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| Preconstruction Real Estate Investing in a Nutshell | |
| Many average Americans are convinced that investing in real estate is beyond their financial means. Most people have the idea that real estate investing is simply the process of buying existing homes for their current value and holding on to them long enough to see them appreciate. And, this is certainly one way to invest in real estate. However, this manner of investing often requires you to pay the full current value of the property you're purchasing, meaning that you may have to wait several years to see any appreciation in your investment. But, there's another way to invest in real estate that can help you see a return on your investment more quickly, without years of making monthly mortgage payments. Preconstruction real estate investing is a unique way to get into brand new properties before they're even built, allowing you to control a high end real estate investment for a period of time with little cash out of your pocket. Most of these investment opportunities exist at vacation destinations and are for condominium and other multi-unit properties. Here's how it works: The Reservation Period The reservation period is the first period in real estate development. The developer will put together a model and drawing of a proposed property to show potential investors approximately what the property will look like and approximately how much the property will cost. For a small deposit of around $5,000-10,000, you can secure first right of refusal on a property in the development being designed. Developers pre-sell such properties to help them ensure that there's a market for their development. In exchange for securing the property so early in the development property, you'll gain a small purchase price discount over investors that come into the property at the following stages. So, your investment is likely to begin appreciating right away. The reservation period is a risk free period, and usually lasts approximately six months. Your initial investment is placed into an escrow account. At any time during the reservation period, you can change your mind and get your investment returned to you. The Hard Contract Period The next phase of preconstruction real estate purchasing is the hard contract period. Before you become committed to a contract on a property, the developer is required to offer a Right of Rescission period, during which you can opt out of your reservation, getting a refund on your reservation deposit. Each state mandates the required length of this period, so it can vary, but in many states, the period is 15 days. If you choose to stay in the investment after the Right of Rescission period, you'll actually sign a binding contract on the unit you reserved. When you sign a contract, you'll get a firm price on the unit you're purchasing and you'll be required to put down 20% of the total purchase price of the unit. Following is an example of the cash required to purchase a $300,000 condo unit on the beach. Your original deposit amount can be put toward your down payment. In addition, you can apply to obtain half of the 20% deposit from a bank through a letter of credit. In order to obtain a letter of credit from a bank, they'll require that you have two times the amount you're requesting in assets. Let's take a look, then, at the amount required to pre-purchase a $300,000 condominium on the beach. $10,000 - reservation deposit 20% down payment - $60,000 So, after deducting your reservation deposit, you'll need to have $50,000 for a down payment. As long as you have $50,000 in personal assets, you can get a letter of credit from the bank for half the down payment, or $25,000. So, at the time of contract, you would actually have to have $25,000 in cash available. The down payment is the only money you're required to pay to have a contract during the construction period, which can last anywhere from one to two years. During this time, you'll make no mortgage payments, insurance payments or tax payments. For an out of pocket financial investment of $35,000, you are controlling an investment worth at least $300,000. The investment has likely appreciated during the six month investment period, and will likely continue to appreciate during the construction period. Closing or Certificate of Occupancy This is the final period of the transaction that occurs after construction is complete and when ownership of the units is passed to the buyers. A traditional closing will take place, at which time you'll finish paying for your unit. You can either pay the balance in cash, or arrange financing of the remaining balance. Going back to our previous example, when you go to close on your $300,000 condominium, you'll owe $265,000 in cash or you'll need to obtain a mortgage for this amount. You'll have to include the $25,000 amount that was covered in the letter of credit as part of your final payment - this letter of credit was simply a security instrument to be used during the construction period. Now that the construction period is over, you'll have to pay this amount as part of your purchase. |
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