IL Postcard

Dear Ronan, You're Nuts!

Date: 09/27/2008

Saturday, Sept. 27, 2008

Read more about investing in foreign real estate in International Living Postcards—your daily escape

Hi Ronan,

In every international real estate book I read it talks about buying off-plan. That seemed like the best way for me to go for buying a condo to live in and as an investment. However, two weeks ago, a successful acquaintance of mine (in real estate) told me not to do it, that it's a formula for disaster. I took that with a grain of salt because of all the positive information I heard about it: “As long as you do your homework on the past performance of the developers,” etc. Anyway, I spoke to a friend who owns many hotels and apartments around the world, expecting him to disagree. He told me the exact same thing. He said, “DON’T DO IT!” What’s your view on buying off-plan?

Dear International Living Reader,

Buying off-plan, or pre-construction, is where you are buying into a development before it has been constructed. You are relying on a set of architectural plans. Frequently, developers will offer substantial discounts to buyers willing to buy based on a set of plans. The best pre-construction projects will sell out before a shovel goes in the ground.

Developers need investor funds to stay in business. That’s a strong incentive to create simple and profitable investor terms. Also, bank finance for construction costs will typically be dependent on a certain level of pre-sales. The developer will want to hit that number as soon as possible. By shortening the length of the project, he can increase his return on investment. This timing issue creates a symbiotic relationship between developers and investors.

If the developer has a good track record (and we are in a normal credit market environment), banks practically compete with each other to lend him the money for a deal like this. With pre-sales in place, the bank’s risk is minimized. By simplifying the deal, the developer minimizes his administration costs while securing his construction funds at a very competitive rate.

Buying off-plan makes more sense for the real estate investor than for someone buying for personal use. For the investor, the unit doesn’t have to meet your personal taste, and you probably don’t mind that it will take a few years before you take possession of your unit once the market is seeing appreciation. It should, however, be a property that a large portion of the general public wouldn’t mind owning or staying in. You are buying the unit to eventually sell or rent to an end user, and you want to make sure the property will be attractive to that level of the market.

The end user may be a long-term renter, a first-time homebuyer, a short-term vacationer, or even another investor. That will depend on where and what you are buying. You will want to analyze who the end user will be before you put your money down, as you will want to make sure there will be a big enough market to sell your property into.

This timing issue opens up the opportunity for investors who are willing to buy and flip properties. It also creates a symbiotic relationship between developers and investors.

So you’re in at the discounted price to compensate you for taking on some of the early development risk, but the real incentive to buy pre-construction comes from leverage. While the terms of the payments vary from project to project, no matter what the terms are, you are leveraging your returns to some degree. A typical deal will start with a small down payment—say, 5%—and work through various staged (progress) payments during the construction period until you have paid in anywhere between 5% and 80%. The balance is due when the keys are turned over.

Let’s walk through a sample deal to show how leverage works when buying pre-construction. You purchase (pre-construction) a $100,000 condo with a 10% down payment. The balance is due on completion in two years' time. A 20% increase in price during the build period means a 200% return (net of fees) if you were to flip. Of course, leverage, like buying an option, can work in two ways…a 10% fall-in price means that you are down your entire investment.

I have recently bought pre-construction units in Brazil with as little as 0.75% down. The price of these units prices rose by 15% within a month of members of RETA and me buying, leaving us with a staggering paper return.

Buying pre-construction can be a great way to accumulate a rental portfolio. Capital appreciation can mean that, at closing, a bank will lend based on the new valuation (again, assuming a normal credit market situation), not the price you paid. This can mean that you can pull cash out of the property the day you pay for it.

Buying pre-construction is a strategy that will maximize the retail investor’s return on investment in the early to middle stages of a market appreciation cycle. Buy pre-construction at the top of the market and you risk losing your entire investment...and maybe even more than you have invested if you are contractually bound to complete and that clause is enforceable.

As with any other investment, buying pre-construction requires a clearly thought-out strategy and an understanding of the risks involved.

I hope this helps you make your decision.

Regards,

Ronan McMahon

P.S. If you would like to join me in my scout for the best real estate investment opportunities around the globe, you are welcome to join the Real Estate Trend Alert group. As I mentioned earlier, many of the Real Estate Trend Alert members are enjoying 15% appreciation on units they paid a mere 0.75% down payment on, and there are many more bargains just like this one, you just need to know someone who knows where to find them. Find out more here.

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