I contracted six preconstruction properties between 2004 and 2006. Four with one builder (two in one project, two in another) and two with another builder (one in one project and one in another).
My plan was to hold for rental income until the properties had appreciated significantlym, then 1031 exchange to other investment properties.
So far I have completed settlement on five of the six properties. The sixth will be completed in April this year. Of the five properties I purchased, two were tenant occupied for a year and are now vacant. I have renters in two others, while the fifth property has been vacant since I bought it in April last year.
In the course of the last couple of years, my coastal SC retail market went from very hot to lukewarm. Resale inventory is really high right now with fewer buyers looking. Everyone says this summer will be better. The builder who is finishing my sixth property has really slowed down his construction pace because his pre-construction inventory is not selling.
Preconstruction investing is speculating that the market demand for either sale property or rental property will be there when you take delivery of your property. You need to have a fallback plan or an alternate exit strategy if things don’t work out as you had hoped.
Personally, I have the resources to carry me through the slow times. Right now, even though I have three vacant properties in my rental portfolio, my total portfolio is still generating a positive cash flow.
If you don’t have the financial resources to carry the property when your primary exit strategy fails, then you shouldn’t be actively pursuing this niche. There is less risk with other investing strategies.
Given the current climate of the real estate market, I am waiting on the sidelines until later this year when the foreclosure property market really heats up. To prepare, I am consolidating cash by selling one or two of my marginal producing properties or refinancing equity to take cash out of a couple of my rentals.
I am of the opinion that the real estate bubble is still slowly deflating. We have not seen the bottom yet, but we are close and should be there by the end of the year. The double digit appreciation we saw that made preconstruction property so attractive peaked in 2005. My crystal ball tells me that appreciation will return to a more normal 2-3% (plus or minus) adjusted for inflation.
In the days of 15% appreciation and 5% interest rates on our financing, we could convince ourselves that we were making at least 10% per year on anything we purchased. Said another way, our cost of financing was a negative 10% – how could we lose money?
In the more rational times ahead, if it costs 7% - 8% for the money to purchase a property that only appreciates 5% per year (2% inflation adjusted), the quick profit opportunities in pre-construction speculation are going to be a lot harder to find, if not impossible. The quick flip scenario will not be the most probable exit strategy for most.
Alternate strategies such as hold for rental income, or sell on lease option, will still mean delaying the sale of the property for a couple of years. Chances are, the property will not cash flow as a rental holding. If the property does not produce a positive cash flow as a long term rental holding, then I would not recommend you jump into the game without substantial financial resources to carry you.