Pre-think Pre-construction and Dodge Disaster

Sunday, March 30, 2008

Read more about moving overseas in International Living Postcards—your daily escape

You’ve probably heard this before, but it bears repeating: Buying into a project or development in the pre-construction phase is risky. I don’t mean it could be risky. It is risky.

A project in the pre-construction phase is precisely what it sounds like…a project where nothing has been built. The British call pre-construction sales “off-plan” sales, perhaps because people are buying pieces of the development directly off the plans…since nothing else exists.

If you’re an international real estate wheeler-dealer, this may be the kind of risk you can handle. You’re in it for the greater returns that come from buying property at the steeply discounted prices offered by some developers in the very early phases of their projects...usually as a way to get enough presales to secure better financing terms from their lenders.

And if you are such an international wheeler-dealer, you don’t (hopefully) have all of your international investment eggs in one basket…you’ve spread your risk around a bit among other investments and can afford any potential loss.

But if you’re shopping for a full- or part-time place for yourself, possibly with an eye toward some rental income when you’re not using it, be very careful about pre-construction deals…especially if the transaction you’re thinking about involves a big chunk of your savings or retirement nest egg.

When you visit the site of a project in pre-construction, remember that what you see there at the very moment of your visit is precisely what you’re considering buying. If there is nothing there but dirt, then you’re buying nothing but dirt…along with the promise of the developer to build whatever he’s promising to build there.

Don’t get me wrong; I’ve seen some pre-construction deals completed as planned, on time, and on budget. Smart expats have been lucky enough to latch on to deals like this and save considerably over what they’d pay for the same condo or villa at a later stage of development.

But how can you tell which pre-construction deal will pan out and which one won’t?

You can’t. That’s why they call it “risk.” Anything can happen at any time, and a developer who tells you otherwise is trying to make a sale.

However, there are a few telling qualities of pre-construction developments that can give you a clue as to how they’re going to go. These are completely subjective things that I’ve noticed myself in dealing with real estate developments throughout Latin America.

These tidbits aren’t meant for speculators and wheeler-dealers…they’re meant for people who are using their own hard-earned money to get something they’ve always wanted and can’t really afford to lose.

So for what it’s worth, here are some tips if you’re looking at a pre-construction development anywhere in the world:

1. Make sure the developer owns the land in the first place. Believe it or not, some developers will take reservations for units or parcels in their planned development before they actually own the land. In fact, that’s what they want your money for…to buy the land. This kind of project can’t even be called “pre-construction.” It’s “pre-reality.” Only wheeler-dealers with nerves of steel need apply.

2. If the developer does own the land, find out how much debt the project has sitting on its back. A project in its very early phases that is heavily financed will probably spend a significant portion of the money it gets from you and other early buyers to service that debt...and debt service comes before roads, sewers, electricity, and your unit. Developers who can prove to your lawyer’s satisfaction that the debt load of their project is low or non-existent get huge gold stars.

3. Don’t buy into a pre-construction project based on projected rental returns. Nobody knows the future, so nobody can tell you what the rental return will be for your unit…if it’s delivered. And if a developer guarantees you a certain rental return for a certain period of time, ask him how he’ll do it. As far as I know, the only way to guarantee a specific amount of rental return without seeing into the future is to arrange to pay it with something other than rent…something like a hidden markup added to your sale price. You’re getting your own money back, possibly from an investment fund from which the developer is earning a little something extra for himself as well.

[Editor’s note: To learn about the one guaranteed rental program that is the exception to this rule…see Turn Every Dollar You Invest Into $1.20…Instantly.]

4. Don’t buy into a pre-construction project based on the eventual presence of a fabulous anchor hotel or resort operator. I’ve heard this from a hundred developers: “I shouldn’t even be telling you this, but just this afternoon we received a letter of understanding with a four-star operator—whose name I can’t mention—to build the anchor hotel and spa on the property. Do you know what that will mean for your property value?” Yes, I do. Nothing. A letter of understanding is worth a little less than the paper it’s written on. If I had a dollar for every fabulous four-star hotel deal I’ve heard about that didn’t happen, I could build my own hotel. Until a hotel of any kind is actually under construction on a project, it shouldn’t have any real affect on your property value unless you’re trying to sell your unit to a sucker, which is probably what the developer is trying to do to you.

5. Don’t buy into a pre-construction project of detached homes or villas that the developer himself hasn’t had enough faith to build a few spec units on. A couple of model villas/bungalows/townhomes or a decent clubhouse already built on a property can be a fair indicator that the developer is in good financial shape, has great backers, or has a well-heeled construction partner. It may also indicate that the developer won’t need to use the money he gets from your sale to build the unit he sold just before yours.

That’s about it. There is a whole host of ways that developers will sweeten pre-construction deals for prospective buyers. They’re all designed to reassure you…usually with some kind of cash refund guarantee or collateralization clause that offers land against non-performance of contract—or sometimes with an investment scheme that lets you participate in the future profits, if any—of the development corporation itself in some way.

But none of these sweeteners can change the fact that buying pre-construction is buying dirt and a promise. If you go the pre-construction route, try to make sure the promise has something behind it.

Dan Prescher
Publisher, International Living

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