Every level of government has pledged to deliver more housing. Until recently, new rental housing supply came primarily from condominium development. In this article, we’ll examine the development process at a high level and explore what legal recourse can tell us about the status of distressed projects.
The development cycle for condominiums typically spans five to ten years and involves several key phases:
- Land assembly and design: The developer acquires land, designs the project, and obtains conditional approval.
- Pricing and pre-sales: The developer begins pre-selling units to buyers, who may be buying as landlords (investors) or future homeowners. Once the developer has reached the presale threshold required by its lenders, it can start developing the project. This development is funded through the presale revenue, loans from lenders, and the developer’s own capital.
- Construction: With funding in place, the developer starts construction.
- Occupancy: Once construction reaches a certain point, occupancy can begin for units that are ready for occupancy, even if they haven’t been sold yet.
- Condominium corporation formation and payment: The condominium corporation is established, all liens are discharged, sales are closed, and lenders are paid. Any remaining funds represent the developer’s profit.
Risks in the Process
The developer faces several risks between pricing the project and repaying lenders. One significant risk is interest expense, as most loans have floating rates. With interest rates rising sharply in recent years, developers have seen their profit margins collapse.
Development costs add to this pricing pressure. This includes contracts with trades, managing construction material expenses, dealing with municipal fees and charges, and navigating the complexity of the approval process.
The COVID-19 pandemic, along with rising interest rates and inflation, has significantly complicated this process. Disruption in supply chains, quarantine measures and labour shortages slowed construction. Additionally, shortages of material and skill trades have driven up prices.
Statistics Canada’s Building Construction Price Index shows that construction costs across Canada increased by almost 45% from Q1 2021 to Q2 2023, covering 11 major metropolitan areas, including Toronto. In Toronto specifically, costs have risen by over 86% since Q4 2018, which coincides with the period when many of the projects now nearing completion were priced.
Buyer Protections
In Ontario, under Section 81(1) of the Condo Act, a buyer’s deposit for a condominium unit is held in a trust account by an escrow agent and cannot be accessed unless the builder has the appropriate insurance. Deposit protection insurance guarantees the return of the buyer’s funds if the builder files for bankruptcy, breaches the Agreement of Purchase and Sale (APS), or if the buyer exercises their statutory right to terminate the APS.
For a builder to use the buyers’ deposits to finance construction, excess condominium deposit insurance must be in place. Take, for example, a 50-unit condominium project with an average unit price of $500,000. Each buyer is required to deposit 20%, totaling $5 million in deposits. However, only $1 million ($20,000 per unit) is covered by Tarion Warranty Corporation, a not-for-profit company established in 1976 under the Ontario New Home Warranties Plan Act. To access the remaining $4 million, the builder needs additional insurance coverage. Firms that provide this coverage typically charge a premium between 0.5% for well-established developers and up to 1.25% for less experienced developers working on smaller projects.
In insolvency proceedings, unit holders are often presented with two options: they can either surrender their units in exchange for the return of their deposit, possibly with an additional premium, or apply the deposit plus the premium toward a repriced unit. The developer is typically responsible for funding the premium, while the insurers cover the return of the deposit.
Insolvent Projects
Given the multiple layers of pricing pressures, some projects have gone into insolvency. The legal process that follows often reveals the challenges faced by the project. If the project has been mispriced, bankruptcy is usually the most viable solution. In such cases, the proceeds from the sale of a project can be used to pay out creditors who are unwilling to participate in the next phase, allowing the project to be repriced. Under the Bankruptcy and Insolvency Act, this process discharges any unpaid claims, enabling the purchaser to start anew.
Alternatively, if the developer wishes to retain its existing contracts while repricing the units to better align with current market conditions, they will likely proceed under the Companies’ Creditors Arrangements Act (CCAA). While repricing may help, it is a time-consuming process and does not guarantee that the units will sell at the new price.
Conclusion
The challenge for existing projects is that developers with multiple ventures are abandoning or slowing down some projects to manage the potential influx of new supply hitting the market. This will likely result in a slower pace of new condo development in the coming years. While struggling projects are likely to be restructured so that they can be completed rather than abandoned, the uncertainty surrounding these developments is not good for a housing market already grappling with a supply shortage.
In the coming weeks, we will delve deeper into the condo market to explore where the key challenges and opportunities lie.
Independent Opinion
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.
