The first time I remember hearing about this was in the late seventies. As condominiums became more popular, the prices rose consistently (remember that this was a time of high inflation too). Smart investors took advantage of this before the condos were even built.
First you need to understand how these projects were financed. A developer would determine that there was enough demand for a condo complex, get an option on some land, and have a plan drawn up. The banks didn t want to loan money on an unproven plan, however. How did the developer prove that the units could be sold?
By selling them! If you want to be the proud owner of one of the beautiful new units in the Blue Spruce Condominiums, you had better buy now! That was essentially the pitch, but of course people wouldn t (and couldn t) pay for something not yet built. They could sign the contract to close on the unit once they were done, however, and put down a $500 deposit.
If the units were expected to sell for $55,000 when done, the developer might sell the first dozen for $50,000, just to get things moving. Once he had enough contracts in hand, the bank would put up the money so construction could begin. Six months later, as the condos neared completion, the last ones might be selling for $65,000. Things already there to look at tend to sell for more. (And inflation was at double digits during some of these years.)
Investors who bought a unit at first had a contract to buy at $50,000. If it was assignable, they could just sell it to a buyer for say $13,000, which with the $50,000 price added up to $63,000, still a discount from the going rate of $65,000. If the contracts were not assignable, he could sell the unit and do a simultaneous close. This latter way had more costs, but he still made over $10,000 on an investment of $500.
By the way, as long as the language of the contract limited damages to the deposit amount, (ask an attorney), the buyer could walk away if necessary. The most he would lose is $500.
Pre-Construction Investing - A More Recent Example
Around the time we moved to Tucson, Arizona (2004) there were new subdivisions going up all over. One developer had a subdivision where he was building homes to sell for $150,000 and by the time they were half sold, he was starting to sell them for $200,000. Lucky homeowners who put their deposit down early got to move into a home with $50,000 of instant equity. This did not go unnoticed by investors. Soon many of the sales were to investors who intended to immediately resell the homes for a profit once they were complete and they closed the purchase. Some did very well in this way.
Eventually, the developers stopped selling to the investors. So many investors were in on the game that when the subdivision was done, the developers had to compete to sell their own remaining homes while all the investors were trying to unload theirs. Prices could be pushed down or houses could sit on the market longer, creating more expense for the developer. They preferred to sell to people that were actually going to live in them.
There are other ways to invest in pre-construction deals. Some builders need your help to get financing, for example. If you agree to buy their new house, you can use your credit standing to get a construction loan. They might line up a dozen investors to get a subdivision built in this way. The sales price is set at a level that hopefully assures both you and the builder a profit.
You sell as soon as the home is complete. The builder may sell to you for $160,000, knowing the home will be worth $190,000 when done. If his cost is $130,000, and you are his way to get the money to build it, he is happy. Often the bank may not know that it is an investor and not a resident buying the home (you changed your mind?), but you can let your conscience be your guide when it comes to the financing paperwork.
You can do something similar with condo conversions. When an apartment building is converted into condominiums, the developer may need to pre-sell enough units to get the cash and/or financing necessary for the deal. These early sales are often at prices far below what the finished condos sell for. You might put a $2,000 deposit down on a $85,000 condo that is worth $95,000 or more when it is done.
You ll notice one thing in common about all of these examples. They assume a hot real estate market where things are selling relatively fast and prices are rising. That is what you need to really make money safely with pre-construction investing.
Copyright Steve Gillman. For a Free Real Estate Investing Course, and to see a photo of the home we bought for $17,500, visit: http://www.HousesUnderFiftyThousand.com
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