Here’s a new way of looking at pre-construction condominiums, which continue to be shown in a negative light.
The best assets are those that are liquid, yet a pre-construction condo purchase is one of the most immovable assets there are…
The idea for this post was actually borne out of the discussion that took place in last week’s Friday Rant.
I was on a panel at a seminar where, among other things, we discussed pre-construction condos.
I’m pleased, in the self-satisfactory, sly-grin kind of way, to say that all of the panel members agreed that buying pre-construction condos in Toronto no longer makes any sense, however we did find one person in the crowd to argue with, and argue – we DID!
I kept hearing the word “Investment” thrown around, and that really bothered me.
I argued that purchasing a pre-construction condo was just about the furthest thing from an “investment,” and a few people didn’t quite catch on.
Let me explain…
An investment, by definition, is something or somewhere that you direct money or capital in order to generate a financial return.
In most cases, but not all, this investment is likely:
1) bought
2) sold
There are lifetime investments in which you never actually sell or dissolve the investment, for example, a security or insurance that pays out a regular income stream or dividend. But many, if not most investments are eventually sold.
That takes us to the notion of liquidity.
“Liquidity” is defined as “the ability or ease with which assets can be converted to cash.”
Are you liquid?
Are you flush with cash and do you have investments? Or do you lease your car and condo and live off your credit cards?
Somebody who is “liquid” is somebody who has cash and little to no debt.
An asset that is liquid, however, is one that is easily converted to cash.
Cash is the most liquid investment there is. It’s CASH!
Then what?
I suppose bonds are very liquid, since they can be bought and sold with ease.
Stocks are liquid too, as they can be sold with the click of a computer button.
Commodities are liquid too. Once upon a time, if you owned 20,000 bushels of corn, rods of steel, or bricks of gold, they wouldn’t be liquid at all, since you’d have to store them, sell them, transport them, and finally collect your cash back. But technology has changed all that, and almost any investment you can make on Etrade, TD Waterhouse, or the like, could be liquidated very easily.
Rare coins? Stamps? Are these liquid? The market for these items is specialized, and it could take a while to sell them, but they’re not entirely illiquid.
What about your car? Sure, there are forums like Auto-Trader on which to liquidate that.
Your grandfather’s Rolex? No problem – you can pawn that in about five minutes in any one of the fine establishments on Church Street in between Shuter and Queen.
What about your house?
Well, your house is a huge asset – both in terms of its size and its value. It can’t be moved from place to place, and the market for this asset is highly specialized too. But at the end of the day, you could have it sold in a day if you really wanted to, and you could have it turned into cash in weeks.
So this brings me to the long-winded point I’m trying to make, which if, by now, is not completely clear, then I’m not doing a very good job…
Pre-construction condos are illiquid assets.
Are they not?
Consider what you’re buying for a moment. Try and picture it in your mind. Do you see it?
It’s NOTHING!
You’re buying NOTHING!
You’re buying the idea of a condo eventually being built on a parking lot or perhaps where the sales centre now stands.
Don’t tell me that you’re buying a future condo or some sort of “promissory note,” because you’re not. We all know that condominium projects do fall-through, and there is never a 100% guarantee that a condo is actually going to be built.
As a pre-construction condo buyer, you’re buying a massive ball of risk and uncertainty, and the best part is: you might not be able to sell it.
If you want to sell your car – you can do that today!
If you want to sell your stocks – you can do that in ten seconds!
But when you “buy” a pre-construction condo, and I put “buy” in quotations because you’ve really just given a $25,000 deposit and agreed to wait like a moron for 5 years of a 2 year project, you don’t really have anything to sell! Your asset is illiquid!
Let’s say you bought a pre-construction condo, er, put down a deposit on January 1st, 2012, and it’s scheduled to begin construction in November. What if by November, you want to sell it? Well, what have you got to sell? You have a contract, that’s all. You have a contract in which you have few rights, lots of uncertainty, and of course the obligation to pay $xxx on xx-date, or be in breach of contract.
How tough is it going to be to sell your contract when there are sales centres all over the city offering new contracts? Oh – pretty tough!
Where do you sell your contract? Well, you can probably list it on MLS, but if construction hasn’t begun, who is going to buy your “investment?”
But wait – there’s more!
Here is the best part – the part I loved telling the crowd from a few weeks ago where that one chicken-clucking-moron was hopping up-and-down in his seat at the thought of being “the first in line” at the next V-V-V-VIP launch party. Ready….
The developer might not let you assign your contract, which means that you might not be able to sell your ‘investment’ until after the condo has closed and the building has been registered.
Right! We almost forgot that part!
So…….we were talking about liquidity, right?
If you have an investment that you are NOT PERMITTED to sell, how the hell is this really considered an investment?
Ladies and gentlemen, pre-construction condos are illiquid assets, which in my mind, aren’t really an investment vehicle. If you can’t sell something, aren’t you taking on a massive, unimaginable risk?
If you own an existing, resale condominium, and the world economy imploded tomorrow – you can sell your condo and close in a few days if need be.
But if you own a piece of paper that details how your $25,000 deposit was accepted by the developer on xx-date and how you owe them $xxxx more money in the future otherwise you forfeit your deposit, how exactly are you going to sell that in a time crunch? And what if the developer won’t let you?
Yep – you’re stuck with it!
Great investment there, genius!
Remember the discussion we had last summer about pre-construction condos versus options trading? Remember the guest-post that one of my readers submitted? It was fantastic! And it showed that options traders would be utterly confused by the idea of pre-construction condo “investing,” since you’re making a bet on the future, but you can’t get out of the bet, and the cost of your bet is astronomical.
Imagine if an options trader was forced to follow through on every option? It would defeat the very purpose of the “option” in the first place.
Any true “investment” should have the ability to be bought and sold. Period. It’s that simple.
If you can’t sell your investment, then it’s not an investment – it’s an obligation, and a liability.
Is that what pre-construction condos in Toronto have come to? They’re now simply liabilities?
Well, don’t look now, but a new real estate brokerage in Toronto specializes ONLY in pre-construction condos, whereby their value is “getting you to the front of the line.”
Good God. What is the world coming to.
It’s like morons lining up to jump off a cliff, and somebody saying, “I can get you to the front faster.”
In the words of Jerry Seinfeld: “Good luck, with aaaaaaaaalllll THAT!”
jeff316
at 8:16 am
Good post. An agent was trying to convince my sister about the merits of pre-con and I vehemently advised her not to when really I should have just directed her to your blog.
Ralph Cramdown
at 9:35 am
Some of the best investments are not liquid. Think raw land, private equity, commercial real estate, and sometimes art and collectibles. These are all assets which you’d likely take a significant haircut on if you needed to liquidate in a week or two. Investors naturally have liquidity preference, which means they prefer liquid assets and typically need extra compensation to hold illiquid assets — even cashable GICs pay less than non-cashable ones.
Now as to buying a pre-sale, not insisting that it be assignable, and paying today’s $/sqft or more to write a put option of indefinite duration in a low inflation environment, well, that’s just plain poor “investing.”
Dan
at 9:48 am
25 grand is a small price to pay for the promise of unlimited virtual golf and hot chickaroonies. Its the condo dream babay!
Dan Dickinson
at 11:28 am
I wasn’t there, but it’s possible the audience member was arguing semantics. I mean, buying pre-construction condos *is* an investment, at least insofar as any real estate purchase is an investment. All investments carry risk, including real estate, but obviously buying pre-construction carries much more. Perhaps it even used to be worth it, back when there was a risk discount in the pricing, but now units three years from being done, and carrying a substantial risk of being altered or of never being built, seem to go for essentially the same price you’d expect on the day of closing.
As someone who bought pre-construction (back when it was worth it) I can tell you why we did it: we wanted the option to buy a) a layout we wanted in b) the building we wanted. We weren’t looking for a generic 2-bedroom in whatever building in a general neighbourhood, we wanted a specific unit (on a high-enough floor) in a specific building. We were willing to take on some risk for that option. We never looked at it as an investment though; for planning purposes we hoped our unit would be worth on day 1 of closing what we paid for it, plus opportunity cost of the initial payment. In fact, it appreciated 45% by the time we moved in, so we lucked out. But we never assumed we’d make money, even back in the days when it was a reasonable assumption. I think we’d have been crazy to do so.
One last thing: if I ever line up to a spotlight-ridden, red-carpet, gala opening of some condo’s pre-sales, just shoot me.
buk
at 1:17 pm
what other investments charge a 5% commission to sell?
Devore
at 4:50 pm
I know you don’t like pre-sales (or pre-construction, whatever), and neither do I, as an investment. But a pre-sale is not “nothing”. It’s a contract. It’s a futures contract. A contract to purchase something described in the contract in the future at a specific price. It’s a bad contract, because the “something” can be changed on you, and “the future” is not a specific fixed date. But it’s not “nothing”. People buy and sell pieces of paper all the time, and it’s not “nothing”. Cash is pieces of paper. When it really comes down to it, cash money is ultimately a promisory note, just another form of a futures contract.
Liquidity is also, as you note, a continuum. Stocks are very liquid, for example, because the transactions are lightning quick, the units are perfectly fungible, and there are many participants.
A house is not very liquid, on the other hand. Takes time to do all the paperwork and assorted due diligence. Financing, title, inspection, etc. The units are not fungible; your house may have a very narrow appeal. The market is highly segmented; unlike with stocks, you can’t buy a slice of a house here, and a slice there, etc. Finally, not that many people looking to buy a house at any given time. Once you have one, you don’t generally keep looking for more, even if you get more money.
There is not much you can do to improve the transaction speed. It is what it is. You can improve the appeal of your unit by renovating/decorating/staging it, and you can create nearly instant demand by dropping the price.
That is the general theme among illiquid investments. You need to drop the price, depending on how much pressure you’re under to sell it.
A pre-sale is totally illiquid, first of all, if you’re not allowed to re-assign it by the developer. You can I suppose create a contract (would that be a derivative?) so it is sold/assigned to another party as soon as it becomes able to.
If you’re holding one of those, there is a market for them. There is ALWAYS a market, at SOME price. If it would cost you money to walk away from a contract, the price might even be negative. And of course that’s the key. You can get out of any investment, no matter how illiquid, by dropping the price sufficiently.
So why would you want one of those things? Well, as another poster noted, less liquidity = more risk (you’re locked in and can’t move to respond to market changes) = more reward potential. Now, in the case of pre-sales today, that may not actually be true! but that has nothing to do with the lack of liquidity in this market. It has to do with good marketing and lack of education and due diligence on the part of investors.
Devore
at 5:36 pm
Ohh.. can I reply to my unpublished post? Apparently I can.
So those previous blogs about pre-sales vs options were interesting, but I think missed the point. A pre-sale is not an option, so why compare it to one?
It is more of a cross between an option and venture capital, no?
There is a web site around, Kick Start, that allows you to contribute “seed capital” to a proposed project looking for funding. It might be a thing, a service, a film even. It might be a feel-good donation, essentially, where you get nothing in return. But usually you get something out of it. Like a cheaper thing, once they finish developing it. Or a free DVD ahead of general release and your name in the credits.
You put money in, it is held in trust. If the project doesn’t take off, you get your “deposit” back. If it does, then at some unspecified future date you have to put more money in, in order to get something out of your “investment”. But it’s a black box. The specs may change. The schedule may change. You can walk away, and lose your deposit. You could, conceivably, give or sell your “rights”, your piece of paper, to someone else, who would then be able to exercise the benefit you have funded.
So is Kick Start a futures option? Not really. It’s totally illiquid, by the way. It’s more like a condo pre-sale, actually.
The point is people are willing to take on varying levels of risk to get a return on their investment. It’s not all or nothing. They may have some bonds, they may have some stocks, they may have some penny stocks, they may have some gold bricks, and they may have a portion of their money in a pre-sale condo. If they need to raise money, they do what other investors do, sell the most liquid assets first. Liquid assets first, because they will get the best price. In a fire sale, time is money.
But they do have an expectation that their less liquid investments will give a greater return, to compensate for the increased risk.
Max KHAZANOVICH
at 6:17 pm
Hi Devore,
I like your thinking because you understand both the derivative and real estate markets.
Perhaps you could contact me to discuss a possibility of establishing the resale market for preconstruction condos in Ontario beyond the MLS?
Thank you,
/Max Khazanovich, MBA, REALTOR®️ at Right At Home Realty Investments Group Inc.
+1.888.789.0906 Toll Free
Lonnie Lieto
at 8:46 pm
Really great information, thanks for the share and insights! I will recommend this to my friends for sure.