There are worrying headwinds for Toronto’s front-end real estate market as buyers are increasingly worried they won’t be able to close their sales deals due to significantly higher interest rates.
Some real estate agents have noticed an increase in requests for so-called assignment sales – a legal transaction in which the original buyer of a condominium transfers the rights and obligations under the purchase agreement to another buyer before construction.
Calls from concerned buyers have doubled in recent months for Simeon Papailias, managing partner of Royal LePages REC Canada, as many wonder if they can walk out of a deal with the developer.
New condos are typically sold before a building is constructed, and sometimes years before buyers receive the keys to their homes.
“We’re seeing a huge spike in requests from people due to fear and instability in the market,” he said. “We’re getting inquiries from clients as to whether they should walk out of a deal or just keep the property and close.”
There are some buyers trying to get out of the business at all costs, he added.
That’s largely because of high interest rates and the required stress test, which requires borrowers to prove they can afford a mortgage that’s more expensive than what’s being offered, which is now in the seven percent range. Many people are unable to qualify for the mortgage and feel “a lot of pressure”.
Mortgage rates have risen sharply, with the Bank of Canada raising its overnight lending rate seven times in 2022 to cool inflation. From March 2022 to January 2023, mortgage rates rose from historic lows of 1.5 percent to over 6 percent.
However, a more worrying sign for buyers who have chosen the contract sale route is that contract sales are becoming increasingly difficult to close in the first place, said Ron Butler, mortgage broker at Butler Mortgages.
Typically, investors buy a property before construction and then attempt to sell it before completion to make a profit. For example, if they bought the condo for $500,000 before construction and the market value of the condo is $700,000 when they decide to sell, they will sell it for a little less – giving a new buyer and the owner an incentive still makes profit.
But now GTA condo prices have fallen nearly $90,000 since peaking in February 2022. That means buyers who’ve bought since the pandemic hit may have to sell the property for a lot less — and lose money, Butler said. Still, it’s better than losing the 20 percent deposit paid to the developer.
And it’s even worse for people who bought pre-construction single-family homes during the pandemic.
If they bought for $1.5 million in mid-2021 and have to close in September 2023, single-family homes are likely to be valued by lenders at $1.1 million, Butler said. These buyers will find that they cannot get a mortgage large enough to cover the purchase price, and that mortgage will be much more expensive than they expected in 2021 when interest rates were low.
“You’re going to need a mountain of cash to make up that $400,000 shortfall, and that’s a real hazard for some people,” Butler said. “If they can’t close, the contractor confiscates the deposit and sells it for whatever he can get for it because he has to clear out his inventory.”
Butler said builders repossessing pre-construction properties could become more common in the last half of 2023 and 2024.
If people who bought before construction can’t find a new owner with a commission sale, renting could be an option as rents have skyrocketed in the GTA. But even with higher rents, it probably can’t cover the increased property taxes, condo fees and mortgage payments, Butler said.
“When you look at the idea of having a rental property, it’s difficult to be cash flow positive,” he said. “Although rents are going up, it’s not high enough.”
It’s important to note that not everyone who bought pre-construction properties will be affected, real estate experts say. People who bought before construction four or five years ago still earned equity on their investment and won’t be as affected by the new interest rates as people who bought and overextended during the pandemic.
Jordon Scrinko, executive director and co-founder of Precondo.ca, a condominium agency, said buildings he sold in 2018 and 2019 closed in mid-December and none of his clients were unable to close.
“A lot of people fret about interest rates but don’t have the ability to liquidate,” Scrinko said. “But those who have overstretched themselves and bought more units than they shouldn’t have will struggle to break even when trying to sell.”
It is difficult to understand how many buyers cannot buy the property before construction. Contract sales are not advertised in the MLS system. As a result, there are no transaction records and a “full understanding” of what the allocation market looks like is limited, said Shaun Hildebrand, president of Urbanation, a market research firm that tracks developments.
Typically, contract sales average five percent of project units, he said. But even if that were to increase by as much as 15 percent, that’s “a fairly marginal increase given how big the housing market is today,” he said.
Condo prices in Toronto are still up slightly year-on-year, suggesting orders for sale haven’t had a big impact on the housing market yet, he added.
However, high interest rates have discouraged investors from buying units ahead of construction, and that could mean some projects are on hold (75 percent of units must be sold before a developer begins construction on the condominium project).
“Rised interest rates are slowing demand, but so is supply,” he said. “A few years from now, the slowdown in pre-sale activity we’ve been seeing since the second half of 2022 will result in fewer (home) deliveries a few years from now, while immigration hits record highs.”