When is a mortgage payment not a mortgage payment? Move into a newly completed condominium and you are likely to find out.
Reader Dennis Melnbardis raised the question in a recent e-mail. He ran into this vexing situation head on.
"[It]was a great mystery - and a huge unexpected cost. A few years ago when my father purchased a condo, he was charged what was described as 'rent,' which we ended up paying for four months while we waited for the condo building to be 'registered.' This apparently depended on the percentage of occupants who had actually moved into their units," he wrote.
"In my father's case, it was four months of payments ... that did not actually count toward that mortgage and which my wife and I had to help out with because my father could not afford it. If a building is under construction for several years, why can't it already be 'registered' before completion?"
I asked lawyer Anne Hudson of Michael Peter Haddad Professional Corp. to explain the situation. Her firm regularly handles new condo purchases.
First, the idea of what is known as "phantom" rent only affects to the buyers of new condominiums, she says. Second, it is widespread, especially in the city of Toronto.
Under Ontario's Condominium Act, a developer can pass on to buyers the costs he must bear between the time a buyer moves in and when the project is registered and handed over to the newly organized condominium corporation.
Purchase deals cannot officially close until a project is registered. Until then, ownership lies with the developer, and the buyers are, in effect, tenants.
The developer still must make payments on the loan that financed construction, pay municipal property taxes, and cover the upkeep costs for common areas such as the pool and landscaped grounds.
The Condominium Act says that since people who have just moved in are not yet owners, they must pay enough in rent to ensure the developer is not out of pocket.
How widespread is phantom rent? Ms. Hudson says that she can think of only one condo in the past seven years where buyers did not face such payments. While in most projects the rental period is two to four months, she has seen situations in which that period stretched to eight months.
Now, down to the nitty gritty.
The Condominium Act allows a developer to charge tenants for three main expenses in the period between occupancy and condo registration: property taxes, a prorated share of common operating expenses and interest on the unpaid balance of the purchase price.
That interest rate is based on what the Bank of Canada says is the rate for one-year mortgages.
"In fact, many people may have negotiated mortgages lower than the suggested rate," Ms. Hudson says. That means their phantom rents may be higher than the regular monthly mortgage payments they will be paying once the project is registered.
Why are there phantom rents?
The bureaucracy is swamped with new condos, and the process of registering new suites is a lengthy one.
Before a condo can be registered, the developer must file what is known as a declaration with both the municipality and the provincial land registry office.
That is just the first step, however.
Once that declaration is registered, each unit within a condo must be properly described and recorded at the land registry. In the case of a condo with 300-plus suites, it is like registering an entire subdivision. It takes time.
Ms. Hudson says that, on average, the process takes about two years. Developers usually start the legal process the moment construction starts.
Problems arise when it takes less than two years to build the project. Yes, people get to move in, but they do not yet own their homes. The paperwork is not yet completed.
With more than 330 condo projects currently under way in the Greater Toronto Area, it is easy to understand the challenge faced by the bureaucracy, she says.
So, can anything be done to avoid an unpleasant surprise come move-in time?
Start by going through the documents with an experienced real estate lawyer during the 10-day rescission period - the time buyers get to change their minds after signing an offer to purchase, Ms. Hudson says. Then you can make counter offers to the developer or seek changes to the purchase agreement.
A larger down payment tendered in increments before closing will reduce the unpaid balance and the interest charged as part of phantom rent. An all-cash sale will do away with that element of phantom rent entirely.
"What I can also see happening is that developers may be more willing to offer incentives as the condo market cools," Ms. Hudson says. "A slowing in sales may also mean a slowdown in new projects and that, too, will help reduce the number of registrations that must be dealt with."