People often buy presale units with just a small deposit and preapproval from a lender that comes with a time limit. If it’s a hot market, they can sell a short time later for a profit without having put up much money. But a declining market exposes these buyers to significant risk.DARRYL DYCK/The Canadian Press
The Vancouver region is poised for a record year of condo completions, with 20,468 presale units scheduled for occupancy by year’s end, according to Zonda Urban, marketing analysts who track the sale of condominiums prior to or under construction.
The completion of these condos, often referred to as presales or preconstruction units, is 53 per cent higher this year than the record year of 2021. More than half the units to be completed this year are in high-rise towers; one quarter are in smaller buildings and 22 per cent are townhouses.
There are a couple of situations that could play out for presale completions or, depending on who you ask, they could both play out. If preapproved for a mortgage at a lower rate, some buyers will be dealing with the extra cost of a mortgage at a much higher rate. And if the lender now values the unit at less than the purchase price, the borrower may no longer qualify for the mortgage amount. That would mean the buyer would have to find the money to make up the difference in value, or try to sell the unit, known as an assignment sale.
People often buy presale units with just a small deposit and preapproval from a lender that comes with a time limit. If it’s a hot market, they can sell a short time later for a profit without having put up much money. But a declining market exposes these buyers to significant risk. That happened in 2009, when some developers sued presale buyers who tried walking away from their deposits.
Canadian vendors have successfully sued purchasers who backed out of a sale, usually for the difference between the original purchase price and the lower price that they eventually sold the unit for.
Presale purchasers and vendors may be rereading the fine print of their contracts right now in search of loopholes.
“Think of the thousands of presale agreements that are coming up for closing this year,” says Ron Usher, real estate lawyer and general counsel for the Society of Notaries Public of B.C.
“Did those people understand the cost of their mortgaging?” he asks. “Did they predict what they thought the value would be? We are seeing collapsing deals of appraisals coming in that are not supporting values. That will be one of the more interesting stories this year, in Vancouver and Toronto particularly. What is going to happen with all these completing presales?”
It’s too early to know how the year will play out, he added. Those who locked in their rate early enough will be on solid ground with the current valuations, he says, as long as they have the income to service the loan. And rising rental rates will help keep purchases cash flow positive.
Mortgage broker Alex McFadyen said that most buyers are not aware of the risk.
“Some properties have appraised at value, but others have been appraising at far under value – as much as a couple of hundred thousand,” he said. “I can confirm that this is happening and will likely continue to be the case over the course of this year.
“Some individuals have been able to come up with the cash difference, whether it be from the equity of their homes or a gift or savings.”
Mr. McFadyen says that most buyers do not do their due diligence on obtaining full mortgage approval in advance, safeguarding against the unexpected.
There’s a major caveat for presales completing this year, says Ryan Berlin, senior economist for Rennie Group, whose Market Intelligence division advises developers and other clients.
There is the very real possibility that completions might not happen owing to construction delays and labour shortages, which could push occupancies into 2024, Mr. Berlin says.
And if units do complete this year at record levels, says Stefan Greiner, Zonda Urban manager, advisory, then the number of completions will likely decline in the following years.
“If completions in 2023 will be at, or near, highs, and slower market conditions persist, I would anticipate lower-than-average completion totals in future years,” Mr. Greiner said.
Mr. Berlin doesn’t expect a problem for the majority of buyers. He said about 95 per cent of those presale purchases were made prior to the crazy hot pandemic years, which means they are still priced lower than the current average. And that should give most people a safe buffer, he says.
“The exposure doesn’t appear to be tremendous,” and it will vary according to location and type of unit, he explained in an e-mail.
“If it does arise, the onus is on the buyer to fill the financing gap, again with more equity or a larger down payment.”
In the U.S., there’s less risk for the buyer but more risk for the developer, says Bob Rennie, who’s marketed many condos in Seattle.
“In Seattle, when you sell a presale, only 5 per cent of your deposit is ever at risk. It’s called a ‘safe harbour’ clause. Even if you put up 10 to 15 per cent of the deposit, only 5 per cent of the purchase price is at risk. And if you don’t disclose the ‘safe harbour clause,’ none of it is at risk. So we have more at stake here.
“[In Canada] the banks offer construction financing predicated on the success of a presale,” he says. “As long as you sell 60 to 70 per cent of the building, the banks will advance construction financing. The developer offers presale prices so that people will buy early and the banks will get financed.”
In general, it’s a system that has worked well for decades, but also one where the buyer at the bottom can get stung.
This is not one of those years, Mr. Rennie says. He cites immigration levels and pent-up demand for housing that is less than $1.5-million, which is 80 per cent of sales on the Multiple Listings Service. He figures buyers will act as soon as there’s a small rate drop.
“I think there is a pause in the market, and everybody is looking around. They are questioning things, but my belief is that whether it’s this June or September or next February, when rates come off an eighth to a quarter of a per cent, I think similar to coming out of COVID, that there will be a lot of pent-up demand based on the skepticism in the market right now.
“You have 20-per-cent deposit up. The market has fallen 7 per cent. Are you going to walk from your deposit?” he asks. “No. If you have 20 per cent up and the market falls 30 per cent, are you going to try to get out of a contract and leave your deposit? Yes. But then it’s all litigated. Although we have general rules, every purchase is going to be purchaser-developer specific. But we are not in that market.
“So ask me if I’m worried. No. We are not going to have a systemic fallout this time.”
And so far, developers are sticking to their schedules, he says.
“I can’t think of an address that is delayed,” Mr. Rennie says. “And I haven’t seen any cancellations where they don’t go ahead with the project and put the land up for sale.”
Mr. Berlin and Mr. Rennie said the likelier obstacle is higher interest rates. If a buyer obtained a preapproved rate before rates started to climb, they might be locked in until completion. However, if they are approved until June and their unit completes in September, they’ll be dealing with a higher rate, Mr. Rennie says.
“And then they take out a floating rate and hope that rates ease off a bit,” he says.
Toronto real estate analyst John Pasalis, president of Realosophy Realty, agrees that the majority of condo completions shouldn’t have a problem with appraisals since they were bought more than five years ago. It usually takes several years for a condo to complete, particularly if there’s a rezoning involved.
“The investors who might have an appraisal issue include anyone who bought over the past two to three years, either in a building with a faster completion cycle, or in a bigger building but purchased midway through the building’s construction, for example,” Mr. Pasalis says.
Realtor and lawyer Patricia Houlihan predicts problems for more recent buyers who might face double the payments on a property that’s dropped in value. She thinks it will take about 18 months to play out.
“The scary thing is a lot of people we are doing have variable mortgages, and now they have had to lock in because variable going up so much, and they are paying double. And other people locked in at 2 per cent and only did a three-year [rate], or something. When their mortgage comes up how are they going to pay it? It’s more than double the interest rate.
“I worry about those people,” Ms. Houlihan says.
Long-time real estate expert and appraiser Rudy Nielsen also emphasizes the rate increases as a stressor for a lot of buyers, and also those whose mortgages are coming due.
“There will be a lot of people with that variable rate mortgage who won’t be able to make payments. A lot of people bought their houses five years ago on five-year terms, and they are coming due, too. People don’t have the paycheque to cover the increase,” Mr. Nielsen said.