Back a few years ago, investors known as speculators jumped into the market and started buying properties, only to turn around and sell them at a higher price than what they originally paid. The result was an industry experiencing skyrocketing home values that were greatly over-inflated, and a higher demand for homes.
Though home speculation was nothing new to the industry, the low interest rates and loose lending requirements during those days allowed the number of speculative buyers to increase at an alarming rate. In fact, to combat the rise in speculative markets, many new home developments even started to include language in their purchase agreements that would dissuade such behavior from an investment buyer. Terms such as a 2-year no-sale clause or a ‘right of first refusal’ became common place in many new home sales contracts.
The inclusion of a no-sale clause was the first attempt to curb opportunistic investors. The no-sale clause was developed to ensure there was no sales competition within the development. Developers would not want to compete against the sale of their own product, nor loose a potential purchaser. Keep in mind that in those days, the sales strategies for most of these developments was to increase pricing with each new phased release. In many of the larger urban in-fill developments, 100 units or more, most of the pricing may have the last few phases of the development selling for 15 to 20 percent more than the first phase.
For the speculators, this meant purchasing in the first phase and holding the unit until the last few phases of the sell out process. Placing the unit on the market at 10 percent higher than the original purchase price meant beating out the developer (assuming the developer was selling units at 20 percent higher than the first phase), by 10 percent for the exact same unit. Even if they use an outside agent to facilitate the sale, the speculator was still able to net 5 percent, which was not a bad investment for simply obtaining a loan, purchasing a unit and holding it for a couple of months. The profit to the speculator could, in many cases, then be placed into a 1031 exchange account for future properties. In essence, done properly, the speculator could purchase his next property with little or no money down through the use of the 1031 funds that would now be available to him.
To the prospective purchaser, however, the addition of a no-sale clause was somewhat of a sticking point in the contract process. What if they suffered a job loss, or needed to be relocated? There were no provisions in the purchase contracts to cover every legitimate reasons that would cause a purchaser to sell their unit.
To answer this rebuttal, the developers came up with the ‘first right of refusal.” The addition of the ‘first right of refusal’ to new home sale contracts essentially allowed for a purchaser to re-sell their home by first offering it back to the developer, and in most cases, at the price that was originally paid for by the purchaser. Usually limited to one or two years, this provided the opportunity for the developer to continue the sell out of the development without further competition during the sales period.
Today, most new home developers are just happy to get a purchaser. With sales prices falling by the day and no end in sight, I have seen many developments cutting prices or making deals upwards of 20 to 30 percent off asking. It will be interesting to see what the industry will learn when we come out of this market on the other side. Or do you think we will fall back to what we already know? After speaking with many of my colleagues, one thing is for certain, we sure miss those speculators.