Condos are becoming an increasingly attractive option for real estate investors across Canada. According to a CIBC study, nearly half of Toronto condominiums were sold to condo investors.
This trend isn’t surprising. The reduced maintenance burden frees up the investor’s time while the desirable locations of condo developments help attract quality tenants. Not to mention that condos are much more affordable than single detached homes making it easier to generate monthly cash flow.
Buying a pre-construction condo is a great way to lock in a low price on an asset that’s likely going to appreciate the day you take the keys. However, there’s also many traps an investor can fall into when buying pre-construction. Don’t get caught committing these costly mistakes:
Buying From an Inexperienced Developer
Today’s hot markets make it enticing for new developers to get in on the action in hopes of making a quick buck. Unfortunately this lack of experience can bring with it all sorts of problems. For example, if the project management team is new, expect delays in delivery dates. Corners were cut on structural or mechanical components? Expect costly special assessments.
Buying an investment property from an experienced developer mitigates some of those risks. However, part of a condo investor’s due diligence involves researching even the most experienced developer’s track record.
Forgetting About the Cap Rate and Rental Potential
When shopping for pre-construction, look at whether the neighborhood has rental potential. Do renters want to move there or does the area need a few more years to gentrify? Nothing spells out negative cash flow like an empty condo.
Similarly, part of due diligence involves market research and finding out how much rent you’ll be able to charge per square foot. Calculate the cap rate and if the numbers seem tight on paper, they won’t get any better when you take possession of the condo.
Miscalculating Rises in Maintenance Fees and Mortgage Interest
So you’ve found a development that meets your desired cap rate and are ready to sign? Maybe take a few moments to consider that the condo fees you’re basing your calculations on are estimates by the developer at the time of closing. Once the property incorporates, it’s possible that the residents may vote for a rise in order to build up the contingency fund or pay for changes to common elements the developer skipped out on. Not to mention that over time, these fees rise year-on-year.
The same concept applies to mortgage interest. Remember that since 2007, we’ve had access to cheap money. However, mortgage rates can change with economic times. Protect yourself by considering the risk that over the next decade, interest could rise which will affect the profitability of your investment.
Getting Dazzled by Amenities
Shared amenities like spas, swanky lounges, wine cellars and dog walkers are great add-ons that’ll woo prospective tenants. They’re also going to cost you a fortune in condo fees – those recurring expenses that don’t build equity.
You’re not buying this condo for yourself or your family so don’t get caught up in the developer’s hype. Fancy amenities may attract the attention of renters but it doesn’t necessarily translate in signing higher leases. Renters want the basics, but there’s a limit to how much they’ll be willing to pay for the extras.
Paying for Upgrades That Aren’t Necessary
Too often, condo investors are under the impression that skipping on a particular upgrade will limit how much income they can generate with the property. The truth is, unless you’re in the highest income area of your city, tenants won’t be willing to pay hundreds of dollars more for aesthetic upgrades.
Hardwood vs engineered floors, quartz vs granite countertops and high vs low floors are examples of costly upgrades that won’t necessarily translate into higher rents. The units will present just as well to prospective tenants. The trick here is to make the selection that is similar to the premium upgrade.
Underestimating Closing Costs
Depending on the developer and the market you’re in, some of the closing costs at the time you sign are estimates of what’s due upon possession. Legal fees, land transfer tax and pre-paid property taxes are relatively easy to predict. However, expenses like municipal development levies may unexpectedly be due.
Development levies are paid by the developer to the municipality and were estimates when the developer applied for the permit. Between the time the project is approved and when you get the keys, these can go up and amount to thousands of dollars. Negotiate a cap on such variable closing costs when possible. Otherwise, plan a contingency fund for such a situation.
Involving Your Lawyer Too Late
Pre-construction condo investors sometimes feel that they’re on the verge of losing on a good deal if they don’t close quickly. If the numbers look good and the research is solid, why not sign right away?
The problem is that not having your lawyer review the documentation could increase your exposure to risk. A good lawyer will identify liabilities such as no caps on municipal levies (see above), loose delivery date clauses and flexible floor plan statements.
In some provinces, the buyer is entitled to a 10 day cooling-off period. So if you’re in a competitive market and truly feel you’ll miss out, use this to your advantage and have your lawyer review the contract during this period.
Not Reviewing the Preliminary Bylaws
Some condo developments outright ban rentals. While this is rare, it’s nonetheless a reality that could cost a condo investor. In most cases, the developer would have informed you beforehand of his bylaw. However, if it’s in the bylaws at the time you signed the sales agreement, you have no recourse. Involving a lawyer from the start of the process (see above) virtually eliminates this mistake.
Purchasing For Short-Term Rental Without Due Diligence
If you’re planning on buying an investment for AirBnB or other forms of short-term rentals, make sure the preliminary bylaws allow you to do so. Keep in mind that many developments ban short-term rentals once the residents incorporate.
In some cases, the developer can be convinced to include grandfather clauses for short-term rentals. However, it’s best to consult with your real estate lawyer beforehand as situations change from province to province.
Wrapping This Up
Condo investors buying pre-construction have a lot to gain, especially in booming markets. That said, the age-old golden rules of real estate investing: due diligence, numbers over emotions and impeccable research, still hold true.