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…