Is It Time to Stop Buying Pre-Construction Condos?

I had a discussion a few days ago with a client about buying a pre-construction condo in the downtown core. The one-bedrooms were starting from $610,000. That's $1,300 a square foot, excluding all the closing costs at the end. You’ve got development charges, there's HST for investors, there's Section 37, and then you’ve got the usual stuff, which is the land transfer taxes and legal fees. When I looked at that potential investment, it was hard to justify investing in.
Let's look at some numbers. Today, that specific area, the downtown pocket we're looking at, is trading at about $1,000 a square foot. So, $1,300 a square foot plus the closing costs will put it close to that $1,400 mark. Let's say in four years from now, when the project will be completed, that is a 40% premium based on today's prices.

Let's do the math. In order to get to that level, today's resale condos would have to continue to appreciate at 8% to 10% every year for the next four years in order for the resale prices to catch up to that level where the pre-construction condo is being sold today.

It's hard to see that. Here's a couple reasons why.

One - Interest rates have gone up and might continue to go up. The cost of borrowing will increase. As an investor, every $100,000 is anywhere from $450 to $500 a month. That payment will increase.

Two - I just can't see a 10% appreciation for four years straight every year in the condo market. I think there's more supply coming onto the market, more completions in 2019. The economics are not there to sustain that 10% appreciation on an annual basis.

The other thing to consider is because of the cost of borrowing could be going up in future years, that rent per square foot has to significantly increase in order to support the cost of borrowing of that specific condo. When I look at these numbers, we have to look at what's resale in that specific pocket, what's the pre-construction selling at? What's the difference? When it's such a big premium to the resale market, that's highly speculative, but the economic fundamentals have to be there to support that price difference for the pre-construction. And quite frankly, I just don't see that.

Are all pre-construction projects bad? No, they're not. Are there good ones and bad ones? For sure. It's critical to do that analysis when deciding on which pre-construction project is the right one for you. Look at what that specific pocket is trading for. Look at what the appreciation has to be for that project over the next three to four to five years in order to support the value. Look a the closing costs because all that stuff you have to take into account. And then look at the rental income. What's happening in that area? Are there purpose built rentals? Are there more developments coming in? More supply of rental properties in that area will increase competition from a landlord perspective and as supply increases, balances out the demand and the prices stabilize. If there's more supply of condos coming into that specific area, that will absorb the demand and the rental appreciation will not be there to support the additional cost of borrowing.

There's a lot of factors to consider when deciding what's a good pre-construction project versus putting your money into a resale condo that's available on the market today.

What I wanna leave you with is you will hear that pre-construction is great. It's the only way to go. Then you hear on the flip side, resale is the best way. You should not look at pre-construction. Life is not black or white. It's grey. There are good projects. There are bad projects. There's good resale. There's bad resale. It's important to do the analysis, understand the numbers and see if the economics support the value of a specific project if you're buying pre-construction or the economics support the resale value for a specific condo that you're looking to buy.