If you’re willing to move every few years and are tolerant to some risk, you should consider buying and selling pre-construction condos as an investment strategy.
It’s an easy way to make money in real estate by living in your own place. You also skip the hassles of renovations, staging and house flipping.
In this in-depth article, we look at:
- how pre-construction condo investing works
- three different strategies you can use
- pros and cons of this investment strategy
What Are Pre-Construction Condos?
Pre-construction condos are sometimes called “new build condos”. Here’s how they work:
SIGNING: You commit to buying a new condo with a builder before ground is broken. Nothing’s built yet: the builder only gives you an estimated occupancy date. That’s why they’re called pre-construction condos.
DOWN PAYMENT: Between the time you sign and your occupancy date, you pay the developer the down payment in portions. These payments follow a specific schedule.
DELIVERY: After a year or two, the builder wraps up the condo development and hands you the keys.
How Does Pre-Construction Condo Investing Work?
Pre-construction condo investing works by deferring the value of current money into the future.
In other words, you buy an asset at current prices and when you take possession years later, it gains in value. Depending on the neighborhood, that increase can be significant. This increase is where money is made (or lost).
A Case Study: the Numbers Don’t Lie
Let’s take Montreal’s Griffintown condo market as an example:
In 2015, the average price of a resale condo in the Griffintown condo market hovered around $400 per square foot. For an 800 sq ft condo, that’s $320,000.
Now fast forward to 2017 (move in date) and prices went up to $450 per square foot. That same condo is now worth $360,000.
If the down payment was $64,000 (20% of the sale price), in two years you grew that investment by another $60,000.
Not bad right?
Consider that if you live in the condo for another year (more on that later), the neighborhood prices soared to $500 a square foot. Now we’re talking $400,000. That $64,000 grew by an extra $80,000.
Should You Live in the Condo After Delivery?
In most cases, gains from the real estate market aren’t taxed if they were made off your primary residence. What counts as a primary residence? For the average person, it’s a property that you live in for a year or two.
You have to pay capital gains tax on your profits if you don’t live in the pre-construction condo for at one least year after delivery.
That tax can eat away at your gains. Especially compared to basic investment strategies.
If you intend to live in the condo for at least a year after delivery, you don’t have to worry about capital gains. That said, get the advice of a tax accountant before attempting such a strategy. Your situation may be unique.
An Investment Strategy
Assuming you decided to invest (and live) in a booming condo neighborhood. How can you take advantage of the situation?
The option that presents the least risk is to put a deposit on a pre-construction unit. You then live in it after delivery. A few years later, sell and walk away with the equity. You can then invest that money into a more permanent property.
In the best case scenario, the market appreciated while you were waiting for your condo. During the year you lived in it, you also built real equity. Just by living in your own house, you made money.
Worse case, the market doesn’t increase as fast as you’d hope. At least your condo helps you build up equity while the market catches up.
Limiting Risk In This Strategy
To limit financial risks, you’ll need to implement the basic rules of real estate investing:
- Only buy in a development that’s in a great location.
- That doesn’t just mean close to downtown.
- It could mean an area that combines easy access to mass transit and within walking distance to great amenities.
- Put your trust in established builders that have a proven track record.
- There are many indicators showing the neighborhood will change for the better.
- Make sure you can afford to live in the condo after delivery:
- 28% of your gross monthly income for mortgage payments.
- 32% of your gross monthly income for total housing payments.
- These include mortgage payments, property taxes, condo fees and insurance.
- Your total debt payments should not exceed 40% of your gross monthly income.
- This includes housing. Examples of debt are credit card repayments, car loans, student loan installment.
A Riskier Pre-Construction Condo Investment Strategy
Sometimes the real estate investment fundamentals are so obvious that you know an area is going to thrive. For those of you more tolerant of risk and who don’t mind moving, you can try this*.
Note that it relies on condos which qualify for tax rebates:
- Sign one pre-construction condo (and live in it after delivery)
- Ask the builder not to apply for the HST rebate on your behalf
- At tax season, claim the HST rebate and put that money aside
- Start shopping for new condo developments in your area. Use the HST rebate as the next down payment.
- Sell the old condo after living in it long enough. Apply the gains you made against the new condo.
Side Note: Before attempting this, consult a tax accountant. You may also not qualify for certain mortgages, consult with your mortgage broker. Finally, make sure the condo you are buying qualifies for the HST rebate.
By the time your second pre-construction condo is ready for delivery, you’ll have spent two or three years in your first place. Any profits you make shouldn’t count as capital gains. After your first condo sells on the resale market, your gains can go towards reducing the mortgage of your second unit.
How many times you can do this depends on:
- Your tax situation and the advice of your accountant
- Whether more pre-construction condos can be built in the area
- If your condo qualifies for an HST rebate
Bear in mind that by absorbing the HST rebate into the sale price, you’ll also make higher mortgage payments.
Selling Your Pre-Construction Condo Before Taking Possession
This is called an assignment sale. It involves selling the purchase agreement you had with the builder to someone else. This takes place before the property is registered as a condo.
You take advantage of the fact that your pre-construction condo gained in value between the date you signed and before taking possession.
These kinds of transactions aren’t common and involve a lot of risk. The builder also has to agree to let you sell your deed. If the builder doesn’t, you’re stuck with the unit.
There’s also serious tax implications to this strategy. That’s why it’s only recommended for seasoned real estate investors.
Why Invest in Pre-Construction Condos?
Buyers have a lot of advantages on their side when investing in pre-construction condos:
- Low barrier to entry: the payment schedule for the down payment is spread out over many months. This makes it easier for buyers to come up with the money required to get in on this investment strategy.
- No expenses during waiting period: while you’re waiting for delivery, you’re not paying property tax or condo fees. That’s a lot of money saved. Especially compared to a resale condo.
- Get to live in a brand new condo: fresh walls, new appliances and pristine floors await you once you take possession.
- Choose the finishes you want: during pre-construction, you get to choose whatever upgrades to the condo you want. Just bear in mind the resale value of those upgrades.
- Great way to reduce your final mortgage: assuming you put all your equity into your permanent home’s purchase.
Risks and Costs Associated to New Build Condo Investing
While there’s money to be made with pre-construction condos, they come with risks. Some of these can be annoyances while others can become financial liabilities:
Late Deliveries
Depending on the builder, there can sometimes be delays in delivery. This can get complicated if you’re renting and need to time leaving your apartment for your condo.
Market Fluctuations
Pre-construction condo investments depend entirely on market appreciation. If you invest and the market goes down, you’ll have to continue living in your condo for a few more years until the market catches up.
Tax Implications
Before attempting any of this, consult with a tax specialist. Depending on your situation, the federal tax service may view your profits as capital gains and tax you.
Realtor Fees
Even if your property gains in value, remember that there’s realtor fees you’ll have to pay when you’ll want to sell. You can DIY selling your condo yourself to save on these fees. However, this comes with a set of additional risks.
Condo Closing Costs
Every time you buy or sell a condo, you need cash to pay for closing costs. These include the land transfer tax, lawyer or notary fees, utilities hookup fees, etc.
Mortgage Breaking Fees
Depending on your lender, you may have to pay a penalty to get out of your mortgage. Some lenders offer the possibility of rolling into a new mortgage at no additional cost. Inform yourself beforehand.
How You Can Mitigate These Risks
Pre-construction condo investing can be made less risky by being willing to make sacrifices for a few months (or years). Here’s what you can do to minimize the risks:
Be Ready to Live in Temporary Housing Situations
It’s possible that you terminate your lease but there be delays in delivery of the condo. In this case, you may have to find temporary housing or be willing to sleep on a friend’s couch or in a parent’s basement. In either case, you may have to live out of luggage for a month or two.
Willing to Limit Furniture Purchases
If you’re planning on moving within a year or two, avoid buying furniture specific to your new condo. It may not fit in the next condo. Furniture doesn’t have good resale value.
Learn to DIY the Basic Things
When you take possession of a pre-construction condo, there’s finishes that aren’t installed. These can be: light fixtures, upgraded closets, blinds or drapes. If you learn to DIY these basic upgrades, you’ll be able to add value to your property without spending money on contractors
Build a Large Reserve Fund
New build investing is fun so long as it doesn’t stretch your finances to limits. To avoid financial stress, build a reserve fund of at least 1% (aim for 2%) of the value of the condo. This is on top of the estimated closing costs.
Do Your Research
As with any real estate transaction, research everything thoroughly. It’s not just about your builder’s track record. Try and find out if the city implemented tax levies in your neighborhood. What about the state of the economy? Are you buying right before a recession? You should also try and find out what the city’s goals for the neighborhood are for the next 10 years.
Read Everything Two, Three or Four Times
Before you sign anything, take the time to understand. If you’re not sure about something, ask the professional asking you to sign for an explanation. No one is forcing you to sign anything. If you need help or a second opinion, go get it.
Pre-Construction Condo Investing Isn’t For Everyone
In some cases, investing in new condos isn’t the right move. If any of these descriptions apply to you, reconsider pre-construction condo investing:
- New to a city
- Unfamiliar with the target neighborhood
- Don’t like moving often
- Not willing to live in less than perfect conditions
- Difficulty living with risk
Wrapping This Up
There’s a lot of money to be made investing in pre-construction condos. However, the strategy isn’t right for everyone. Conduct your due diligence and research. Don’t forget to check in with a tax specialist. Make sure new condo flipping is allowed in your area before signing anything.
