Key Considerations When Buying a Pre-Construction Home
Buyers typically have two choices when purchasing a home: buying an existing property or opting for a pre-sale home.
A pre-sale, also known as a pre-construction sale, refers to the process where developers sell homes in a development before the construction is complete. While this type of purchase offers unique advantages, it also comes with its fair share of challenges and risks. This article will delve into the benefits, challenges, and risks of buying pre-sale homes.
The Benefits of Buying Pre-Sale Homes
Customization: One of the most alluring benefits of purchasing a pre-sale home is the opportunity for customisation. Buyers can often choose finishes, fixtures, and other design elements, allowing them to leave a unique imprint on their future residences.
Lower Price: Pre-sale homes are often available at a lower price than existing homes in the same area. Developers may offer promotional pricing during pre-construction, making it an attractive option for buyers looking to save money.
Pre-sale homes should be cheaper than buying an existing home because the pre-sale buyer is taking on some of the project risks from the developer. If prices were guaranteed to go up, developers would always wait until the building was complete before selling the homes. Buyers who purchase early, particularly at VIP sales events, will get the best selection and prices and, in some cases, the ability to combine units.If you bought the same unit the day after it was complete, you would still get a new home but wouldn’t get the ‘pre-sale discount.’ That's because it’s finished, and you will have avoided all the risks of pre-construction purchases.
Potential for Appreciation: In a real estate market that’s on an upswing, there is a possibility that the value of a pre-sale home may appreciate before the completion of construction. When you take possession of the home, it could be worth much more than what you agreed to pay for it a few years prior. This potential for increased equity can be an appealing aspect for many buyers.
New Home Warranty: Most pre-sale homes come with a comprehensive warranty package from the developer, ensuring that any construction defects or issues are rectified at the developer's expense, providing peace of mind to buyers.
Calm Presentation Centre Experience: In hot markets with bidding wars and limited supply, visiting open houses and bidding in a ‘blind auction’ is stressful. In these conditions, buying a home pre-sale can be a lot easier than competing against multiple offers because there are many units for sale in the building at one time, and you are negotiating with a sales representative.
Pets Are Allowed: Since new buildings have fewer restrictions, new building bylaws often have no pet restrictions!
Mortgage Vacation at Occupancy: When you buy a pre-construction home, you may run into a situation where the builder lets you move into your unit before the rest of the building is complete. Depending on your province, this timeframe is known as your occupancy period or interim occupancy period.
Since the building isn't finished, and you don’t yet own your unit, you don't need to start making mortgage payments. However, you must pay the developer an occupancy fee for each month you live there until you eventually take ownership.
Occupancy fees allow the builder to cover the cost of your living in their building until it is complete.
Because this amount is cheaper than renting an apartment, you may find it appealing to move in early to settle into your building.
The Challenges of Buying Pre-Sale Homes
Uncertain Completion Timeline: One of the main challenges of purchasing pre-sale homes is the uncertainty regarding the completion timeline. Construction delays are common, and buyers may face unexpected setbacks, resulting in a longer wait time before moving into their new home.
Limited Information: Unlike buying an existing home, where buyers can physically inspect the property, pre-sale purchases are often based on floor plans, renderings, and marketing materials. This limited information may make it difficult for buyers to envision the final product fully. There is the potential for the completed home to fall below the expectations set in the marketing brochures.
Potential Market Fluctuations: Buying a pre-sale home means committing before the property is built. While real estate markets can be unpredictable, there is a risk that the market conditions may change by the time the construction is complete. Buyers should be prepared for the possibility of the property's value being different from what they
You pay sales tax on a new home: Depending on the Canadian province, the buyer will be subject to either the Harmonized Sales Tax (HST) or the Goods and Services Tax (GST). Sales tax is payable on the purchase price payable at the time of completion. You might be eligible for a rebate, but you must pay on the closing day up-front and then apply for the tax refund.
For example, homebuyers living in Ontario are subject to a 13% HST when purchasing a new home, while in British Columbia, pre-sale buyers are subject to 5% GST.
The New Housing Rebate is a partial refund on the sales tax paid on purchases of brand-new properties. You need to meet some criteria to be eligible for the New Housing Rebate, and the amount received also varies depending on the new home’s purchase price.
Imbalance in Legal Consequences: When it’s time to close on a purchase, the buyer is obliged to follow through on the agreement. If a buyer fails to complete without a valid legal reason, they will forfeit their deposit, and the developer will have a right to pursue further damages.
On the other hand, if the developer fails to close, they only have to return the deposit to the buyer. There are no other legal consequences for the developer.
Risk Associated with Pre-construction Purchases
Pre-sale agreements generally shift risks from the developers to the homebuyer. That is why pre-sales sell for a better (discounted) price when compared to a brand-new completed home.
The five main risks of buying a pre-sale home are:
Market Value: What will be the unit’s market value by the time it is ready to be occupied? Can anyone reliably say what the price of a property will be 2, 3 or 4 years from now? While various economists try to predict house prices two years in advance, two economists rarely predict the same outcome, and they are often incorrect. No economist pretends to know with any certainty what home prices will do in the future. They are simply providing educated guesses supported by historical data.
A pre-sale agreement is essentially a ‘futures contract’ (i.e., a commitment to buy something in the future) with an uncertain delivery date. While the price paid to the developer is guaranteed, the buyer does not receive a guarantee that the market value of the home they purchased will be equal to or higher than the pre-agreed purchase price.
As a result, the buyer carries the risk of market fluctuations, absorbs the losses if the market value goes down, and captures the gains if the market price rises.
Financing Costs: Nobody knows with certainty what variable or fixed mortgage rates will be 2 or 3 years from now. They could be lower or higher.
While your homeownership budget may work when you calculate it at today’s mortgage rates, does it still work if rates rise by one or 2 per cent by the time the home completes?
Make sure your budget can handle a rise in interest rates.
Mortgage Approval: While a purchaser may qualify for a mortgage today, there are a few ways they may not be qualified when the purchase closing date arrives:
a) The rates have gone up, or mortgage qualification rules have changed, and you no longer qualify for a mortgage according to the bank’s lending guidelines.
b) The property market value has dropped below the pre-agreed purchase price, and the bank only lends you money based on the current market value. The buyer needs to make up the difference with a larger down payment.
c) You may be laid off or have your hours reduced since you were initially pre-approved for a mortgage, so the pre-approval is no longer valid.
Delayed Completion Date: This is a moving target in pre-sale contracts. Most contracts provide an estimated completion date, generally a year or two away. However, the contract will stipulate that the date is subject to change by the developer for a significant amount of time.
Thus, the developer may extend the closing date many times up to a specified “outside completion date”, which may be several years past the original estimated closing date. The developer may be within its rights to extend the closing years beyond the date the purchaser may have planned for.
In the meantime, the purchaser is on the hook to buy the unit for what may feel like an indefinite period of time.
In contrast, when the developer is finally ready to complete, the contract provides for a short closing period (usually 7-10 days), within which the purchaser must be prepared to close or face a breach of contract.
Quality of Finished Product: When developing marketing materials, the developer’s marketing company will take great pains to make the homes look as favourable as possible in the showroom and online promotional material.
Sometimes, when you move in, the final product doesn’t feel as spacious or luxurious as the brochures imply. As well, sometimes the developer makes changes without asking you.
Purchasing a home from a floor plan requires vision and experience. The Disclosure Statement will have a clause that allows the developer to make small variances to the floor plan during construction if needed (e.g., adding a load-bearing column in the corner of your living room would be considered a slight deviation from the plan). While the change might be “small” legally, it could be a significant enough change to your enjoyment of the home that you feel you would have chosen a different home had you known about the change.
Also, based on legal precedent, the size of a condo unit can be 5% smaller than described in the draft strata plan or marketing materials with no recourse to the buyer. Likewise, things like appliances, hardware, and cabinetry can be substituted.
Key Takeaways
Always have your own realtor represent you when you buy any home.
The developer will pay the realtor a pre-arranged commission for bringing in a buyer (so your realtor will still get paid, and you get independent representation).
After signing a pre-sale agreement, immediately bring the contract to your lawyer for review. You are allowed roughly a week to rescission your offer. If you change your mind after reviewing all the documents in detail with your lawyer, you can cancel the contract within this period.
Always retain your own lawyer to represent you on the closing. Often the developer will provide a “recommended lawyer” for closing who may have (what appears to be) a discounted legal fee package for buyers. Discounted fees generally mean discounted service.
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