Real Estate Pre-construction – There is Nothing New Under the Sun
“Nothing new under the sun,” this an universal truth coming from the book of Ecclesiastes 1.9, “Nihil novum sub sole”. And it can be applied to pre-construction sales within the developed world, through the self-financing model that has been re-discovered now to release the new projects. In absence of construction lending this is a method widely spread in virtually all emerging economies. This business model enables investors and buyers to take advantage of long-term construction because it helps pay off the property as the construction advances, canceling having to pay the total price at the end of construction.
In the post global crisis world a de-leverage trend has evolved from the old business model of buying property with a small 20% deposit to the even older one of self-financing. Speculators seeking for 100% returns on their investment in a couple of years resulting from flipping their units with a price increase of only 20%, are now faced to the alternative of paying 100% of the price facing lower profits, but with lower risks as well.
In a growing economy, the 20% down model proved to be successful locally for over a decade in the major U.S. cities, especially in Miami. The problem surfaced in the downturn of the economy where investors decided to loose their deposits when faced with a lack of bank financing for the remaining balance of 80% of price. This highly leveraged model driven financial returns, rather than by real demand from end users, led to a construction oversupply. During the collapse in 2008, with no end buyers to resell prices collapsed over 50%, well below replacement cost.
A few years after by the same token this has been the main reason for the renewed interest in investment in places like Miami, where cash investors all around the globe have scooped out most of the unsold inventory since early 2010 at bargain prices, with both an attractive rental income and with substantial potential for future appreciation.
Projects such as ‘My Brickell’ or ‘Apogee Beach’ by the Related Group of Florida, among a few others have pioneered the Latin American self-financing model. Typically the units are paid out throughout construction in 5 installments of 20% each, at contract execution, groundbreaking, top off, occupancy permit and grand opening.
At the same time the lack of new construction projects in the last 5 years, has generated a pent up demand now that most unsold inventory has already been, thus prepping out the beginning a real estate cycle. By now construction costs have dropped dramatically and pre-construction prices are even with those of existing inventory and sometimes even lower. One of the advantages for investors is that the deferred payments improve the financial returns. For many Latin American buyers, it is much more convenient to pay in 5 payments of 20% in 2 years as a form of savings, than to make a one time investment in cash five times bigger.
The advantage of this model is that it eliminates the possibility of broken condo projects and the possibility of a new collapse in prices as in the prior cycle. While there may still be a risk that certain investors may fail to meet all payments on a downturn ending up with half-built project as it happened before during the bust of the market in emerging economies. The key here is the qualification of the investor by the developer on one side, as well as the qualification of the developer from the investors. During the next years, the market will be controlled by seasoned developers that have the proper track record that would give the investors enough confidence to give them 100% of their money, not relying in any sort of bank financing.
Another advantage is that the lack of construction financing, eliminates significant costs of interest, guarantees and hefty legal structures, reflecting the savings in price to the investor and the end user. As an example Apogee Beach in Hallandale with only 49 units out of which 25 are already under contract, is selling at an average of 450 per square foot. The closest comparable, the Trump Hollywood, is selling at an average of 550 per square foot. Buyers will access 2005 prices for units to be delivered in 2013. Whoever paid 550 at Trump Hollywood will resell in 2013 above that price, therefore creating a built in profit at the time of purchase of those who choose Apogee Beach. However the risk of a building to be built is higher than one already built, that can enjoy from day one a rental income. As always returns need to be risk adjusted to make sense, and there’s investors out there with different risk tolerance and appetite.
From the perspective of developers the business will be way less risky, limiting their exposure in a falling market. In any case, each model has its advantages and disadvantages. It is yet to be seen if this old recipe expands within the Miami market and if more projects take this old recipe, that now appears as a novelty.
About Axis Real Estate
Axis Real Estate is a leading real estate sales and marketing company in Miami, that focuses on delivering value to its customers. By providing market intelligence to shed light on any specific property in town, Axis screens smart and profitable investment opportunities. With an extensive track record of its principals in the development and construction arena, Axis Real Estate has a real advantage in the depth of its industry connections, when compared to any other brokerage company. Both the pipeline and the network of the company are continuously expanding, into the regional and international markets. Axis Real Estate is a one stop shop, that provides all key services necessary to assist its foreign customers in buying, managing and selling its properties.
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