Some buyers who bought pre-construction homes as an investment could risk having to sell at a loss if interest rates continue to rise, which could affect prices in the broader real estate market, according to the experts.
In a practice called an assignment sale, some buyers buy homes hoping to resell their contract with the builder before the unit is ready for occupancy. This is a common investment practice that allows buyers to take advantage of the rising real estate value of new developments.
“You benefit from a rising real estate market without having to take out a mortgage or deposit assets beyond the required 15-20% deposit, so it’s a very good deal,” said attorney Mark Morris. at legalclosing.ca.
But he said falling home values are wiping out the potential for disposal sales. This will force these pre-construction buyers to close at a time when rising interest rates will make home ownership costs prohibitive. In some cases, the transfer sellers have agreed to buy multiple units, which makes it all the more difficult to conclude their purchase contracts.
If it’s about waiving a 20% down payment, Morris expects those unable to sell on assignment to simply walk away when closing the unit they’ve agreed to. to buy.
“It’s a growing problem and it’s something on the horizon,” he said.
Pre-construction values set the floor price for the entire class of homes, including resale condos, so if those who bought to resell on a mission are experiencing widespread financial hardship, the pain will be contagious, Morris said.
Despite four consecutive month-over-month declines in the average home price in the GTA, prices still remained 5.3% above June 2021 levels last month, the Toronto Regional Real reported Wednesday. Estate Board. But it was condominiums that led the annual gain, rising 9.3% year-over-year compared to single-detached homes, which rose only 3.5% during this period.
Sales of homes and condos fell about 40% last month compared to June last year.
Homes as well as condos are coming to the sale market, but there are more homes of the latter type being built in the GTA, said Ian Serota, co-official broker and director of Keller Williams Legacies Realty.
Because homes have sold for higher prices than condos over the past two years, those are the deals he suspects will be less likely to close. Like a $2 million disposal listing he spotted recently in Burlington, these homes are more likely to sell for the original price rather than sell for a profit by the original buyer.
“These people are also having a hard time qualifying because they’re taking a higher leverage mortgage, or at least they would have been, but now they’re not necessarily eligible for that,” Serota said. “They probably never really did it at first.”
But the distress level of the disposal seller depends on when the house was purchased. Many homes to occupy now were purchased in 2016 and 2017.
“While people aren’t necessarily happy with the interest rate they’re getting for closing, they’re still able to close and qualify (for a mortgage),” he said.
Serota said he is already hearing rumors of developments that will be canceled given the falling prices and rising rates.
Shaun Hildebrand, president of Urbanation, a development market research firm, said he hadn’t seen any official cancellations.
But in the first quarter of the year, his company identified more than 5,000 new homes that launched on presale more than a year ago and sold for $1,000 a square foot or less, which he says makes them economically impossible to build.
“There are a very large number of potential projects here that could be canceled and there are probably others that could have been delayed in terms of starting construction and canceling the risk given the environment of the costs,” he said.
Labor and material costs have increased dramatically during the pandemic, along with supply chain issues.
Hildebrand said the current situation with new developments is similar to what happened in 2018 when 4,687 units were cancelled, following the last major price hike that peaked in early 2017.
“We are getting closer to the same kind of situation,” he said.
“We were expecting over 30,000 units to launch this year, but because of what’s happening, we’re not going to end up anywhere near that level.”
Because rents have risen dramatically over the past year, those who bought condos two or more years ago can likely still cover their owning costs by renting them out, Hildebrand said.
But the projects that have sold over the past two years have been bought at record prices. This might have made sense when interest rates were at 2%, but it’s harder to argue economically when rates are at 5%.
“It’s those buyers who were probably buying on capital appreciation, price speculation rather than long-term rental income,” he said.
But he expects the real distress won’t be evident until 2024, when projects in the early stages of development are now ready for closure.
Although people buying with the hope of selling on mandate are a relatively small group, mortgage broker and real estate observer Ron Butler expects half of them to face difficulties when it comes time to close.
“You may have spent the last five years selling these condos by assignment and never having to get a mortgage and you weren’t even tied to the need to get a mortgage,” he said. declared. “And it’s not going to be pretty.”