Investing in Toronto Preconstruction Condos 101.
What should I invest in? Houses vs. Resale Condos vs. Preconstruction Condos.
Preconstruction condos have their place in real estate investing. If you’ve worked with the Volition team, or if you’ve attended our meetups, you’ll know that we preach that freehold (i.e. land) is generally the best investment. But land comes as a price… both in terms of monetary perspective and from a time/energy perspective.
Condos are easy. You buy a condo, and if it’s in a half-decent location, it’s easy to rent it out, and it’s easy to manage it. The building itself and the amenities is largely taken care of by the condo property management. Your unit is generally fairly new and thus not likely to run into too many issues. And if you’ve chosen your location carefully, you should be able to attract what we consider to the our A+ tenant profile (millennial, a couple of years out of school, making $60-80k, working for a large firm in downtown Toronto, etc.). And again, if you’ve chosen a good location, then the economic fundamentals of the area will support economic growth, job growth, population growth, etc. Pretty straightforward.
Houses are a bit trickier. Funny enough, the reason you want to buy a house is not actually because of the house… It’s because of the land. It’s the land is that is the appreciating asset. The building is actually a depreciating asset, because it gets older over time. But the hard part is that land is generally not an income generating asset (with the exception of a few use cases, like mobile home parks, etc.). So you need a building on top of the land in order to generate some income. And then you need to lease out that building in order to cover your expenses and hopefully generate some positive cashflow. So now, not only are you managing tenants, but you now have a building that you are having to take care of and worry about. Generally, freehold/land/houses have been a better investment in Toronto over the past 10-20 years (and even longer), averaging a 10% compound growth over the long term… this is why the nice Italian grandma who lives next door who bought her house for $20,000 40 years ago now owns a property that is worth $1.2M… (Recall the “Rule of 70”: at 10% growth, it will take 7 years for prices to double. At 7% growth, it takes 10 years to double). So here we go, $20k -> $40k, $40k -> $80k, $80k -> $160k, $160k -> $320k, $320k -> $640k, $640k -> $1.28M. That is 6 doubling periods, which is equivalent to 42 years at 10% growth. Therefore, I’ve just been able to prove that Toronto houses grew at 10%. QED.
Condos, on the other hand, have grown at about 7% compounded over the past 10 years. That’s not bad either. A real life example is the preconstruction condo I bought in 2008. I bought it for $295k and a recent comparable sold for $550k in 2018. That’s roughly a doubling period of 10 years, which generally equals a 7% growth. QED. Also not bad, considering at a 20% downpayment, a 7% growth actually equates to a 35% return annualized.
More specifically, I bought it in 2008, and it wasn’t built and I didn’t take possession until 2012. It normally takes 4-5 years for a preconstruction to be built. When I took possession, it was worth about $350k. So at 7% growth applied between 2008 and 2012, that figure ends up being $387k. The difference between the figures is accounted for due to the fact that condos were not very hot during that phase, so it was only closer to 5% growth. Condos in the last couple years (2017-2018) really took off for a variety of reasons (I’ll leave that for a future article), so the growth in condos in 2017 and 2018 has been closer to 10%, which picks up the slack.
That was the background info. Ok, now to preconstruction. Why is preconstruction a good idea?
I’ll sum it up quickly.
Why Preconstruction Condos?
- Resale is cashflow negative. Condos right now are generally cashflow negative at 20% down (there are a few exceptions, but this is the general rule). Cashflow negative is bad for many reasons. It means that you are continuing to fund your investment out of your own pocket. It also makes it harder to get financing for your next property because of your Debt Servicing. Real estate is supposed to work hard for you, not the other way around! It literally means that you have to work harder at your job just to keep your investments afloat!
- Potential for positive cashflow. Rising rents allow for preconstruction to be cashflow positive after the building is constructed. Rents rose 10.7% in Toronto last year according to Toronto Star or 15.7% according to Toronto Storeys, so if you grow current rents at even just 3-4% for 5 years, you’ll be into cashflow positive territory by the time you take possession.
- No tenants. As per a previous article we wrote entitled “Why Invest in Toronto“, tenants are the BIGGEST RISK TO YOUR BUSINESS! It’s not “the market”, or interest rates, or Trump, or any one of the thousand things that regular average joe investors think… quite simply, it’s tenants. Preconstruction allows you the luxury of not having to deal with tenants for 4-5 years while the building is being built. AWESOME.
- Delayed Deposit Structure. Most preconstruction condos have a delayed deposit structure, with 5% initially, then 5% in 90 days, 5% in 270 days, 5% in 720 days, or some variant. This means that you don’t need all the capital upfront. In fact, some developers (i.e. one developer in particular that we are working with and are Platinum VIP Brokers for) are offering an INSANE deposit structure: 5% initially, then $1000 a month until you make up another 5%. For example, for a $600k 2bdrm, this would be $30k initially, then $1000 a month for 30 months.
- Mortgage. As investors, the biggest roadblock we all face, at one time or another, is financing. Some will hit their financing wall earlier, some later, but everyone will hit it eventually. Preconstruction offers a way to continue to invest, and not have to continue to qualify for mortgages. You don’t need a mortgage until the condo registers (i.e. 4-5 years down the road), which is amazing. This can be great if you have too many mortgages already. This also can be great if you cannot qualify for a mortgage right now, but anticipate that you will be able to in the future (new to Canada, bruised credit because of divorce, new job, don’t make enough salary now but will in the future, etc, etc, etc. There are a dozen different use cases that follow under this category). Also, precon doesn’t hit your credit bureau, so you could potentially buy preconstruction, and then CONTINUE to invest in regular buy-and-hold investment properties that need mortgages.
- VIP pricing/incentives. As Platinum VIP Brokers, we have early ground-floor access to projects. This is important, because it can often mean built in equity as soon as the NEXT phase is released. We recently had one client purchase a preconstruction 800sqft condo at $1000/sqft, and within 3 months, the next phase pricing was released at $1200/sqft. He made a paper gain of around $160k in 3 months, without hardly lifting a finger (well, he did have to sign his cheques, I suppose). This is obviously not guaranteed, nor a typical case, but it can happen. A more typical scenario is the price-per-sqft goes up maybe $25-50 for the next phase… but either way, it’s built in equity. And then there’s the regular incentive crap that most people buy into… upgraded countertops or something like that.
- Today’s pricing. This ties into #1 and #2 above. You are buying at today’s prices and will be getting tomorrow’s rents. The problem with #1 above is that you are buying at today’s prices and getting today’s rents. If you were able to get today’s rents and you bought at yesterday’s prices (i.e. you bought years ago), then you could also be in cashflow positive territory. And in terms of valuation, you’re buying at today’s prices for a future built condo unit (which is traditionally worth more after it’s built). Why is it worth more after it’s built? I could write an entire article on why, but to keep it short and sweet, it’s because of expensive developer financing (the “mezzanine” financing in the early stages of a condo project is very expensive, and only after pre-selling 60-70% of a building can they switch over to a triple A lender at triple A lender rates). Also, it’s due to uncertainty… you are only buying a piece of paper, a contract. At the presales stage, you aren’t actually buying a unit. So you don’t know if it’s actually going to be built, or if the developer is going to go bankrupt, etc. Also, you don’t have a physical unit to inspect prior to purchase. You are HOPING that it will be built like you think it will be, and as per the floorplans and feature sheets.
Because of some of these aspects, some investors tend to think that preconstruction condos are just for speculators, and that they don’t fall into the tried-and-true buy-and-hold investing model.
I disagree. At the end of the day, real estate investing is all about identifying risk, figuring out your strategy, and mitigating risk. There is definitely an element of uncertainty, but that uncertainty can be mitigated thru careful research and location selection.
For example, one of the areas that the Volition team is helping our clients with is in the Eastern Waterfront area. Why? Two words: Google Smartcity (or three words if you think that Smart City are two words). Technically, it is Sidewalk Labs (Google’s sister company), but for all intents and purposes, we can think of them as Google. They won a proposal from the City of Toronto to develop the eastern waterfront called Quayside, which is an area just east of Parliament and south of Lakeshore. It’s potentially a gamechanger, with 50,000 new jobs, and the new Google Canadian HQ will be going in there as well. You can read a descriptive Globe & Mail article about Google Smartcity here. So we naturally selected a preconstruction development right beside it. Boom.
And even in the event that everything falls thru, the City of Toronto has mandated that it will be developing that area. So even if it’s not Google who’s going to be developing it, someone will be. And if it’s not that… George Brown is near there, Corus is nearby, it’s close to downtown, it’s near other developments and condo buildings that are already more expensive on a $/sqft basis meaning it still has upside potential. And the area is definitely going to continue to gentrify. And it’s still proximity to Distillery District, and to East Harbour (50,000 new jobs, new transit hub). These are types of defensive measures that we take to mitigate “market” risk (again, refer back to our Whitepaper for the 4 Types of Risk in Real Estate Investing).
Ok, you’ve convinced me. What do I do now?
So now we know why Preconstruction fits in as a investment strategy into your overall business strategy. But how do you actually execute?
Buying Preconstruction is not actually as easy as it sounds. It’s actually very challenging… if you aren’t working with the right agent. I know it sounds cliché… and maybe it is. But it’s also very true. When trying to get early access and ground level pricing, developers in Toronto only give a select number of Platinum VIP agents access to units. This is called “allocation”. This is often because of that agent’s reputation and relationship with the developer. So if you wanted to walk in off the street and get access to VIP pricing, good luck. Similarly, if you wanted to work with your brother or aunt or sister-in-law’s chiropractor who is an agent on the side and wanted to get access to the best possible deals and best possible pricing, also good luck. I’m not trying to being pretentious or condescending. This is just the reality. Those agents are only going to get access only after the presales early phases have already sold out, and now the developer can switch over to Triple A financing and start their construction, and then they can just sit and wait for the other unit to sell… now at a much higher premium.
So what do you do? Align yourself with an agent who has early access, and one who can get allocation, and one who can be your advocate, and one who can get you assignment rights, and one who can cap your development fees, and one who can help you select effective floorplans that minimize wasted space, and one who can help you identify your tenant profiles & projected rents & projected cashflow & projected returns.
This article has focused on the why. The next article will focus on the how, including touching on HST, HST rebates (and the forms to use to get the rebate back), assignments, occupancy, owner occupied vs. rental, pros/cons,and exit strategies (i.e. what if can’t qualify for a mortgage after it’s built?)… and most importantly, how Preconstruction Condos help new investors get started as part of a broader investment strategy using the “Stepping Stone Approach”, and how to build up to eventually owning land in Downtown Toronto!
Meetup: Pre-construction Condos – Do they make sense as an investment?
We actually delivered a meetup presentation specifically for Preconstruction Condos in May 2018. Details of it are available here. Contact us for the slides/video/audio.
https://www.meetup.com/Volition/events/rcztmpyxhbwb/
About Us
The Volition Investment Properties team are experts in Toronto real estate. We’ve helped investors invest in over $110M+ in real estate, build over $47M+ in wealth, and generate $4.5M+ in cashflow. We’ve also educated over 650+ investors at our Monthly Real Estate Investment Mastermind meetup (www.meetup.com/Volition). Contact us today for a free 60 minute complimentary consultation to see how we can help you reach your real estate goals, so that you too can “Live Life By Design, Not By Default”.