 Miami
Beach (4/12/05).We are frequently asked for an explanation of
pre-construction condominium property as a strictly financial investment
or speculation.
This essay presumes that the prospective purchaser is a financially
sophisticated, high-net-worth individual who is qualified to evaluate and
make investments with a high degree of risk. We further assume the
investor has no interest in taking title to, leasing or occupying the
property him/herself.
As a strictly financial speculation, new-construction in
Miami-Dade County has a lot going for it:
- over a decade of consistent strong appreciation of residential
property values
- considerable limitations on availability of prime land for
high-rise construction
- increasing costs of construction due to rising commodity
prices for cement, steel and other inputs
- high leverage with no "drain" on investor's balance sheet or
available credit lines
- no carrying costs on the property from contract through
closing: developer bears all costs of financing, real estate
taxes etc. while your property (hopefully) appreciates.
- many developers have programs in place to permit speculators
to re-sell units still under construction after the project is
substantially "sold out."
Although each developer is free to set the terms of the purchase
contract, there is a large degree of uniformity in this marketplace at
present. Typically Buyers are required to put up a total of 20% of the
purchase price, generally split into an initial payment of 10% at the time
the contract is formed, and a further 10% due upon some specified occasion
in the construction process, usually groundbreaking or, in some cases,
"topping off" of the structure. Thereafter, no further sums are due from
Buyer until the property is ready for closing, typically two years or more
from the date when sales began.
One significant benefit is that under State Law, the first 10% of any
funds paid by the Buyer must be held in a regulated trust account and are
not turned over to the Developer until closing. Hence even if the
Developer fails to complete construction or ends up in some kind of
financial disaster, one-half of the anticipated investment is sequestered
and protected from this risk.
So if one assumes, for example, a $500,000 condominium unit, the entire
sum required for investment is $100,000. No financing application is
required, no financial statements or credit checks are performed; no
outside party has any involvement in your purchase. If economic and market
conditions remain favorable, there is a likelihood that after two years
the unit might have a market value of $720,000.00 by the time the contract
is due to close. At that point, the investor would place the unit on the
market and seek to locate a "retail" buyer, that is, and end-user who
wants actual possession of the property. He has tied up a capital of
$100,000 and received a profit of $220,000 on it, that is an annualized
yield of 100%.
There are two factors in play in the Miami Beach property market that
are relatively recent and which will have a strong impact on the
housing market:
1. The conversion of existing high-rise construction to condominium
ownership: Almost every possible building site in Miami Beach with a
"water feature" has long-ago had some kind of high-rise apartment building
constructed on it. The great majority of this construction was done during
the 1960s and 1970s, after the advent of the jet airplane and the
residential air conditioner made this community accessible and this type
of construction practical. High-rise construction has a typical "design
life" of 40 years; this is why, for example, the IRS guidelines depreciate
it over this period.
All of this housing was constructed by sole owners, whether wealthy
investors or corporations, and intended to be operated as rental
apartments. By now, the majority of these buildings would have been judged
to be functionally obsolete, economically inefficient to run, fully
depreciated and ready for the wrecking ball. But instead, they
have, over the last twenty years, almost entirely been sold as condo
units. So a building which (before this change) would have belonged to one
financially savvy investor owner, and be at the end of its service life, would
have been torn down and a new, up-to-date, efficient structure put on the
site. Think Las Vegas, for example, where big casino/hotel properties are
frequently dynamited to make way for bigger, newer structures.
But a typical high-rise condo has 300+ owners, some savvy, most not.
Their units are not investments fully depreciated and obsolete...they are
people's homes. Getting 300+ diverse people to agree to dynamite
their building, borrow the money needed and construct a newer building on
the site is a fantasy. It's almost impossible to do except in a few
special cases of small condo projects where a developer has been able to
purchase enough units to effectively gain operating control of the
building.
So a large portion of the most desirable land for building multifamily
housing has been, for all practical purposes, withdrawn forever from the
market. At least until something changes in terms of how condo are managed
and governed. |
2. Historic Preservation: At one time this notion applied to
classic buildings like Grand Central Station and the Louvre. Now it
applies to such dubious architectural achievements as the Carillon Hotel,
the odd coral-rock cottage and even termite-infested motel cabins. Thee
has been an infinite expansion of historical districts and preservation
mandates as well as a geometric growth of "styles" for which legal
protections are sought...including "MiMo" the predominant architectural
style of the '50s-'70s era in which the bulk of prime waterfront apartment
buildings and hotels were erected here. So in addition to condominium
ownership, we have another factor in play: the increasing tendency to
designate obsolete buildings as landmarks which must be preserved.
These two factors, will tend to limit future construction of housing
units in desirable Miami Beach locations. Already the shortage is being
felt as new construction projects are actually underway on Normandy
Island, hitherto an off-beat location with mostly low-rise multifamily
units. It is also driving the redevelopment of downtown Miami, another
area with very limited available waterfront land for development.
Of course this is still a risky investment. As I
mentioned above the developer could get in financial trouble and fail to
complete the project. This is rare but not unheard-of. One can minimize
this risk by sticking to developers with a track record building the type
and size project under consideration.
A second area of risk if that market conditions could turn against the
investor and he might find that the property is not worth more than he
contracted for it...and, of course, possibly less. If the investor could
not then come up with the cash to close the transaction, he/she could lose
the entire $100,000 down-payment. However, these are not commodities like
pork bellies and cattle futures, this is real estate and if you are still
reading this far, I assume you have an underlying economic outlook that
suggests that housing values will remain stable or rising in this market
area.
Pre-construction is therefore an area where many of the investment
decisions seem counter-intuitive. An investor seeking to benefit from an
anticipated rising market for housing would prefer the longest possible
lead-times and the lengthiest possible construction period so as to
maximize the rise in underlying real property values. Investors familiar
with this type of speculative purchase are usually willing to take any
steps required to "get in early" and contract for a property at the very
lowest prices, those offered to "insider" buyers during the "pre-opening"
phase. This is typically done with a "Letter of Intent" or similar
document which states an investor's interest in a purchase without binding
either party to a transaction. Developers have found these useful to "weed
out" the "tire-kickers" and "faint of heart" and whether or not the
practice makes any sense, it has become the commonplace means of entry to
"pre-opening" level sales pricing.
At Buy the Beach Realty our Site Specialists keep an eye on this market
and often have pre-opening access to projects coming on line. This is a
great advantage for our customer base, but at the same time, customers
must recognize that "pre-opening" numbers and availability are often
sketchy, subject to revision and manipulation as the developer gets a feel
for what the market will bear for the product. However, we have been
successful in making many attractive pre-sale placements for our
investors.
When new construction projects come on-line for pre-opening sales, we
notify our email mailing list subscribers first. In some cases, we do not
place them on our web site due to marketing restrictions imposed by
developers.
If you want to subscribe to our email newsletter, link here.
The links below will take you to our New Construction pages. Happy
hunting.
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