Buying pre-construction properties in Tulum and Mexico in general

[Mike Lambert]

Hi everyone,

Over the last few years, I've responded to almost 700 posts on buying and investing in international real estate yet I haven't written any single post. In order to best help all of you who want to buy or invest overseas, I figured out it made more sense to answer your questions rather than trying to guess what you'd like to know.

So, this is my first post. Those of you who've read my replies to posts know that my answers can be long because I try to put in as much useful information as I can. Obviously, since this is my own post, I had to follow the same standards or higher so you might want to get yourself a nice cup of coffee and sit comfortably ;-).

Why did I decide to finally write a post now and write specifically about buying and investing in pre-construction properties in Tulum and Mexico in general? On the one hand, many of you have been asking about that subject, whether through the forums or through contacting myself directly (which is understandable since buying a pre-construction condo in Tulum or Mexico in general can be a very attractive investment opportunity if you buy the right property at the right price in the right location from the right developer). On the other hand, I just started working on my own development in Tulum so there’s a lot I can share on the topic.

Many of you have thanked me for helping you buy a property in the area thanks to the informative content I have published on the forums or I have shared in our private communications but I know that there are many more people I've helped who haven't pulled the trigger even though they wanted to. The three reasons that come up the most are: 1) they’re not comfortable with handing over their money to a developer without knowing if he’s trustworthy and capable of delivering the property as agreed, 2) they feel they’re priced out of the market and 3) they don’t have either enough cash or access to financing. Sadly, in those cases, sharing my knowledge and experience might not be enough indeed. By wondering if there was any other way I could help these people, I decided to do my own development project in Tulum that would address these three issues of risk, price and financing, in order to meet the needs of the savvy buyers and investors.

To this end, I spent almost the entire month of May on the field. With the help of my local partners, I found solutions to these three issues that I’m going to use in my own development. I’m now going to share them with you to help you assess and compare the offerings from the different developers.

1. Risks

Unlike what many people think, the main risks of buying a property in Mexico pre-construction have little to do with corruption or drug cartels. They have most to do with the developer and the fact that you have to advance a significant amount of money against just a piece of paper without any guarantee that you’ll get either your property or your money back.

There are actually two distinct risks here. The first is that the developer is dishonest by either scamming you or using your money for other purposes than the construction so you’d need to find out whether the developer is trustworthy. I realize that it’s easy for me to do thanks to my network on the ground but it’s probably much harder for you. Yet, you can do online searches and, most importantly, use your common sense.

A few days ago, one of you asked me what I thought about a particular development in Tulum he was thinking of buying into. I looked at the website and I saw these beautiful renderings. Yet, I didn’t let that distract me and the first thing I wanted to know is who is behind the development to see if I know them or at least can ask my network about them. I was flabbergasted to see that there is no “about us” section and absolutely no information about the developer anywhere. This tells me one of three things: either it’s a scam or the developer has something to hide, has nothing in his background to justify that he could make the project a reality or the developer doesn’t think it’s necessary that he gives any information about himself, which in my book amounts to gross incompetence. Whichever it is, I don’t know about you but I’ll give that project a pass, even if I find the project attractive.

Now, onto the second developer-related risk associated with any pre-construction purchase/investment. Let’s assume that you found a great project with a trustworthy developer. You decide to purchase and you start making payments, alongside with other buyers. The developer cannot wait to make his money as quick as possible and move onto the next project. Therefore, he’s going to start construction as soon as he gets some money. This is a problem because if he can’t sell enough units, he’ll have to halt construction, his project is going to go bust and the buyers will lose their money. This is the main reason why a project would fail and that’s probably what it is when you see idle building frames in the landscape.

There’s another version of that same risk when the developer uses the money from his first buyers for anything other than the construction like personal expenses for example. He thinks it’s ok to do that because he’s going to use the money raised from future sales to complete the construction. By doing so, he’s putting himself and his buyers at great risk of having the project go bust as there’s no guarantee he’ll sell any more units. One of the advantages of being longer than usual on the ground was to catch up with the latest gossip. I was flabbergasted to hear that even some of the largest and most experienced developers are doing that and other shenanigans. By the way, this shouldn’t discourage you from buying in Mexico because the majority of the Mexican developers are honest. It’s the few that aren’t who account for the horror stories you might be hearing or reading about from time to time.

There is a double solution to eliminate or at least significantly decrease these two risks:

a. Instead of having the buyers advance the funds to the developer directly, the buyers will pay into an escrow account under the control of an independent third party. In order to access the money, the developer will have to prove that the project is fully funded, present invoices from his suppliers and/or provide evidence of construction milestones being reached. That’ll make the buyers much more comfortable that the project isn’t a scam and that their money is going to be used for the construction.

b. Having the developer wait for the project to be fully pre-sold before asking the buyers for any non-refundable money. This way, when the time comes for the buyers to put their first dollars on the line, they can be confident that the project is fully sold and therefore fully funded and won’t go bust during construction. Many developers aren’t doing that because selling a project completely first takes time, which obviously is a problem.

So, if you know the developer or have good reasons to think he’s honest and capable, you could consider advancing the money directly to him if you’re comfortable with that. Alternatively, choose a developer who uses the escrow account mechanism.

Also, if you’re one of the first buyers in a project, you’ll pay less but your risk will be higher. If you’re one of the last buyers, your risk will be lower but you’ll pay more. So, if you buy early in a project that you know will go ahead only if it’s fully pre-sold, you have the best of both worlds: a lower price and a lower risk.

2. Prices

As mentioned above, prices in Tulum (and other parts of Mexico for that matter) have risen over the years. This, combined with the necessity to have a sizable amount of cash, has priced many would-be buyers out of the market.

Here, the solution is for the developer to sell properties that are qualitatively as good below market and make up for the lower profit margin by selling quicker and more and having happier clients.

Some of you have asked for my opinion on 2-bedroom condos in Tulum in the upper $300k - $400k range. It would only make sense to me if it’s a lifestyle decision and, even in that case, you could most likely find a much better deal. Such condos are meant to be second residences, not rentals. If you’re looking at an investment, I’m not sure how you’d be planning to make a profitable one. The problem is that you buy by the square footage (and the fanciness) and you rent by the number of bedrooms. As a result, the smallest condos in a given category will generally be the most profitable investments. So, if you absolutely want to spend $350k - $400k, you might as well buy two condos instead of one, which will increase your return and decrease your risk.

Now, a word about the fanciness aspect. Mexico has a lot of great architects and the quality of the construction in the higher-end of the market (in which foreigners and upper middle-class and wealthy Mexicans buy) is very good. The beauty and the quality of many developments in a place like Tulum is impressive and it’s hard to resist the call of the beautiful renderings. While it’ll make you feel great to have an exceptionally beautiful condo, you’ll have to pay a significant premium, which you’ll be unlikely to profitably recoup through your rental income.

On another note, many developers offer a discount if the buyer pays 100% of the purchase price or at least a large part of it at the signing of the contract or at the early stages of the construction. Typically, the more and/or the earlier you pay, the higher your discount will be. However, the higher your risks too (remember the two main risks I outlined above?)! The solution to that, as mentioned above, is for the buyers to pay into a third-party controlled escrow account. As a buyer, I’d have no problem paying 100% of the purchase price at the conclusion of the contract against a substantive discount provided that I can pay into an escrow account.

And for the buyers who are less comfortable with the pre-construction risks, there’s a solution too: buying through resale shortly before delivery. From time to time, I find myself on the selling end of this. When a pre-construction deal is exceptionally good, I might buy more condos than we need knowing that we can resell the surplus shortly before delivery. I actually did one such sale recently. The building was almost done and so the pre-construction risk for the buyer had completely disappeared. Yet, I still gave the buyer a large discount to have him buy from me instead of the developer and I gave him some seller financing that he couldn’t get from the developer.

Let's finish this section with an important distinction. If you buy a property for lifestyle that you might be happy to rent as well to cover your costs or even make a small profit (or not rent at all), by all means buy that more expensive beautiful property, which would still cost you significantly less than a similar property in a comparable US location. If you buy a property mostly as an investor, try to buy at the best possible price, without sacrificing excessively on the quality. This will be the main determinant of your ROI, alongside with the financing if you can get one (see next section).

3. Financing

The other and actually the main solution for buyers priced-out of the market for the lack of available cash is for the developer to offer financing.

For example, the buyer would pay up to say 50% of the purchase price by the time the property is delivered. Then the developer will give the buyer say 5 years to pay the remainder of the price. If the buyers buy the right property, the cash flow should be more than enough to cover all the costs, including that of the financing. Such a situation would result in a much higher ROI.

Beware that some developers are offering what I call fake financing. Fake financing is allowing you to pay in installments but entirely by the delivery of the property as opposed to paying 100% at the signing of the contract! This is no financing from the part of the developer. Real developer financing only exists when you can pay back after the delivery of the property.

Do you have a good deal if the developer offers it to you? All other things being equal, you do of course. However, it isn’t a good thing if the only reason behind the financing is the inability of the seller to sell without it. In the same vein, developer financing doesn’t transform an otherwise bad deal into a good deal. Therefore, developer financing in itself alone isn’t a good reason to buy a property.

On a separate but related note, judging by the questions I’m being asked, it seems like a few people are interested in buying units condo hotels. I can see the main attraction, being that you could make some nice money by having nothing to do. Personally, I’d never consider that option for multiple reasons: 1) you cannot properly dispose of your own property as you can’t rent it by yourself, 2) the price is inflated as they make you pay for the convenience, 3) the performance of your unit is completely dependent on the performance of the building as a whole and the performance of the management, 4) property management is extremely expensive and they’re going to be the ones making most of the money while you take all the risks and 5) you cannot get rid of the property managers if they don’t perform. Also, the revenue estimates are generally widely exaggerated in order to justify the exorbitant property management fees.

Finally, if people are interested, I’m happy to post updates on how my own development project works out.

I hope this helps!