As rising interest rates batter the real estate market, sellers of preconstruction condominiums are finding there are limits to Toronto’s demand.
It takes years for a preconstruction contract sold today to turn into a finished condo that has to be fully paid for. But industry insiders say the current environment is making long-time condo investors – the engine of the preconstruction market – pickier about the kind of deal they want to tie themselves to.
Zonda Urban’s numbers for the second quarter show in the multifamily space (condo apartments and townhouses) there were 6,129 units launched, which is down 12 per cent from a year ago. In terms of sales, Zonda vice-president of market research Pauline Lierman is seeing some projects soar while others bellyflop.
“We had a bunch of launches – 29 projects launched 30 buildings – that sold 48 per cent of their units,” she said. “And 42 per cent of those sales are in two projects alone, across four buildings. That would be good on a surface level, but the three-year average is 63 per cent [absorption] on a quarterly level.”
That’s a serious adjustment considering that in 2021, Toronto-area developments saw 85 per cent of projects sell 70 per cent of their units in less than three months, according to data from Urbanation Inc.
“Ultimately volume is down because people don’t want to pay the high interest rates,” said Ms. Lierman. In July the Bank of Canada raised the benchmark interest rate a quarter-point to 5 per cent, a level not seen since April, 2001.
Predicting the future rate environment has some buyers rattled, it seems. “It’s a mental scare: people just don’t know: is it [interest rates] going to come down? Is it going to flatten? There are a lot of different signals going on right now and I think, for people reading them, might it be tough,” Ms. Lierman said.
Rate hikes hit preconstruction condo investors when they have to close on a unit they signed a contract for and paid deposits on in previous years, at which point the full cost comes due. Mortgage broker Ron Butler is often consulted by clients facing this situation.
“Investors who bought condos in 2017 and 2018 that are closing now are very sad about the mortgage rates. But they paid 20-per-cent less than resale condos are selling for today,” Mr. Butler said. “They still feel they must close because even though the unit is negative cash flow they are still ‘in the money’ on price.”
The cash-flow comes from renting out units, and even though average asking rents in Toronto are up 14 per cent from last year and are approaching $2,600 per month (according to Rentals.ca), in many cases that still won’t cover the costs of owning a newly built unit.
That said, there is a release valve for investors who want to get off the treadmill: assignment sales, where buyers sell or flip preconstruction contracts to another party.
According to real estate lawyer David Feld, he’s seen an uptick in clients seeking to assign a unit prior to closing. Higher rates raise the costs of things such as interim occupancy fees – sums paid to a developer when an apartment is finished but the building hasn’t formally registered, a process that in some cases can take months – because the interest on those unpaid balances is often above the current prime rate.
He’s also seeing more clients than ever before coming in during Ontario’s 10-day cooling off period of signing a new condo preconstruction contract to back out of deals.
For brokerages that specialize in selling preconstruction condominiums, things are still busy. And unlike last summer, when a series of central bank rate hikes caused developers to delay launches, many builders are full steam ahead to launch new condos after Labour Day.
“It takes time for the development world to absorb the facts that prices have changed and incentives and deposit structures have changed, and some people didn’t get it right,” said Barbara Lawlor, president and CEO of Baker Real Estate Inc., which specializes in preconstruction condo sales.
Pricing, as it turns out, has been more important than location. Twenty-one of the 29 projects Zonda tracked were priced under $1,300 a foot. “Only a handful over $1,400, and those did not perform well,” Ms. Lierman said. Some of the most successful projects were in the 905-belt of Toronto suburbs and were priced between $1,150 and 1,250 per square foot.
According to Ms. Lawlor, developers realize that in addition to pushing the right product at the right price they must also have generous deposit terms and schedules if they want to get skittish buyers on board.
“Our buyers are first and foremost investors,” she said. “They don’t scare too easily, but around the [seventh to ninth] bank rate hike, they were paying attention,” she said.
According to Ms. Lawlor, buyers who are staying in the market believe in the long-term fundamentals of scarce housing supply and rising population. “Because of the long horizon of closings, people who want to invest in new construction condos believe in the equity gain – and there has been gains for 20 years,” she said.