Understanding Preconstruction from the Developer's Viewpoint

By Chris Anderson, PhD

Preconstruction sale is a term that signifies real estate transactions that takes place before a project is completed.   Many investors have a hard time understanding why sometimes they can purchase a property at a discount when bought preconstruction.   The key is to understand how important this process is for a developer so let's pretend we are a developer for a minute.

Finance is the most crucial issue that decides the success of a project. As a developer, suppose you have the land in front of you and your mind is filled with the idea of a dream project that will make you millions.   Unfortunately, you lack finances or the ability to get financing so the chances are meager to convert it into a reality.   By making arrangements to offer this property to preconstruction investors however, now you have a simple method where not only will all your risk be minimized but you will have lending institutions bending over backwards to help.   SCORE!!!    So now as the developer, your job is to give incentives to investors (lower price) to buy your project while it is still nothing but a sketch and a dream.

In addition, most developers want to use preconstruction because it ensures their projects demand in the market.   They do not wish to put their funds at risk without any positive assurance. Similarly, whether they raise funds through private lenders or banks these preconstruction investors would make sure that their loan is repaid timely since money will be coming in by closing on their properties.   Pre-selling has gradually become a very common technique for developers with almost every condominium being usually sold in the pre-construction phase.

So as a developer, you have two choices:
1) try to get full value for your projects when they sell but had incredible difficulty getting financed or
2) sell at a discount to preconstruction investors and then simply keep doing deal after deal after deal.
I think the choice for many is obvious.   It becomes easy to procure further loan by producing the presale papers that add material value to your construction project.   If you patiently go for preconstruction sale, your efforts are likely to bear good results. There are four main phases of preconstruction sale namely, reservation agreement, right of recession period, contract for sale and closing for sale.   Under reservation agreement, the buyers have to deposit around 5% or less of the buy price as a nominal charge to reserve a particular unit.   This deposit goes to an interest bearing bank trust account; in any legitimate deal, the developer DOES NOT have access to these funds.   A buyer can make the deposit even if he or she has a nominal intention to buy the unit, as the deposit money is refundable at this stage.   While not every reservation agreement converts into a contract for sale, it decides the amount the developer could raise through pre-selling.   If the developer accumulates enough sales contracts, he gets the loan otherwise they have to keep working to reach the needed amount.

Sometimes it may happen the developer could not carry on the task of construction because of some major problems.   In such a case, he would need protection from probable suits, likely to follow.   The "need to be built" disclaimer provides protection to the developers if he could not proceed with the construction task.   It is a step taken during the marketing phase of preconstruction sale.   It is better to chalk out a schedule specifying a timetable informing the likely completion of various construction works.   It should form one of the issues to be discussed during preconstruction meetings. Construction work often involves unforeseen aspects that may tempt you to change certain items decided on earlier.   In such a situation, you have to inform the owner and discuss its aspects in the preconstruction meetings.   The most crucial phase of construction of a new building is when the construction process is about to start. It needs meticulous planning and ultimate precision when it comes to construction.   A minor fault in the beginning may mar the total structure.   It needs flawless preconstruction planning and good service to ensure client satisfaction.

Most developers do not appreciate flipping.   Some developers who feel the price is going to shoot up are wise enough to make contractual commitments that enable them to raise prices if the market demand crosses the expected predetermined sales.   This sometimes makes flipping a profitable option, which is usually not a favorable aspect of developer's business strategy.   The most risky side to flipping from the developer's view is that he might misjudge the demand of the unit in the market.   While he would expect to sell it at a higher price, the market demand will show him a different face.   Eventually he may have to slash the price to make a bargain.   Thus, it would incur heavy loss on him, which may further tell adversely on the future business.

Preconstruction sale is usually beneficial for both the developer and the buyer.   Through it, the developer procures necessary financial aid and the buyer buys it cheap compared to later.   Before investing in any deal however, you must carefully perform your own due diligence and educate yourself about the entire process and how to best grow profits at minimal risk.

Chris Anderson is a leading authority on preconstruction real estate investing. Get his 4 day e-mail course and a 33 minute video free today! Visit http://www.GetPreconstructionDeals.com.

In addition, Dr. Anderson is the on-line training coordinator at the Van Tharp Institute, a group dedicated to providing world class training for investors and traders.