The Toronto Star has been relentless in its doom and gloom analysis of GTA real estate. Everyday, another article is published telling us that sales are dropping, prices are dropping, and now they are focussing the inability of buyers who are locked in on purchase agreements with high prices, to complete their transactions. One of those articles provides some support for revisiting the mortgage stress test which currently is no less than 5.25% on shorter term mortgages and up to 7.43% for 5-year fixed term mortgages. https://tinyurl.com/mttm3852
Recently, the CBC has joined the bandwagon of doom and gloom and had a report on their newswire and on the national news that reads as follows:
"They purchased homes right before the real estate downturn. Now they are struggling to close." https://tinyurl.com/y4vpxxu3-CBC
The CBC focussed on a low-rise, single-family subdivision involving homes in the $1.5M-$2M range being built by Paradise Developments Valley Oak community, a reputable low-rise builder in the GTA for many years. The article concerned the plight of some purchasers who are facing a potential perfect storm impacting their ability to close. Appraised values have dropped for homes that were purchased a year ago by almost $300,000 and carrying costs have more than doubled as a result of rising interest rates. Purchasers are then facing less mortgage money from the lenders resulting in a shortfall for closing and potentially, not even qualifying at all, because of the increase in the interest rates.
Similar dilemmas arose in 2017 and 2018 after the rapid rise in new home prices in the previous year when the bubble burst, particularly with the introduction of foreign buyer tax and the mortgage stress test and other regulations imposed by the federal and provincial liberal governments to cool the market. At that time, purchasers were facing purchasing properties that had dropped in value as well. They did not face the impact of the required mortgage stress test to qualify but still, many buyers balked at closing or were unable to get full financing based on their original purchase price.
Back then, many builders tried to make accommodations with purchasers by reducing prices, extending closing dates with larger deposits being paid, or giving vendor take-back mortgages. The fallout was ameliorated by these steps.
The question now remains as to whether the collision of increasing interest rates and falling values will impact on closings for new builders, whether low-rise or high-rise, and what steps builders can take to avoid these situations.
Start Updating your Mortgage Approvals even before Final or Occupancy Closings
- Many of our clients have been reviewing their mortgage approvals and have found a number of them to be fraudulent. A large number of them come in from mortgage brokers and the mortgage broker puts the approval on his own letterhead without justification, or even worse, falsifies bank letterhead to issue an approval. These should have been verified initially but should be carefully reviewed again and verified with the lenders.
- Even for valid approvals, if they are not recent, letters should be going out to purchasers requesting them to be updated, presuming that the purchase and sale agreement allows the Vendor to do so. All of our low-rise and high-rise agreements provide for same.
- Although a fraudulent or non-existent mortgage approval or one which has lapsed and has not been replaced could be a reason to terminate a purchase and sale agreement and retain the deposit as it is being treated as a default under the purchase agreement, we have been recommending to our clients in most cases to avoid problems with purchasers and HCRA/Tarion, to return deposits with statutory interest, if any, and have signed a mutual release. With falling values, builders may wish to rethink this philosophy because they may have suffered damages but to weigh that against the time and expense of suing purchasers who are obviously in financial difficulty already.
- When a purchaser is legitimately having difficulty closing because of dropping values or increase in eligibility requirements, vendors should be flexible and sympathetic. They should give them extra time to work out other arrangements and where appropriate, potentially consider small VTBs if their construction lenders will allow them to do so. Most of my clients have not gone the latter route. However, working with purchasers cooperatively and sympathetically will help vendors in the event complaints are made to HCRA.
- Where vendors are considering terminating purchase agreements because of the lack of mortgage approvals in situations where projects are no longer viable, they should be especially careful in dealing with purchasers fairly and giving them ample opportunity to rectify defaults or chose the option a builder is giving them. HCRA has made it clear that they expect builders to deal fairly and transparently with purchasers in these situations and will examine the facts of every case if purchasers complain about mistreatment or illegal activities. Remember, HCRA has the power to discipline or take away building licenses.
Clearly, the biggest risk for developers and lenders for closings are those purchases that were made over the last 2 years when values skyrocketed some 30-50%. The perfect storm of dropping values and non-eligibility for closing mortgages will certainly impact those projects like the Brampton Project. For those, developers will have to be both pragmatic and vigilant. Builders will have to be flexible but firm in dealing with purchasers. According to the CBC, Paradise has agreed to extend buyers up to 3 months for closing for increased deposits and continues to discuss solutions with purchasers. They have made it clear, however, that as a builder, they have relied on the purchase prices of the contracts and the revenues flowing from those sales to meet their cost obligations, and have constructed homes in reliance upon same.
No matter what happens, I have no doubt that the regulatory authorities, and in particular HCRA, will be watching these situations very closely if purchasers lose deposits, get sued or can't otherwise close. Even though builders may be within their legal rights to take the steps they do, HCRA will be expecting them to deal compassionately and fairly with purchasers. So please remember that.
As for situations where mortgage approvals are no longer available or were fraudulently provided, in situations where costs have dramatically risen to the point where builders can no longer build and make a profit, HCRA has already put out an advisory earlier this summer as to how they expect builders to deal with their purchasers when exercising rights to terminate, either via the early termination conditions or the non-availability of mortgage approvals.
Again, how things are presented, what timelines are given, the type of approach and tone of communications with purchasers will be very important and carefully reviewed by the regulatory authorities.
2023 may be a slow year for sales but many low-rise and high-rise projects are being completed with interim or final closings happening throughout the year that will keep us all busy. We will all be watching the results of these closings very carefully to see the impact of this perfect storm on the ability of purchasers to close.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
