May 5, 2020

About Buying a Condo Pre-Construction - The Process

Pre-construction condos are condo units typically sold through a 4-step process prior to the developer completing construction of the building and delivering units to  end-user buyers.

Due to the requirement for developers to “pre-sell” a percentage of the building (50-75%) in order to receive a construction loan, pre-construction sales have become and important sales channel for developers. Early buyers that complete a non-binding letter of intent / reservation or execute a binding contract, prior to  the 2-3 year construction period commencing, are able to purchase units at a discount when the building is completed.

During the last condo boom, which extended through 2007, developers made it easy to buy and flip reservations and contracts, creating an environment ripe for creative financing and fraud.  With lessons learned, the most recent cycle of new construction condo development has more stringent deposit requirements and limits on contract assignment.

Regardless of the new restrictions, pre-construction buying as a way to help developers secure financing and to provide financial incentives to buyers, is still very much alive and active around the world. The following guide provides details to help you navigate this growing market and potentially make money by buying “pre-construction”.

The 4 Steps of a Pre-Construction Sale

#1 Reservation

Non-binding reservation agreement. 10% deposit. Developers are still finalizing plans with the City and State. Either party can void at any time before the contract and all deposits are returned.

Pros - non-binding, low and refundable deposit, best pricing, widest unit selection options

Cons - details may change, maybe never built, long time to delivery

#2 Contract

Once a developer gets an approved “offering plan” from local and state governments,  the purchase contract and condominium documents are delivered to reservation holders (typically 3-6 months after reservation). Buyers have a 15 calendar day recission period after signing. Developers will require an additional 10%+ and full deposit is non-refundable.

Pros - details finalized, more certainty the project will get built; below market pricing; and wide unit selection

Cons - larger deposit (20%+), 15-days to cancel before binding and non-refundable

#3 Construction

Groundbreaking on foundation and then 24-36 months of construction. Additonal 10%+ deposit. Additional deposits during construction stages - ie. 25th floor or top-off. Typcially 50% total deposit before closing. 

Pros - three years or less to closing and occupancy, below market prices

Cons - less selection, large non-refundable deposits

#4 Completion /Closing

Once the  developer receives the certificate of occupancy (CO), developer sends out letters to request closing within 30-days.  Final money exchanged and the buyer becomes the official owner.

Pros - see finished product before buying, fast closing, immediate occupancy, flexible payment terms, incentives on remaining inventory

Cons - close to market prices, limited inventory, if any

Advantages to Pre-Construction Buying

The top advantage to buying pre-construction is cost savings. By buying early, developers can show progress to their lenders and have built-in pricing flexibility. The early discount pricing is known in the industry as Schedule A pricing, typically the lowest pricing available to the public.

The secondary benefit to pre-construction buying is the unit availability. The earlier you commit in the process, the bigger the selection of units available to you,

Risks to Pre-Construction Buying

To balance the potential financial reward of buying during the pre-construction phase, there are several risks of which you should be aware.

Pre-construction Closing Costs

Typically, the seller is responsible for paying transfer taxes and their own legal fees in a resale transaction. However, many developers / sponsors of new construction projects expect their fees to also be paid by the buyer. In a softening market, the buyer can negotiate these fees as well as the payment by the developer of luxury & mansion taxes, where applicable.

Here is a list of some of the typical buyer closing fees associated with a pre-construction transaction:

Development Fee - a % of the purchase price and additional charges for options not included in purchase price. Typically 1.5% - 2.7%

Capital contribution - A working capital contribution equal to 2 months of HOA fees payable to the association to provide it with initial funding. Can be used by HOA for any purpose and is not credited towards other assessments and charges

Reimbursements to seller / developer -

(i) utility / telecom reimbursement for deposits or fees advanced by the developer for the benefit of the specific unit being purchased. Amount is not known until closing and is typically de minimis

(ii) reimbursement for closing fees - not known until closing and is typically de minimis

Outstanding amounts - amounts for sales tax for options and upgrades

Late funding fees - fees charged to the buyer for late funding of deposits or other payment obligations

Attorney fees - legal fees are negotiable items, but typically in a resale transaction, each party pays for their own legal. In pre-construction, the developer can try to get the Buyer to pay for their legal fees associated with the unit closing.

Buyer’s title insurance, title search and title review - negotiable  and optional if Seller elects top pay

Here is a list of some of the typical seller / developer closing fees associated with a pre-construction transaction

Deed recording in public records - a de minimis transaction fee

Documentary stamp taxes = equal to $.60 per $100 in purchase price

Title insurance premium - if issued by Seller’s closing agent

The Condominium Documents

The “Condo Docs” include all of the information related to buying and living in the condominium. It is critical that you and your legal counsel read the entire set of documents to avoid any issues at closing.

The documents include several ownership and operating details including:

There are several items to be aware of before finalizing your contract:

  1. Square footage - since you are buying based on square footage, it is critical for you to understand what is included in the square footage of your unit. Typically, square footage is the entirety of the interior space. This includes columns and interior walls which may reduce the liveable square footage. The condo documents will break out the Unit Area (liveable) from the Typical Area (what is being paid for). Rely on your broker or legal counsel to make sure you know exactly what and how much you are buying.
  2. Closing Expenses - as shared above, buyer’s will typically have to pay the developer an additional 1.75% of the purchase price at closing for the “Developer Fee”, plus 2x the monthly association dues which go towards reserves for the building.
  3. Lease Terms - it is important to understand your rights related to leasing your unit if you are purchasing as an investment. Developers often limit leases to 2x per year and no leases for less than 30-days - essentially limiting Airbnb and other short-term lease options.
  • Time for Closing - The condo documents will also set forth the time for closing when construction is completed. Make sure you are able to close at that time to avoid litigation around your deposit.
  • “Our goal is to help you analyze and purchase investment quality condos at below market prices.”

    Richard Swerdlow, Founder