry from the 84% in the example where the buyer sold the condo as soon as he took possession in 2006.

Anybody tired of all these numbers yet?

In the end, we realize that the larger returns come from selling the property as soon as the building is registered to minimize the costs associated with holding it.

And if you were to purchase a second property instead of holding the first property for another 2-3 years, not only would your return be higher on the first property, but you could also experience yet another return on a second property!

Unfortunately, I’m of the opinion that these large returns made on pre-construction properties have almost come to an end.  With many recent projects I’ve seen being launched, the pre-construction prices are just as high, or higher, than existing resale prices!

Nevertheless, it doesn’t stop you from thinking, “If only I knew then what I know now….”

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One thought on “Hindsight!

  1. Krupo

    at 11:56 pm

    Yeah, the 300k+ pre-sale prices kinda sicken me.

    Though you wonder whether or not the units will then be on the market for 400/500k down the road… ah, delicious speculation.

    Made marginally safer if you’re willing to live in the place rather than just let it “go to waste.”

    Damnit, real estate decisions continue to be perplexing. 🙂

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