Should You Buy Before It's Built?
How to Evaluate a Preconstruction Real Estate Investment

By Jordan Taylor

It's an exciting and appealing strategy: buying tomorrow's property at today's prices—but, as with all types of real estate investments, not every preconstruction deal will be a winner. So how do investors evaluate a preconstruction investment?

Brian Haag, managing member of Gulfstream Development Group, LLC, in Cape Coral , Florida, offers this advice:

Check out the developer and builder. This may be one company, two completely separate companies, or a joint venture between two or more companies. Get the details on every entity involved so you can be sure you're dealing with a reputable operation.

You want to know if they have done projects of this caliber before and if they are sufficiently capitalized. If it's a condominium project, talk to the bank that's providing the underlying financing. The developer should give you the name of the bank and a contact. When you call the bank, ask how many units have to be sold before construction is started and how many have to be owner-occupied so that you have a realistic picture of the project.

Check with appropriate local and state agencies to see if there are any complaints on file about the developer. Also check with the state to see if any litigation is pending. Ask for references that include the developer's attorney, other customers, banker, and local building departments. Developers are typically tight-lipped about who their active investors are, but they should be willing to give you a sufficient number of references so you can determine their reputation. Ask for a list of successfully completed projects and documentation that previous investors have made money on those projects.

Find out what plans are in place to protect investors and if the developer intends to own any units. “You don't want to have the developer in competition with you. You don't want him in a position to cut prices on the same product you purchased,” says Haag. “Certainly it's reasonable to expect that a developer or builder would sell directly to the public as well as to investors, but they shouldn't undercut their investors. At Gulfstream, our policy is that we do not offer to the public any product that we offer to our investors. That means a buyer who wants an investor product must purchase it from one of our investors.”

Finally, make sure the developer is looking for a long-term relationship, not just a one-shot deal.

Research the area for sales patterns and growth trends. Find out what's on the market and how your unit compares. Ask the builder what makes your unit a better investment and what will distinguish it from the comparable units on the market. The developer should also give you statistics on growth trends. “Find out what that information is based on and verify it,” says Haag. “You should be able to confirm the data through the local economic development agency or the chamber of commerce.”

Understand the contract and terms. Be sure the contract is fair to both you and the builder. Consider how much you're paying up front and the payment schedule. “Don't let the builder be too far ahead, but don't starve him,” says Haag. “The construction draw schedule should dovetail with the actual construction.”

You should also be sure your deposit is safe. Deposits should be a reasonable amount and escrowed with a third party. If you're not sure your deposit is being properly handled, get a real estate attorney involved.

Read the contract completely and be sure you understand all the terms. “You need to evaluate your level of protection and risk,” says Haag. “A lot of this is just common sense. Set the sales presentation aside and look at the numbers.”

Have an exit strategy in place before you buy. Know what you intend to do with the property before signing the contract. Also, because markets can change, have a backup strategy in case your primary plan doesn't work.

If you're new to preconstruction, be very cautious about working with a developer or builder who does not target investors. Certainly it's possible to find a project under construction, have a house built, then sell or rent it when it's completed—but in that situation, you're competing with a developer who has no commitment to you. “Our preconstruction investors are long-term, repeat customers,” says Haag. “We want relationships with them that will last years, even decades, and we want to build multiple properties for them. As an investor, that's the attitude you want from a developer and builder. If you have that foundation, you can use preconstruction investing strategies to generate cash flow and build wealth.”