Buying preconstruction gives you the potential to make returns of 100%, 200%, or even much more…and fast. It can also offer you the opportunity to build a rental portfolio with little money down.
Buying preconstruction, or off-plan, is where you buy into a development before it has been constructed. You are relying on a set of architectural plans. Frequently, developers will offer substantial discounts to buy off-plan. The best preconstruction projects will sell out before a shovel goes in the ground. Often the best units go to “insiders.”
Developers need investor funds to stay in business. That’s a strong incentive to create simple and profitable investor terms. Also, bank finance for construction costs will typically be dependent on a certain level of presales. The developer will want to hit that number as soon as possible. By shortening the length of the project, he can increase his return on investment (ROI). This timing issue creates a symbiotic relationship between developers and investors.
If the developer has a good track record, banks practically compete with each other to lend him the money for a deal like this (under normal credit market circumstances). With presales in place, the bank’s risk is minimized. By simplifying the deal, the developer minimizes his administration costs while securing his construction funds at a competitive rate.
Buying off-plan makes more sense for the investor than for someone buying for personal use. For the investor, the unit doesn’t have to meet your personal taste, and you probably don’t mind that it will take up to a few years before you take possession of your unit, as long as the market is seeing appreciation. It should, however, be a property that a large portion of the general public wouldn’t mind owning or renting. You are buying the unit to eventually sell or rent to an end user, and you want to make sure the property will be attractive to that level of the market.
The end user may be a long-term renter, a first-time homebuyer, a short-term vacationer, or even another investor. That will depend on where and what you are buying. Analyze who the end user will be before you put your money down, as you will want to make sure there will be a big enough market to sell your property into.
You get a discounted price to compensate you for taking on some of the early development risk, but the real incentive to buy preconstruction comes from leverage. While the terms of the payments vary from project to project, no matter what the terms are, you are leveraging your returns to some degree. A typical deal will start with a small down payment…say, 5%…and work through various staged (progress) payments during the construction period, until you have paid anywhere between 5% and 80%. The balance is due when the keys are turned over.
Let’s walk through a sample deal to show how leverage works when buying preconstruction. You purchase (preconstruction) a $100,000 condo with a 10% down payment. The balance is due on completion in two years’ time. A 20% increase in price during the build period means a 200% return (net of fees) if you were to flip. Of course, leverage, like buying an option, can work in two ways; a 10% fall in price means that you are down your entire investment.
I have recently bought preconstruction units in Brazil with as little as .75% down. In the case of these units, prices rose by 15% within a month of buying, creating a staggering paper return.
Buying preconstruction can be a great way to accumulate a rental portfolio. Capital appreciation can mean that at closing, a bank will lend based on the new valuation, not the price you paid. This can mean that you can pull cash out of the property the day you pay for it.
Buying preconstruction is a strategy that will maximize the retail investor’s ROI in the early-to-mid stages of a market appreciation cycle. Buy preconstruction at the top of the market and you risk losing your entire investment…and maybe even more than you have invested, if you are contractually bound to complete and that clause is enforceable.
As with any other investment, buying preconstruction requires a clearly thought-out strategy and an understanding of the risks involved. You always need to have a clear idea about who the end user of the property will be. Get it right and you will reap the rewards. Even in the current climate, there are opportunities for those willing to look and travel.
Editor’s Note: Ronan McMahon is the Executive Director of Pathfinder (International Living’s preferred real estate advertising partner), which focuses on opportunity for gains in strategic pockets around the world-before most folks have even heard of them. He writes for Pathfinder’s real estate investment service, the Real Estate Trend Alert.