What Is Pre-construction Real Estate Investing?

Investing in pre-construction real estate is one of the most profitable investing opportunities available in the market today. Even though it’s a fairly old strategy, very few investors have a good understanding of it. Preconstruction real estate investing can be best explained with an example:

A developer is planning to build a 100 unit condominium development in a very popular location. The developer has already worked out the numbers and thinks that the project will make a handsome profit. Since he doesn’t have the required amount of capital to complete a project of such magnitude, he approaches banks to request financing.

But before banks lend out millions of dollars to the developer, they want to know that the project has the potential to sell after completion. Since there is no way to know the future and banks like to reduce risk as much as possible, they require the developer to pre-sell a certain number of the units (usually 25%-50%) before they will lend money. In this example a bank agrees to finance the developer if 40% of the units are sold before construction begins.

There are very few home buyers who are going to commit to buying something without actually seeing it with their naked eyes. So the developer has no choice but to approach real estate investors who understand the risk and reward of such ventures. In order to reward these investors for their risk, the developer gives them a 10% discount off the appraised value (after construction value) of the condos if they sign a purchase agreement (contract).

This creates a win-win situation where the developer is able to secure financing and the investors are able to get built-in equity by getting the property below appraised value. The investors who buy these condos before the construction is completed are called pre-construction investors, and this investment strategy is called preconstruction investing.

In this example it was a development from the ground up, but the term “pre-construction investing” can be used for any purchase made before the actual completion of a real estate development. The development may be from ground up or just a renovation project i.e. A condo conversion project where preconstruction investors buy before the renovation is complete is also an example of pre construction investing.

In general, pre construction pricing is 5% – 15% lower than the market value of the finished property. Sometimes the developer may offer other financial incentives instead of a price discount. Some examples include cash back after closing, closing cost credit, free upgrades, rental guarantee or lease back, paid property taxes, waive assessments waived, management fees waived, etc. However, in most cases the developer will offer a combination of a price discount and other financial incentives in order make the deal sweeter for preconstruction investors.

After the construction or renovation is complete, pre construction investors’ have two options to exit. Either they sell their property and make a quick profit, or they can hold the property as a long term investment and build equity. Sometimes investors can also profit by assigning the contract to a fellow investor for a small profit even before assuming title to the property.

Below is summary of the process of preconstruction investing:

The pre construction investor buys a house, condo or townhouse from a reputed developer in the preconstruction phase at a price discount and/or other financial incentives.

The pre-construction investor waits for the construction or renovations to be completed.

After completion of the construction or renovation, the preconstruction investor sells the property immediately for a profit. Or the pre construction investor holds the property to build additional equity due to appreciation and by paying off principal using the rental income. In some cases, exit by assignments is also possible.

By: → Karen Kusumakar

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Construction Loans: Questions And Answers

It would seem that construction activity is still fairly high based upon the number of calls that I get from people about construction loans. There are a lot of calls from people just getting started, as well as from a number of seasoned “construction veterans.” In a large number of those calls, I hear some common questions. So I thought that I’d answer a few of them here.

Q: How do construction loans work?

A: In general, just like every other loan. You sign loan documents and money is funded into escrow. In the case of a construction loan, only a portion of the total loan is released. The balance is released either in preset “stages” or as workers complete portions of the project according to a budget. The former is called a “draw” system and the latter is called a “voucher” system.

Q: How are the payments calculated and who makes them?”

A: Commercial loans have the added security of an income producing property providing the funds to pay the loan payments. For residential loans, it’s the borrower’s income. When a property is being built, there is no secondary source of repayment so the burden of payment would normally fall to the borrower. But lenders didn’t want borrowers to use up all of their funds in case something went wrong with the project, so they created “interest reserves.” This is a chunk of money set aside in the loan to do nothing but make the loan payments during the construction process. The payment is based upon how much money has actually been used or “drawn” at the time the payment is due. This is not the case for private money lenders. They calculate interest on the entire amount of the loan from the initial funding date.

Q: What’s a contingency reserve?

A: This is another chunk of money set aside in the loan to protect you against cost overruns. Since it can take a year or more to complete a project, the prices used to estimate the construction budget become less accurate as time marches on. The contingency reserve is released a little bit at a time during the construction process to cover inevitable price increases.

Q: How do you calculate the maximum construction loan?

A: The maximum construction loan is based upon many factors: Property type, stabilized value at completion, total costs, and equity invested to name a few of the key concerns. For any given property type, there is usually a maximum “loan to costs” and a maximum “loan to value.” The key is this: The largest permanent loan for which the property can qualify, assuming it is built and fully occupied or valued, will limit the construction loan. This is because the construction lender wants to be paid off at the end of construction and the way to do that is with a permanent loan. This does not mean that if the permanent loan exceeds the total costs of the project that you can get 100% construction financing. Just about every lender is going to look for 10% to 20% of the total costs to be funded by equity or cash from the borrower.

I hope that these few examples clarify some of the questions that you might have concerning construction lending. I’ll cover more here in the future. If you should have a question that wasn’t covered, email me at your convenience and I’ll do my best to give you a complete answer.

By: → Craig Higdon

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Some Common Features Of A Construction Loan

Do you need cash for your ongoing construction work? Do you need cash urgently? Do not worry. With a construction loan you can perfectly meet your monetary requirement.

A construction loan is provided to borrower to cover sudden monetary void while constructing a house. This loan is also called as story loan, because, creditors offer the loan after knowing the story behind construction. However, if you opt for a construction loan, you can avail the any sum in between £50,000-£2,000,000. Usually, this loan is offered for a short period of time.

Now, let’s talk about the interest rate of a construction loan. The interest rate of this loan is decided on the basis of various factors, such as, the stage of work, agreement among the parties and so on. Normally, two options are available with this loan, adjustable and variable rates options. As a construction loan is a short-term loan, therefore, the interest rate of this loan is relatively high. So, do not for get to compare various loan quotes before applying for a construction loan.

While availing a construction loan, you can opt for construction to permanent loan program. According to this program, a construction loans will be converted to mortgage loan after the issue of the possession certificate. But do not think that in that case you will have to pay for two different loans. In case your construction loan is changed to mortgage loan, then one will be application and other one closing.

But always bear in your mind that like secured loans, in a construction loan, there is a chance of collateral repossession. In this option, your home will play the role of collateral, thus, if you cannot repay the amount, your collateral will be seized. So, think properly before taking a decision. In such cases, experts’ advice can show you the right way.

By: → Amanda Thompson

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Great Tips For Construction Loans

Construction loans are different from a traditional mortgage loans in a number of ways, but there are also similar terms and such ways that can help you understand what is involved in the whole process.

Like some standard mortgage loans for an existing home, you will need to complete an application document so the bank can determine how much money you can borrow for land, materials, labor and other related expenses that will surely come up. The bank will qualify you for the final mortgage, and at the same time will determine if you qualify for construction loan financing or another type of loan. The bank will determine what kind of construction loan you qualify for based on several items, such as your debt to income, down payment your applying, cash on hand, your home equity and credit scores. Banks will get this information from the major credit bureaus, including Trans Union and Experian. Those scores range from the 710-820’s for the best borrowers, the mid 600’s for average borrowers, and into the 500’s for those with a credit history not great, but may still qualify. They will also consider the amount of money you have for a down payment. When you are looking for a construction loan, you will come up with an interest rate for the loan you use to build your home, and an interest rate for the final mortgage.

Example of this would be if your construction loan interest rate may be 8.7% for 12 months, and then convert into a 30-year conventional mortgage at 6.5% interest for your end loan. The higher interest rate on the construction side of the loan reflects the higher risk the bank is taking, because the house is not yet finished. Occasionally banks offer ARM or adjustable mortgages, that will extend across the construction loan.

Interest rate is just one part of borrowing money from banks. Although banks charge you for processing fees. These fees can be set up in many different ways. One way to understand this is by reviewing the APR, or annual percentage rate. This amount is always higher than the interest rate at which you are borrowing money, because it figured in your effective interest rate over the life of the loan, taking into account other fees you paid for the loan.

When making these important decisions it’s very important to understand what’s included in your loan and the fees involved. Once you obtain your construction loan and begin building your dream home, you will need to manage the loan the bank has provided for you. The bank will also provide additional funds at the end for land and any additional material and labor expenses that might come up.

By: → Troy Francis

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