Should I buy a condo before its built?
The basics of financing preconstruction condos
- Developers must sell a percentage of units before they can start construction.
- Preconstruction condo units can be cheaper than existing ones.
- Risks include design variations, construction delays and increased fees.
- Financing a preconstruction condo takes longer and is more complex.
- Work with an experienced real estate attorney and lender to protect yourself.
Elegant mahogany floors, a sun-dappled living room and cool breeze drifting through sky-high windows — it’s easy to imagine yourself in the perfect condo as you flip through a developer’s sales brochure. Prospective buyers should be wary, however, as purchasing a preconstruction condo can be a risky endeavor.
Price and customization
A preconstruction condo — sometimes called a presale — is a unit within a larger development that has not yet been built. Typically, developers must sell 15 percent of a project’s condo units before they are able to obtain financing to begin building. As such, they often market preconstruction condos at more affordable prices compared to existing units in the area. Your unit may also appreciate faster than an existing condo, as property values usually increase once construction is completed — particularly in hot markets.
Another key benefit of a preconstruction condo is that it is brand new. As the owner of an unbuilt unit, you have some say in customizing the condo to your tastes — be it flooring, lights or cabinetry. You also have a wider choice of available units from which to choose. While a lower price and more customization sounds like a great deal, there is reason for the markdown. You are effectively receiving a discount for assuming risks with design, delays, financing and ownership.
With a preconstruction condo you are purchasing a promise, and expectations rarely match reality. As a buyer, you may only see a rendering of a unit or interact with a model that may not have the same floorplan or square footage as the one you signed for. External conditions such as noise pollution and views are also difficult to anticipate.
Even brand-new units often require minor repairs that can take the developer weeks or months to fix. Beyond your individual unit, the wider project layout is subject to change as well, and the final building design can be a far cry from the promotional brochures.
When purchasing a preconstruction condo, your actual move-in date is variable, as factors such as weather and red tape can delay construction progress. Even after you move in, the building may not yet be officially registered with the municipal government. This means you have not taken ownership of the unit and must pay occupancy fees — similar to rent — to the developer until the registration is completed. This can take anywhere from several months to a year.
Financing a preconstruction condo is more complex than financing an existing unit. Not only are there fewer mortgage options, there are also risks that interest rates will increase. The mortgage does not close until the building is completed and you hold a certificate of occupancy, so the final interest rate can be higher than what you were initially quoted. It could also decline, however.
Once you have obtained the certificate of occupancy and are ready to complete the sale, closing costs are usually much higher than if you purchased a resale property. These costs include expenses such as development and utility connection fees. You may also face special taxes. Moreover, homeowner association (HOA) fees for preconstruction condos often are set low to attract buyers and only locked in for a year. It is common for HOA fees to increase substantially in the second year of ownership as the new HOA builds its reserves.
Other buyers have an influence on the condo project as well. For example, investors may buy several units they plan to rent out, which can affect the atmosphere of the condo. Also, if property values fall or too few people purchase units, developers can force a buyback of sold units. As the developer is the majority stakeholder in the project, it has the right to force owners to sell, usually at a heavy discount from the initial purchase price.
Contingencies are key
Doing due diligence and working with a lawyer and lender experienced in preconstruction condos can help protect you from these risks. First, carefully research the condo developer’s reputation and how successfully their units have sold. Visit completed properties to get an idea of the quality of work and property value after completion.
Next, have a real estate attorney review the developer’s offering plan. As the only legally binding document, the offering plan outlines the unit layout, what appliances and finishes will be made, the construction materials to be used and any developer contingencies. Check these contingencies carefully, as they are usually structured to favor the developer.
Ask to add your own contingencies, such as a home inspection, to protect you in case there are significant variations in construction quality or delayed completion. You can also request that your down payment be held in escrow until more than half of the project units are sold to other buyers, or receive a refund. This helps protect you from a forced buyback scenario.
By taking steps to mitigate some of the risks of preconstruction condos, you can position yourself to make a wise purchase before the shovel hits the soil.