Preconstruction ...

Many people are not familiar with the term “pre-construction.” In the real estate market, this term refers to purchasing a condominium or property in the initial stages of development, prior to the actual construction of the building. There are several steps involved in this process.

Typically, the first step in buying a condo pre-construction is the reservation stage. At this time, a buyer chooses their unit and puts down a reservation fee in the amount specified by the developer. Usually this fee is $5,000 to $25,000. This is not a contract and the reservation may be cancelled at any time by the buyer, and their reservation fee will be returned. This stage normally lasts a minimum of several months, and could last much longer.

The next step in the process is converting the reservations to contracts. At this time, twenty percent of the purchase price is required as down payment for the condo. 10% is required in cash. A letter of credit from a financial institution is usually accepted for the additional 10% by the developers’ construction lender. A typical timeframe from pre-construction sales to closing is around two years.

There are many financial advantages to the buyer when there is an opportunity to buy pre-construction. After the down payment is paid at the time of contract, no additional money is required until closing. When it is time to close, a buyer would have already put down a minimum of ten percent cash in the condo, which is often times the down payment a lender requires for financing. A purchaser in this situation will just be paying closing fees at the time of closing.

A buyer also has limited carrying costs. No mortgage payments. No utility bills. No insurance costs. No property taxes. While the buyer has none of these costs, they are capturing any appreciation that is happening in the market.

For example, let’s say that the beachfront market appreciates at 10% per year. A buyer purchases a $400,000 condo and puts down $40,000 in cash as a deposit.

August 2005 - $400,000 unit and $40,000 cash invested
August 2006 - $400,000 unit has appreciated 10% - $400,000 X 10% = $40,000
August 2007 - $440,000 X 10% = $44,000

In this example, the unit that the buyer has under contract for $400,000 is now worth $484,000 at the approximate time of closing! The buyer has made a theoretical $84,000 on a $40,000 investment in two years. The return can be much higher if a buyer is able to purchase early in the process when the condo units are discounted by the developer to gain interest in the project.

This information is provided as an overview of the pre-construction buying process. Please read the prospectus very carefully of any project that you might have an interest in. All developers and their construction lenders have requirements that vary from others. Also remember, that there is no guarantee of appreciation in any real estate market or investment.