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What are the risks of pre-construction condos?

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First timer from British Columbia asks about contracts, renting during occupancy, closing costs, understanding the risks of pre-con and where to buy a parking spot or not.

TRANSCRIPT

Andrew la Fleur: Welcome to the Ask Andrew Podcast. Real questions from real condo investors. You ask, I answer.

Hi, and welcome back to the show. Thanks for listening to the Ask Andrew Podcast. Once again, this Andrew la Fleur, real estate agent here in Toronto, and founder of TrueCondos.com, and again, we are answering your questions. In this episode, we’re talking to Brett. Brett is a first time investor. He is living in British Columbia, but he’s interested in investing in the Toronto condo market. Interestingly, more and more people from British Columbia in particular, and Vancouver area in particular, are getting interested on finding and investing in the Toronto condo market. Probably a big function of that is yes, they see that growth, they see that Toronto is a stable city, a great place to invest in general, but also that the prices in Vancouver for so many people who live in Vancouver have gotten out of reach, and it’s just impossible for many people to invest in their own backyard. As well, the cash flow situation, when you compare Toronto with Vancouver, cash flow and return on your investment from that perspective is much better, generally speaking, in Toronto than it is in Vancouver. We’ve got a better price to rent ratio.

Some of the things that Brett asked about were contracts and how they work, renting out your condo during occupancy, closing cost, understanding what kind of closing cost to expect, we talked about some of the risks of investing in pre-construction. We also touched on the question of a parking spot, whether you should buy a parking spot or not. I look forward to sharing this episode with you right now. Again, if you’d like to be a guest on the Ask Andrew Podcast, if you’d like to have your questions answered, just go to AskAndrewPodcast.com and click on, “Ask me a question.” Without further ado, here is my interview with Brett.

Start with the biggest question on your mind about getting into condo investing.

Brett: Yeah, one of them would be … Well, it seems with the pre-build business, there’s a rush of the good ones just selling out immediately, and so I’m just trying to figure out how and when do certain details get figured out. By certain details, I guess, I read these things that intimidate people to get into it, like, “Well, there’s all these extra closing costs that will surprise you,” or, “What if the market crashes? Can you get financing on the prices that you paid regardless of the valuation when it’s actually done? What about the right to lease during the occupancy phase?” All those kind of things, who figures it out, and when do you get that figured out, especially when you’re in a short window?

Andrew la Fleur: Yeah. Well, I can hopefully help you figure out … Those are pretty easy ones. I can help you figure out those right now. We’ll just go one at a time. What was the first question?

Brett: Okay, so one question is does the developer have blanket approval for the development, ensuring that financing can happen on the prices regardless of valuation at completion? That was something that I’ve read online where it’s like, “Well, you need to figure out that’s in place.”

Andrew la Fleur: Yeah, so, I mean, I would say inherently, when you’re buying pre-construction, when you’re buying something that’s a piece of paper, you’re buying a contract that you are assuming and hoping is going to turn into an actual piece of real estate that you actually own. I mean, it’s inherently risky. There are inherent risks to buying pre-construction. You’re buying something that doesn’t exist yet. One of those potential risks is sort of what you’re alluding to, the fact that it might not get built. It might not get built for a number of reasons. Maybe it does get built, but there could be some kind of a market crash where the value of the property by the time it’s built is less than the value that you paid for it originally.

Then you may run into financing challenges because of that. Yeah, those are, I would say, realities of buying pre-construction, but I would just say that if you understand that, and if you’re smart and you if you invest wisely, the chances of those things actually affecting you are extremely low. If you look at the track record of people having been doing this for the last 20 years, those sorts of scenarios, while they have happened, it’s extremely rare that those sorts of scenarios can happen. Especially when you’re buying in a good market like downtown Toronto, when you’re buying from a good builder, and there’s many good builders out there.

Brett: Right, so that’s a risk, but I hear you saying it’s not necessarily certain steps that you can take.

Andrew la Fleur: Yeah, in terms of from your side, are there things you’re supposed to be doing in your due diligence to make sure these things don’t happen? Not really. Again, other than just working with good people, working with a good agent who knows the market, and knows the builders, who knows the area. Especially for you, you’re out of town, you’re in BC, I think, right?

Brett: Yeah, in Vancouver, yeah.

Andrew la Fleur: Yeah, you’re in Vancouver, so you’re investing from Vancouver in Toronto, which by the way, more and more people are doing. I’m getting more and more calls from people in Vancouver, which is interesting. Yeah, I mean, if you’re working with good people and people who have a track record, that’s about all you can do, really. Sure, you don’t want to overpay for stuff. You don’t want to get ripped off. You don’t want to buy something for a million dollars pre-construction that is really only worth 600,000 or whatever, but again, we’re not going to let that happen to you.

Brett: Right. I guess the other thing would just be the right to lease during occupancy. I was reading in one magazine that some builders don’t offer that, and you need to maybe be aware of that and negotiate for it.

Andrew la Fleur: Yeah, so leasing during occupancy, it’s a common question that we get. You’re getting into the details of the contract. Every builder is different, how they handle that, but the majority of builders, I would say, it’s basically a blind eye policy. They turn a blind eye, essentially. Pretty much every contract, I would say 80 to 90% of pre-construction condo contract in Toronto will say you’re not allowed to rent it out during occupancy, but the reality is everyone rents it out during occupancy. Most builders just turn a blind eye, and they just don’t enforce that. Or they will just give you an amendment to the contract that says, “Yeah, you can lease it out during occupancy.”

In my 10 years of doing this, I think I’ve only seen one or two buildings where the builder actually firmly put their foot down and said, “No one can rent their units during occupancy.”

Brett: That amendment, is that something that … What I hear you saying is you wouldn’t be pushing for that. The general way is that you kind of assume it’s going to happen.

Andrew la Fleur: It depends on the builder. Some builders will give it to you upfront, as sort of an incentive. It’s kind of a meaningless incentive, like I said, because everybody rents it out during occupancy anyways, with or without that amendment. You know, peace of mind and comfort. It’s nice to have it in writing, of course, that you can do it. Yeah, it depends on the builder. Some builders, like I know this builder will give you an amendment if you ask for it, or I know this builder won’t give you an amendment but they don’t care if you do it. It’s case by case.

Brett: Then, capping closing costs was my other question. These kinds of details, like I say, you get the price list that goes out, and then a week later, sales are going to occur, and then it’s going to sell out in a day. It kind of gives you that week window to go, “Okay, which condo, what’s the price point that I’m willing to go out,” and then these kind of details all need to get worked out.

Andrew la Fleur: Well, yes and no. Yeah, the best projects are going to sell quickly, and the launches are a frenzy of activity where the savvy investors are all trying to secure their units before prices are increased, or before the next round, as quickly as possible, however the builder is handing the actual sales, there’s different ways they do it. You’re always going to have a 10 day cooling off period, regardless, after you sign the contract. Those kind of details can sometimes be worked out during the 10 day in terms of making sure your closing costs are capped, making sure if you look at the leasing during occupancy question if they’ll do an amendment or not, making sure you have an assignment clause in your contract, the ability to sell the unit before it’s complete. Those contract details and having your lawyer, just generally having a lawyer, your own real estate lawyer review the contract for you and with you, and advise you on what is in the contract. That’s what the 10 days are for.

Brett: Okay, right. So the-

Andrew la Fleur: You don’t have to necessarily have answers to all those questions. In most cases you won’t have answers before you sign the contract, but that’s what those 10 days are for.

Brett: Okay, right. That makes sense. You mentioned there are four properties on your recent podcast, and so I’m just wondering about DuEast and Kingly in particular, because I’ve also heard you talk about there’s certain connections that you have or platinum access, and these type of things, so I saw online DuEast has their insider club. It’s if you want to make sure you get in, then there’s this $300 deposit you give and you join that club. I just wanted to get an understand of how, say, DuEast in particular, like if we were serious about DuEast, do we need to join that insider club, or do you have a certain connection there, or how does the situation work?

Andrew la Fleur: Yeah, so all those projects that I mentioned, those four projects, I am a platinum agent, so I have the highest level of access to these projects. That’s really all you need to know. You don’t have to do anything else. Specifically related to Daniels … You’re right, they have an insider or inner circle club they call it. It’s primarily for end users, people who are moving into suites themselves. People, for whatever reason, they don’t want to work with a real estate agent, or they don’t have a real estate agent. That’s what that is for. In terms of you as an investor, and having access to the building, and being able to secure a suite, obviously in my opinion, but you’re much better off working with a platinum agent than you are in that other stream, which again, is more for the end user crowd who are moving into the suites.

The big advantage you have with working with me as a platinum agent instead of that is you’re able to actually pick your suite and reserve your suite in advance of the actual sales day, as opposed to just coming in. At least until now. I mean, it could change, but the way that Dave Daniels has done it, is those people just have to come in and show up for an appointment on the day, and they just see what’s available. If what they wanted is not available, they can’t buy it. Depending on what time they get their appointment. Versus, working with me as a platinum agent, we can actually reserve a suite ahead of time. You know exactly what suite you’re getting and what the price is before the actual sales day.

Brett: Yeah, that’s helpful. Great. Thanks for that. Another quick question would be just about your input on purchasing a parking spot. Especially if you’re going maybe for a one bedroom, then the parking spot is quite a big price. Whatever, it could be 20% of the price of the condo you’re paying, almost, to pay on a parking spot and locker.

Andrew la Fleur: I don’t think it would be that much, but it might be 10% depending on the price of the parking. With parking, it really depends on what building, the location of the building, the number of parking spots in the building compared to the number of suites in the building. So many factors that go into whether I recommend you to buy a parking spot or not, from a professional perspective. It’s not like a blanket rule statement that I can say yes or no. Generally speaking, if you’re buying something above 500,000, 600,000, then most cases, you probably should get a parking spot. If you’re buying stuff under that, in most cases, you probably will not bother getting a parking spot. Again, it really depends case by case. What is your approximate budget as you’re looking at making investment now?

Brett: Yeah, like 350 to 4.

Andrew la Fleur: 350 to 4, then yeah, you’re not going to be getting the parking. You’re not even going to qualify to purchase parking anyways. It’s not even going to be an option. In any building, they have limited parking spots, so they are usually only available with the two bedroom suites or larger. If you’re talking about anything downtown Toronto, even in the suburbs under 400,000, it’s not going to be a two bedroom, and most likely it’s not going to be qualified for parking.

Brett: Okay. If you just paying, say, a one bedroom, or one and a den, then typically you’re not going to be getting a parking spot.

Andrew la Fleur: Right, yeah.

Brett: Yeah, okay. Then, finally, just the strategy of securing a contract and then selling prior to closing versus waiting to rent it out. I guess, particularly thinking about DuEast that has, it’s only a 10% deposit. Then, does the amount of the deposit potentially impact the strategy?

Andrew la Fleur: Yeah. I mean, generally speaking, I’m not fan of assignments. Generally speaking, my investment philosophy, and what I teach people, is to be a long term investor and to build a portfolio over time, and basically, my philosophy is never stop. Keep building, and building, and building, and never sell unless either you have to, or you have something better to put the money into. If you have good properties, and they’re all rented out, and they’re all paying for themselves, and they all have positive cash flow, they’re in good buildings, they’re appreciating in value, they have good tenants. That’s the goal for every property is all those things. If you have that, then never sell. That’s how you’re going to truly build wealth, is by holding onto properties for the long term as opposed to flipping them every couple of years kind of thing.

With that being said, yeah, if you have a lower deposit, then it makes it more favorable to think about doing an assignment and selling it before it’s complete. It’s just easier to do. It’s easier to make a profit when you have less into it. That being said, there’s many other reasons why assignments I’m not a big fan of. One reason is developers really discourage them, and developers don’t like assignments. Generally speaking, they make it a little bit difficult for you to do assignments. The other thing is the government. The government, CRA definitely does not like assignments. I can for sure foresee a day in the not too distant future where they’ll either be severely restricted, taxed, or just outright banned perhaps by the CRA.

Counting on them as a primary strategy, I would say never think of it as a primary strategy. Think of it as a backup. Plan to hold the property, is what I always tell people, and rent it out, but if your circumstances change, if things change in your life, or you need the money for whatever reason, emergency situation, whatever it might be, think about assignment as a plan B. You want to make sure you have the ability to assign just in case, but don’t make that your primary strategy.

Brett: Yeah, and it wouldn’t be the primary strategy, but just was curious as to what you would say about that, particularly with a 10% deposit, or if you’ve got two, and then you’re basically three years down the road, [inaudible 00:18:50] where the finances are, and maybe going, “Okay, I didn’t want to keep two.” If the market actually jumped, could we sell off the second one assignment, and then take that profit and roll on?

Andrew la Fleur: Yeah, or roll it back into the other one. Yeah, that’s a strategy that some people have employed with pretty good success, but again, if you’re buying the right properties in the right locations, my argument is you don’t have any reason to sell them. In a way, that’s almost the worst time to sell it is right before it’s done, because that’s right when it’s about to realize its value and potential, and when you sell an assignment, by the way, you’ve got to sell it below the actual market value, below the actual potential, because it’s an assignment, and because they’re much more complicated. Your buyers out there, they’re harder to market. Assignments that sell, they always, by definition, are selling below market value compared to if they were reselled. I always recommend you at least hold the property for at least one year after it’s one. Rent it out for at least a year, and then decide and evaluate.

Brett: Yeah, okay. Great, so basically, the specifics of these properties, I guess in October, the price lists are coming out, and then what would be the step from there? Looking over that, making a decision, and then giving you a call?

Andrew la Fleur: Yeah, that’s basically it. Yeah. You’re going to get the information from me. DuEast in particular is coming October the fourth, the info, and the actual sales event is on October the 14th. As of October the fourth, you’ll be able review everything and submit what’s called a worksheet, which is like a suite reservation form kind of thing with your information, and your driver’s license, and so on. That will sort of begin the process there to try to reserve you a specific suite. Then, if we’re successful, and we’re able to get you a suite that you’re interested in, then the actual contract signing would be on October the 14th. Assuming that you’re not in Toronto, then you should start thinking about a plan for that, and probably the best plan is to basically give me POA, give me power of attorney to sign the contract on your behalf. You can just courier checks over here before the 14th so I have them ready to hand in kind of thing. Does that make sense?

Brett: Yeah. Yeah, so basically as soon as the price list goes out, then it’s open for you to begin to look at places.

Andrew la Fleur: Yeah. It’s not going to be a first come, first served sort of scenario. It’s going to be, “Here’s the price list, here’s the floor plan.” A few days will pass where they will accept these worksheets, and they’ll collect the worksheets, and then after a few days they’ll shut it off, and then they will allocate the suites based on the worksheets and try their best to match people up with their choices. That being said, it’s a supply and demand situation. If they have a thousand worksheets and 300 units, then not everyone’s going to get a unit.

Brett: Yeah. Makes sense, yeah.

Andrew la Fleur: We’ll see how that goes. We’ll see what the demand is like. I expect the demand is going to be very, very high for all of these projects, really, that I mentioned. The four projects.

Brett: Right. Okay, great. Well, thanks. Yeah, thanks for taking the time to walk through that.

Andrew la Fleur: No problem. Hopefully that was useful, and great to connect on the phone, and yeah, we’ll be in touch in the days ahead. Definitely watch for more emails from me in the days ahead with more information about videos, and podcasts, and stuff that I’ve been working on that you’ll be getting in the next few days.

Brett: Perfect. Okay, thanks a lot, Andrew. It was helpful.

Andrew la Fleur: Great. Thanks. Bye for now.

Thanks for listening to the Ask Andrew Podcast. To get your question answered, just go to AskAndrewPodcast.com and click, “Ask a question.”

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