Today and Friday, in a special two-part series, we’re sharing the biggest mistakes we see buyers make when buying pre-construction. We’ve talked for years about the risks and hidden fees involved when buying pre-construction Toronto condos but we want to address the topic again because many buyers are still getting burned.
Friday, we’ll turn our attention to the more idiosyncratic issues but today, we’re taking a look at the first five mistakes from a financial perspective. Here are the most common mistakes we see buyers of new Toronto condos make when it comes to dollars. And sense.
Mistake #1: Assuming Pre-Construction Toronto Condos Are a Better Deal Than Re-Sale
Hands-down, the biggest mistake that buyers of new Toronto condos make is in the assumption that buying pre-construction guarantees you a better deal (and is therefore a wiser investment) than buying re-sale.
After all, it should, right? I mean, you’re taking on a hell of a lot of risk buying on spec and banking on the builders delivering the project on time and on budget. Not to mention tying up your money for years when you could be earning interest through other investments. So you’re bound to out-earn the re-sale Toronto real estate market in return for all of that risk assumption, right? Absolutely, unequivocally, wrong.
Gone are the days when you could easily turn a hefty profit buying at pre-construction lows, selling at post-occupancy highs. There was a time when investing in pre-construction Toronto real estate was almost a guaranteed windfall but as demand increased so too did condo prices. Plus, until recently with the new Ontario Condo Act (still to be passed; it’s not law yet), there was little control in place over things like financial disclosures by developers that can seriously impact your carrying costs down the road.
Our research shows that the average pre-con Toronto condo is overpriced by 10% by today’s market standards, which means that you’re paying speculative prices for what the building should be worth come occupancy years down the road.
Why are you paying tomorrow’s rates today while the builder earns profit on your investment? Not to mention the lost opportunity cost – you can buy and sell a re-sale Toronto condo in that same 3-4 year period, earn a healthy profit (typically far more than you’d earn playing the waiting game during construction) and still buy into that same new Toronto condo building you originally had your eye on when all of those initial investors sell. Plus, this way, you can actually see the finished unit in the flesh and know exactly what you’re getting.
This first mistake of assuming greater value is closely tied to our next biggest mistake – the dreaded number crunching. Miss a line item or fail to understand your contract and it could easily be a five-figure mistake.
Mistake #2: Not Doing the Math Properly
One of the most common and easiest mistakes to make is not crunching the numbers accurately or more specifically, not realizing what all of the hidden fees are.
You see a list price of, say, $450,000 and think great! That’s good value. But it’s not $450k. It could easily push over $500k once you add in development charges (hydro hookups and other such levies), HST if it’s not included in list already (again, not applicable on re-sale, only pre-con) and extras like material upgrades depending on what is and isn’t included in the published list price.
When all is said and done, you could be paying as high as $50k+ above that attractive, sticker price depending on the particulars. Many buyers aren’t aware of this going in and by the time they see the final tally, they’ve already been sold on the condo emotionally and don’t want to back out.
Now, some pre-construction buyers will be eligible for an HST rebate lessening the load but only for purchases under $450k. You can have a read of our previous article on whether or not buying pre-construction is a wise investment as well as the CRA’s website for more details.
Other fees like lawyer’s fees and closing costs are applicable whether you’re buying pre-con or re-sale but still need to be factored in and they’re not standard, so don’t assume you’ll be paying “market-value” if these things aren’t capped in the contract. We recently spoke to someone who got hit with $15k in legal fees on a pre-con purchase for what should have cost no more than $5k.
Remember, you have a 10-day cooling off period in Ontario on pre-construction condo purchases and so even after signing a purchase agreement, take that paperwork to a lawyer who will ensure that you understand all of the legal language and terms and conditions.
Mistake #3: Assuming Maintenance Fees Won’t Go Up
So many buyers assume that maintenance fees on new condos won’t rise at all or at least won’t rise above the annual rate of inflation. Have a read of the maintenance fee infographic we created after months of research and you’ll see that maintenance fees at new Toronto condos typically rise at a much faster rate than re-sale condos within the first 3 years.
And while you’re typically paying less than average from a total dollars perspective for the first 9 years, that situation may change much quicker depending on the quality of build, deferred builder’s costs and savvy of your condo board. So if you’re leveraged to the max. and banking on cheaper monthly fees, think very carefully about whether or not you can actually afford the building beyond the first few years.
Mistake #4: Using Today’s Mortgage Rates In Your Budget
Current homeowners are blessed (or cursed, depending on your perspective) with record-low mortgage rates right now, rates that should hold through 2016. But we all know that what goes down will, eventually, make the inevitable pendulum swing back up. If you’re using today’s rates to budget crunch to see if you can carry that future condo, you might as well be shooting in the dark.
Prudent buyers will assume an increase to rates of at least a few percentile points but even that may not be worst case scenario. If January’s surprise cut to prime by the Bank of Canada wasn’t proof enough, there is no crystal ball when it comes to economic forecasts.
Now, this problem isn’t exclusive to pre-con buyers – current homeowners may not be able to afford their homes if rates go up more than a few percentile points during their mortgage term (which is why leveraging yourself to the max. is such an issue; always build monthly savings into your budget to create an emergency fund).
But if you haven’t yet bought, you’re in the position to think about these things more objectively. If you’re set on a pre-con condo for sale in Toronto, make sure you plan for best, worst and likely mortgage rate scenarios in your budget plan before signing on the dotted line.
Mistake #5: Selling Too Soon
We’ve had a number of clients who purchased pre-con fully intending on moving in and then got married or had a child while their condo was being built and had to sell immediately, losing money, because the unit was no longer suitable.
Remember, it’s not just that you purchased at tomorrow’s rates yesterday making it difficult to break even once Realtor fees are added in, you’re also more likely to be competing against multiple, similar listings in your same building, particularly in high-rise projects, making it difficult to stand out from the crowd and demand top dollar.
As well, you’ll likely get hit with capital gains tax if you don’t move in or hold onto the condo as a rental property for awhile; taxes could be even higher if the CRA deems it as “an adventure in the nature of trade” and therefore taxable as business income.
The Reward : Risk Ratio is Out of Whack
While investing in Toronto real estate continues to be one of the best and fastest ways to grow your personal wealth, the financial rewards of buying pre-construction are rarely worth the financial risks these days. Re-sale units are generally a much safer bet. That said, there are of course some pre-con deals still to be found but by and large, you’re accepting more risk for the same or less of a financial reward than re-sale.
Just the financial risks alone are enough to put many clients off of buying pre-con once they have all of the facts but it’s not just your bottom line that’s at risk. Join us again on Friday for Part II when we’ll look at some of the more emotionally-charged issues such as getting what you paid for and planning for a future life you don’t yet have.
All photos used via Creative Commons from flickr. Lead image © Loozrboy. Image of construction site viewed through fence © Mary Crandall. Image of construction site at West Don Lands © Eric Sehr. Image of Concord CityPlace under construction © Jason Paris.