Though they are often trumpeted as a great investment opportunity, new construction developments come with some significant downsides and problems.
When we say new construction, we mean builder construction projects (condo buildings or freehold houses) that start with a big sign announcing “Coming soon!” and then a presentation office goes up at some point and eventually construction starts and goes on…and on…and on. If all goes well, the building or the development gets finished at some point and new housing stock has been added to the market.
Let’s consider some challenges with new construction projects and whether they make sense for you.
Buy in one market, move in another one.
For fans of buying pre-construction, the biggest appeal is often that they make a bunch of money by the time the project is built. Pay X now for your condo or freehold home and when it is built in two years, the same size place is selling for lots more. So, you’ve made money by getting in early, right?
There are two points to consider with this aspect.
The first is that you can get the same appreciation over time with any long closing. Consider a situation where clients bought a home and the sellers wanted a long closing of six months. We agreed to it, put down a deposit equal to about 5% and when the house closed in six months, the average price for that home had increased about $150K.
Any pre-construction purchase that relies on price appreciation is essentially just a bet that the market will continue to rise, and by the time you get occupancy it will be worth more. This leads to the second point.
The above scenario only works in a market where prices are increasing. Real estate markets do eventually go down. While short term fluctuations aren’t a concern when you have a multi-year building cycle, you are always buying such projects in one market and closing in another market. If you bought pre-construction when the market was crazy hot, developers used that frenzy to charge more for their projects. When the construction is completed, will the market be in that same state? Will it have plateaued, with the same size home selling for the same price as it was a couple of years ago? Will prices have dropped, with buyers who invested funds for a length of time actually ending up losing money on the current value? There are lots of questions and the answers won’t be known until the project is completed.
You get what you get.
With new construction, you are relying on the builder living up to what the marketing for the project says they will do. We’ve looked at a number of pre-construction agreements of purchase and sale and there are lots of loopholes that give builders ways to change the project.
If we buy a resale condo or house, the paperwork will be about 10 or 11 pages. If we buy a pre-construction or new build, it will be a minimum of 5 times that, and possibly into the 70 or 80 page length. These lengthy documents spell out in no uncertain terms that the builder has the right to change various aspects and the buyer must agree to that in order to proceed.
We’ve seen cases where the marketing for a condo building shows direct access to Toronto’s underground PATH system from the condo but that didn’t happen for the actual build. It’s important to realize that what you are buying is spelled out in a legal document and that it is often different from the marketing material. If we’re feeling generous, we can say that the builder did intend to live up to the marketing, but it turned out to be too expensive during the build process, so it didn’t happen. The buyers who counted on it were certainly not pleased to discover that the legal documents they signed states that the builder can make that change.
On a less critical basis, aspects like unit layout, sizes, balconies, parking, lockers and finishes can all be changed before completion. In most cases this can be done at no reduction in the price paid by the buyer who thought they were getting something else. This sort of thing just doesn’t happen with resale real estate. If you bought a 1,100 sf condo with hardwood floors and 200 sf balcony and moved in to find that the seller had sold off part of the den to the neighbour, replaced the hardwood with laminate and chopped the balcony in half, you’d likely be a little miffed. It doesn’t happen in resale real estate but in new construction it happens all the time.
What’s today’s date? Ah..who cares.
The final problem with new construction is that builders have a vacation sort of mentality to time. You know when you go on an extended vacation and eventually get to the point where you don’t know what time or even day it is?
Builders are notorious (as a profession, not just a couple of bad apples) for promising an occupancy date or other milestones and then ignoring their own promises.
Put simply, with new construction, a deal closing on time is very rare. With resale construction, a deal closing late is very rare.
Again, the paperwork for builders specifies the closing date, but then they specify a later closing date and finally an outside closing date. That’s right, three dates they plan on being done by. You’d be forgiven if you think that outside closing date isn’t a plan but a guarantee. In fact, builders regularly blow past all three anticipated closing dates and finish weeks, months or even years later.
The ultimate risk with any new build project is that it isn’t simply completed late, it isn’t completed at all. Written into the legal documents for purchasing a new construction project are the ways in which a builder can cancel a project, even years into its development.
In 2018, we saw nine condo building projects cancelled in the GTA. That meant that 12 buildings that were supposed to go up didn’t go up and about 4,200 units that were sold were never built.
The reasons vary somewhat, but it always boils down to financial issues. Whether is lack of financing for the project, changes in construction costs, reduced profitability due to changes in zoning or density – it all boils down to the developers not being able to make enough of a profit.
In most cases buyers do get their deposit back, but they rarely get any interest on the deposit and almost never receive any compensation for market appreciation since their initial purchase, which is typically years earlier.
New construction development projects may seem to be an appealing way to get into the real estate market but they also have some significant risks. If you’re considering buying into a new build, make sure you have a good understand of those potential problems.