Understanding the Risks of Pre-Construction Home Purchases
Pre-construction real estate investments in Canada come with their unique set of challenges and risks. These risks are often seen for any/all types of preconstruction homes, but the risks may also differ depending on the style of pre-construction property you invest in.
Like any type of financial investment, investors and homebuyers need to ensure that they are well informed about the potential downsides to make sound investment decisions.
1. Potential for Delays
Entering the pre-construction real-estate market requires somewhat of a cautious approach. Delays, sometimes extending to years, are a significant risk when it comes to the return on your investment. Conducting thorough research on developers can mitigate this risk, as reputable builders are often able to ensure delivery and stick to project timelines due to accessibility, financial resources of their own, and so forth.
2. Escalating Condo Fees
In other words… Condo fee mania! Investor beware: Initial low condo fees can often be (very) misleading. Investors should be prepared for possible fee increases, ranging from 10 to 20 percent within the first two years. These hikes reflect the actual costs of running the condo and must be factored into the monthly budget to avoid financial strain.
At the end of the day, whether you’re purchasing pre-construction or a resale home that has condo fees, this is generally a good approach to ensure you’re maintaining solid cash flow.
3. Pre-Construction Deposit Requirements
Pre-construction properties typically come with higher deposits, often between 10 to 20 percent, compared to the minimum 5 percent deposit structure that is usually required for resale properties. Keep in mind that these deposits are usually staggered over specific intervals (often every 90 days) and vary according to the developer’s schedule, so this can also provide some confidence and flexibility on the flip side.
4. Mortgage Rate Lock-In Challenges
For resale homes, securing a mortgage before the rate lock-in period expires is a standard process. However, when it comes to pre-construction homes, extended completion dates can quite easily surpass lock-in periods, presenting potential financial challenges for investors further down the road. While this shouldn’t be something to turn you away from investing in preconstruction, it certainly is a factor and risk you’ll want to keep in mind and have a plan B for.
5. Interim Occupancy Fees
During the interim occupancy phase in pre-construction condos, investors may have to pay monthly fees that do not contribute to the mortgage. This period occurs before legal ownership transfer and includes condo fees, interest on the outstanding purchase price, and a fraction of property taxes.
6. Risk of Project Cancellation
Alright, now this one is a risk that can come with SIGNIFICANT burdens when and if it happens. Investing in pre-construction properties carries the risk of project cancellations due to factors like insufficient sales, proper project funding, or escalating construction costs. Although investors usually receive their money back, the lack of earnings on this investment and adjustments to the inflated current market prices can lead to reduced purchasing power.
7. Additional Pre-Construction Costs
Investors must also consider extra expenses such as GST/HST, which may offer rebates depending on the province and if the property is a primary residence. Rental intentions can attract additional taxes, but residing in the unit for a period can mitigate this. Closing costs, unique to pre-construction homes, can add up to 3 percent of the purchase price. These include utility meter installations, deposit tracking fees, and land registration system usage.
Strategies for Investing in Pre-Construction Real Estate
1. Researching the Builder
Ensuring the credibility of the builder is a crucial first step. Utilizing online directories and reviews can offer insights into the builder’s track record and reliability. We generally recommend reviewing the history of the builder to ensure and get a good sense of previous projects, expertise, time in market, and track record of delivery.
2. Understanding the Purchase Agreement
It’s imperative to thoroughly understand the purchase agreement, which is a legally binding contract. Enlisting a lawyer, preferably one specializing in pre-construction properties, to review the agreement is a good way to ensure a clear understanding of warranty coverage and contractual obligations.
3. Legal Counsel and Negotiation
Engaging a legal professional with expertise in pre-construction properties is invaluable. Their experience can guide investors through the complexities of negotiation and legalities involved in such transactions.
4. Pre-Delivery Inspection Preparedness
Before finalizing the purchase, conducting a pre-delivery inspection is essential. This step ensures that the property meets the agreed standards and specifications.
5. Seek Professional Guidance
Last but not least, and especially for those who may be new to pre-construction real estate, partnering with an experienced real estate brokerage is highly beneficial. Their expertise in market analysis and understanding of local real estate trends, in addition to the steps and process involved when it comes to purchasing preconstruction real-estate can provide invaluable guidance throughout the investment process.
Conclusion
Investing in pre-construction real estate in Canada requires a comprehensive understanding of the associated risks and complexities. By being well-informed and seeking professional guidance, investors can navigate this market more effectively, maximizing their potential for a successful and profitable investment.
Frequently Asked Questions (FAQs) About Pre-Construction Real Estate Investment
1. What are the common delays in pre-construction projects and how can I mitigate this risk? Delays in pre-construction projects can range from a few months to several years, often due to unforeseen construction challenges or administrative hurdles. To mitigate this risk, it’s important to research and choose reputable developers with a history of timely project completions.
2. How significant can condo fee increases be after moving into a pre-construction property? Condo fees in pre-construction properties can increase by 10 to 20 percent within the first two years. This is typically due to the management’s realization of the actual costs of running the condo. It’s crucial to factor these potential increases into your budget.
3. Why are deposits higher for pre-construction homes compared to resale homes, and what is the typical payment structure? Deposits for pre-construction homes are generally higher, often between 10 to 20 percent of the purchase price, compared to around 5 percent for resale homes. This is due to the nature of the pre-construction investment. The payment structure usually involves a 5-percent initial deposit, followed by staggered payments aligned with the construction milestones.
4. What are occupancy fees in pre-construction condos, and do they contribute towards my mortgage? Occupancy fees are charges paid when moving into a pre-construction condo during the interim occupancy period, before the legal transfer of ownership. These fees cover condo expenses, interest on the balance owing, and a portion of property taxes, but do not contribute towards the mortgage.
5. What additional costs should I anticipate when investing in a pre-construction property? Beyond the purchase price, investors should anticipate additional costs such as GST/HST, which can be rebated under certain conditions. There are also closing costs unique to pre-construction properties, like utility meter installation fees and land registration fees, which can total up to 3 percent of the purchase price.
