"Oh my God, a pink building! I take one." Cecil. Or maybe Basil.

“Oh my God, a pink building! I’ll take one.” Cecil. Or maybe Basil.

(Image credit)

Recently, our BOY PK from Don’t Quit Your Day Job bought an interesting article to my attention, about some Toronto-based homebuyers who got “screwed” buying a pre-sale condo. And by “screwed”, I mean “the builder exercised his legal rights.”

Back in 2011, buddy decided to put down $40,000 on a 1 bedroom (plus den, AKA sex dungeon) condo in downtown Toronto. Construction ground to a halt, apparently because the builder couldn’t get financing. It sounds as though the building is still going up, but will end up being apartments.

The potential buyer interviewed in the story is pissed. He did end up getting his money back plus a bit of interest, but he’s still put out about the whole thing. Although the story never even mentions it, it’s obvious what his beef is. He wanted the opportunity to either flip that condo making a great return on his original $40k, or live in it and enjoy his figurative gloating about predicting the real estate market correctly.

This story illustrates just one danger of buying a pre-sale condo. Here are a couple more.

You must close

Let’s say like the buyer in the story you decide in 2011 that you want to buy a condo for completion in spring of 2015. But in the meantime, some cwazy stuff happens. You know it’s crazy stuff when I spell it cwazy.

It’s nuts to make a house buying decision in 2011 for 2015. You could meet a lovely lady settle for someone who doesn’t retch when they see you without a shirt. You could move to California and become a high powered janitor at Facebook. You could get mercury poisoning from eating too many mackerels from Japan and partially turn into a battery. A lot of stuff can happen in 4 years.

It doesn’t matter what happens, you’re still obligated to close on that contract. When the time comes and you can’t buy the place, the builder has a couple of options.

1. They can keep your deposit. Goodbye, $40,000.

2. They can take you to court and force you to buy it. This usually doesn’t happen because a buyer doesn’t have the ability to close. But if the builder thinks you have the ability to close and you just changed your mind, the builder is able to sue you. And chances are, the builder will win.

The mortgage

Say you put a $40,000 deposit down on a $400,000 condo back in 2011. In this alternate universe, it turns out that Nelson’s prediction of real estate values going down was correct. It’s now worth $360,000. What do you do besides cry alone in a corner?

Au contraire Nelson, you’re missing something. That buyer has already been pre-approved for a mortgage. It’s not ideal, but they’d just move in to the place worth slightly less than what they paid. Hopefully they can sell in a few years because the market CAN’T STAY DOWN FOREVER BABY WHOO!

Uh, no.

When you get a pre-approval from the bank, that’s not even close to a contract. All the lender is saying is that in theory, you’ve been approved for a mortgage worth $x. The bank still needs to approve the property, the down payment, the price you paid for it, and so on. A pre-approval is no more of a contract than your girlfriend promising not to tickle you anymore when she has her fingers crossed.

In the situation outlined above, the buyer would be forced to put down an additional $18,000 to get themselves back into a position where they had 5% down. And since it’s Toronto, they’d be forced to come up with another $10-$15,000 in land transfer taxes, legal fees, and HST for those things. That’s a lot of extra cash to come up with to close on a condo that’s gone down in value.

The downpayment risk

My previous example inadvertently highlighted another huge risk in buying a pre-sale condo. The amount of leverage used is astounding.

A $20,000 deposit can easily control $400,000 in real estate. A leverage ratio of 20-1 is just asking for trouble, especially for someone who doesn’t ever intend on living in the place. Yeah, the bet has done well in a rising market, but we all know of a guy who keeps using his cash to put down a deposit on the next deal. He thinks the market can never go down, and he will get caught with his pants down one day.

Can you imagine someone doing that with stocks? “I have $5,000. Time to buy $100,000 in stocks. Oh dear, the market fell 5%. I have lost all my money.” Just like it doesn’t take long for the stock market to fall 5%, the real estate market can turn on a dime too. But in the meantime, you’ve lost $20,000-$50,000.

If you insist on buying a condo in one of Canada’s main cities (I’d strongly recommend against it), buy something that’s already completed. You’ll have the advantage of going through it and actually touching the damn walls. You’re not taking a huge opportunity risk with your deposit, and you can move into the place in a month or two. And, no GST. Especially at this point in the cycle, it makes no sense to buy a pre-sale condo.

Tell everyone, yo!