Condo Allotment Sales Fuel Canadian Market Speculation

A condominium development in Toronto, on May 19, 2021.Christopher Katsarov/The Globe and the Mail

As tens of thousands of people opt to put down deposits and sign contracts to buy a condo unit before construction begins, those close to the industry say many of them have no intention of buying the finished product.

“A lot of people are buying on the assumption that they’re going to give in,” said Sundeep Bahl, a salesman for Re/Max Real Estate Solutions, referring to the unregulated market where buyers sell or deliver pre-construction contracts to another party. “As soon as you sign, the first question is: ‘Is there a transfer clause?’ Many people are just speculators in the market,” he said.

That is a conclusion that has been reached by many who are close to the preconstruction market, but unlike the public stock or bond markets, there is no data available to study how this market behaves. Builders maintain their own allocation records, most transactions are done in private, and there are no government regulations to collect or analyze these contracts.

“I know people who are buying 50 and 20 [pre-construction condos], they’re going to assign them,” said David Feld, a real estate attorney and entrepreneur who works with True Condo Team, which specializes in pre-construction condominiums. “I’ve done it twice myself. [flipped an assignment] and I have three more to come… three that I have made deposits on.”

The Canada Revenue Agency has performed spot checks on allotment sales because earnings from changing an allotment are taxable. In 2016, the CRA conducted an audit of the condominium buildings and compared the initial sales records to the people who eventually purchased the units. Among 69 projects, he found 2,810 contracts that were invested.

Most pre-construction contracts prohibit owners from advertising an assignment sale on a real estate multiple listing system. So while there are currently more than 50 assignments for sale listed by the Toronto Regional Real Estate Board, it is believed to be only a small fraction of the total available assignments.

“Anecdotally, an increasing proportion of investors have been purchasing pre-sale condos recently, with the expectation of assigning them rather than holding them for rent due to rapidly accelerating prices and lower expected rental cash flow,” said Shaun Hildebrand, president of market research firm Urbanation Inc.

Hildebrand said the costs of new construction condos are rising faster than the rental rates that the traditional investor model relies on to pay off any mortgage. Urbanation’s Toronto area data shows the price per square foot has risen 25 percent in the past two years to $1,324 by the end of 2021. To cover transportation costs once built, assuming a mortgage rate below 4 percent and -cent down payment: A condominium investor would have to charge $6.25 per square foot of rent. Right now, newly built condominiums rent for an average of $3.50 per square foot, which is 80 percent lower than breakeven. While downtown Toronto condo rentals were up 15 percent in 2021, the regional average was closer to 10 percent.

It’s not that the widening gap between purchase price and maintenance costs has slowed buying activity. “Baker Real Estate has released 10 buildings so far this year,” said Barbara Lawlor, CEO of Baker Real Estate Inc., which specializes in selling preconstruction condos to developers. “It’s intensely busy and we’re at a time where demand outstrips supply.”

But Ms. Lawlor said she thinks most buyers will buy and hold condos: “The keyword is not really in our language. … That word has not been used in typical conversation.”

More than 30,000 pre-construction condominium units were sold in 2021, the second-highest total ever recorded in Ontario (after the 2017 wild market that saw 31,216 units sold). That’s up 69 percent from 2020’s 18,000 units. Mr. Hildebrand said anecdotally, buyers who ultimately assign their contract to another buyer before construction closes account for about 10 percent of all units. sold. That means if typical ratios hold, more than 3,000 of the condos sold in 2021 may have been purchased by someone with the intention of selling the allotment.

“January and February was extremely busy, we did 8-10 [assignment flips] in a month,” Bahl said. “Some of those people were making $200,000 to $300,000 more than what they paid.” But Bahl warns that anyone buying today may not find the same pot of gold if the market cools. “If they allocate in the next two or three years, can they make $300,000 more? That is an assumption that has not been tested.”

The industry standard is to require a mortgage pre-approval letter from a major bank to accompany a purchase. This requirement serves two purposes: it eliminates unsound investors or speculators, and it provides a guarantee to the construction lender that previously sold condominium units have a real person behind them. But some in the industry doubt the value of such safeguards.

“They’re not worth the paper they’re printed on,” Feld said, suggesting that a mortgage approval can’t be trusted two to five years later when it comes time to finalize a purchase. By then, the buyer’s circumstances may have changed; loan rates may have changed; even the purchase price of the unit may have changed. What’s more, some in the industry say it’s possible to get mortgage letters from multiple banks, or even from the same bank for multiple units, leaving the question of how the buyer will pay for a later date.

Mr. Bahl said he changed assignments for condominiums purchased for him, after realizing he would not be able to close all of them.

“I think today’s pre-sale investors are probably more short-term minded than in the past, but they don’t represent a systemic risk to the market,” said Hildebrand, who argues that condo prices will continue to rise as long as more people continue to want live in the Toronto region. Assignment flippers are also subject to a number of additional fees that can range from $5,000 to $25,000 to complete a flip. That often means the contract must have achieved more than 30 percent price appreciation to be profitable. “They are contributing to the excessive appreciation that we are seeing, which certainly has the risk of correcting itself in the short term.”

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