Why Investing in Pre-Construction Condos Could Cost You Money

This week, I talked to BNN Bloomberg about the questions you should be asking yourself before investing in a pre-construction condo.

Every day, people tell me they've talked to someone who has made money by investing in a pre-construction (pre-con) condominium (condo) and wonder if they should do the same.

While some have no doubt made money by condo investing (i.e., not purchasing a condo unit to live in themselves but to either rent it out or sell it in order to benefit from the condo's price appreciation), I'm seeing too many people assume that this will always be the case - even though the data suggests that we need to be very cautious about the pre-con market in the Toronto area right now.

This week, I talked to BNN Bloomberg's Greg Bonnell about what I'm advising clients right now (including those who want to buy a condo to live in).
 
Click on the video below to watch the full discussion - and read my summary of the key questions would be investors should be asking right now.
 
 
Key Questions to Ask Before You Invest in a Condo 
 
Price
 
While it sounds obvious that price should matter, the market isn't really behaving like it's sensitive to the cost of units.
 
More specifically, the average price per square foot for a pre-con condo in 2019 was $967 compared to $737 for resale according to Urbanation.
 
This means that pre-con condo units are priced on average 30% more than comparable units in resale (i.e., already completed) condo buildings.
 
So why would you pay 30% and in some cases 40% more for a pre-con unit when you can by a far more affordable resale condo?
 
I think the reason people are doing this boils down to fewer frictions.
 
When you buy pre-con you don't have to worry about qualifying for a mortgage (particularly under the current stress tests, which have only been slightly relaxed recently) and you don't have to worry about managing tenants until building is being completed. 
 
The idea is that you just put down a deposit on a condo and you'll double your money in the 5 years in normally takes for a building to be completed.
 
But with the high prices (and deposits) investors are currently paying, there's no guarantee that market will even catch up to what they paid when it comes time to sell. 
 
Rents
 
The second consideration is the amount of rent you can earn on the investment condo you are buying.
 
When you buy a resale unit, you have a good idea of the rent you can expect by looking at existing rents in the market.
 
But with pre-con condos, many are projecting where rents will be, and in most cases their expectations are unrealistic.
 
Investors would need rents for one-bedroom condos to reach nearly $4K per month to justify the high prices they are paying today - and that's very unlikely to happen.
 
In some cases, when condo prices are so inflated, I've seen agents and builders craft lofty projections that guarantee investors will be able to rent out a 750sq ft condo for over $5K/m as a furnished rental - but again, these are pretty lofty expectations. 
 
Protecting Your Downside
 
Pre-con condos are the type of investment that only work in a world where prices are rising.
 
If you buy a resale condominium and condo prices happen to drop 20% over the next few years, and provided you can keep making your mortgage payments, you can hold on to your unit and wait for prices to recover in the future.  Your condo will have lost value in the short term, but you can hold on for the long term.
 
But if you buy a pre-con condo and prices fall 20%, unless you have a lot of money saved up, you'll be unable to even take possession of that unit to live in it or rent it out because banks only finance what the property is worth, not what you paid for it.
 
We saw this exact scenario unfold with pre-con detached homes in Oakville in Halton Region and in Durham Region in the Greater Toronto Area when buyers paid peak prices in 2017 only to find that when their house was completed, it was worth significantly less than what they paid for it.  Many lost their life savings because they did not manage that downside risk.
 
Given the potential risks, it's critical to ask yourself tough questions before you are enticed by the 'sure-fire' promises of Toronto's condo marketers.
 

John Pasalis is President of Realosophy Realty, a Toronto real estate brokerage which uses data analysis to advise residential real estate buyers, sellers and investors.

A specialist in real estate data analysis, John’s research focuses on unlocking micro trends in the Greater Toronto Area real estate market. His research has been utilized by the Bank of Canada, the Canadian Mortgage and Housing Corporation (CMHC) and the International Monetary Fund (IMF).

Follow John on Twitter @johnpasalis

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