Many preconstruction buyers are facing the realities of a shifting real estate market, especially those who have purchased preconstruction properties, specifically for assignment.
Last quarter was the worst quarter for new condo sales since the financial crisis. According to market research firm Urbanation, condo sales in the greater Toronto region plummeted 79 percent, with just 1,748 new condos sold in the third quarter.
An assignment is typically a transaction where a purchaser buys a unit from a developer and sells the purchase contract to another buyer prior to closing. Essentially, it’s the paperwork trading hands, for a profit. Assignment sales are also usually not listed on public platforms such as MLS and are conducted privately between agents.
Assignments used to be a hot segment for speculators buying preconstruction projects as prices in major Canadian markets like Toronto, Vancouver, and Calgary saw record price appreciation during the pandemic.
With rising interest rates and price drops in Canadian Real Estate, assignment sellers are now finding themselves in a very difficult situation. In recent years, part of the attraction to assignment sales for real estate investors has been the fact that they only need to put the deposit down rather than have full mortgage financing activated. The contract is typically sold well before closing and the investor doesn’t need to deal with closing the property, avoiding closing costs, getting a mortgage, and holding the property.
With consumer confidence at record lows, the buyer pool for assignments has shrunk significantly, leaving preconstruction investors in a lurch as their closing dates approach.
If you purchased a preconstruction home or unit with plans to assign the unit, here is what we’ve typically seen transpire in recent months.
Challenges with closing preconstruction assignments
Potential default on closing preconstruction assignments
If you cannot successfully assign your pre-construction purchase contract, you’re still liable to close on the property, as per your agreement with the developer. Failing to close may mean breaching your agreement and can lead to the loss of your deposit and potential litigation from your developer, where a court can find you to also be liable for the difference between your agreed purchase price to the current market value, plus legal fees incurred by your developer.
Qualifying for a mortgage at a higher interest rate
Unless you have access to cash to pay in full and close your purchase, you will likely need to qualify for a mortgage to satisfy the purchase price and closing costs. Since most preconstruction purchase contracts were signed in a low-interest-rate environment, qualifying for a mortgage can become a challenge. With current rates and the stress-test, most buyers need to qualify at 7-8% interest rates, leading some buyers to seek other financing options such as private financing or alternative lenders, which typically come in at higher rates and fees to account for the added risk.
Appraisals coming in lower
If you can qualify for a mortgage, most lenders will request that an appraisal be performed on the property prior to approving your mortgage. This is where your appraisal can potentially come in lower than what you have agreed to purchase the property for. Every lender has their loan-to-value (LTV) ratios in place and when an appraisal comes in lower, they will only lend to up to that LTV.
For example, if you purchased a condo unit for $800K two years ago and assumed you are getting a mortgage at 75% LTV, your plan was for a lender to finance $600K, with the remaining funds coming from you. Let’s assume the appraiser determines that in today’s market, your unit is only worth $700K. Your lender will now only lend you up to $525K, leaving you to come up with an additional $75K in order to close.
Appraisals coming in below purchase value have become more common recently.
Selling the assignment at cost or below purchase price
With current market conditions, selling an assignment for a profit may be considerably more challenging. Both investors and end-users who are would-be purchasers of assignments are no longer in the market, leaving a limited pool of investors who are on the lookout for great deals. Some developers have even lowered their current prices to attract new buyers and may be competing with your assignment.
In some cases, selling your assignment at a slight loss may be a better option than defaulting on your closing. If you agree to sell your assignment at the original purchase price or below it, it means you still must cover Real Estate Commissions (since you cannot list your assignment on MLS, most assignment deals are done privately between agents), and legal fees. Depending on the circumstance, you may essentially “pay” the buyer to take on the assignment.
Compared to defaulting on your purchase agreement and facing litigation, selling at a slight loss might be a viable option if you are not able to close or rent out the unit.
Closing and renting
Many buyers are opting to close their pre-construction property and wait out the market by renting the property for a while. One thing to keep in mind is that you may not be the only one with the same idea. Other owners in a building or the area may be looking to rent at the same time, creating an influx of rental inventory, which may reduce the rental pool and rental prices. If you are purchasing a condo, you’ll need to check your agreement as to whether you are allowed to legally rent during the interim occupancy period.
Depending on how long you plan to keep your property rented, or vacant, you’ll need to be mindful of new regulations coming into effect in 2023 such as the Toronto Vacant Home Tax and the Federal Government’s anti-flipping laws.
The bottom line
The short-term outlook for the preconstruction and assignment market isn’t a great one. If you plan to assign a preconstruction property, you need the right financial and legal advice to understand all of your options prior to making a decision. Make sure you speak to your Real Estate Agent, Mortgage Broker and Lawyer to clearly understand your options and how to navigate your situation.
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