Custom Search
|
|
How Will Canada's New Mortgage Rules Affect Condo Pre-sales?
On February 16, 2010, Canada’s Finance Minister Jim Flaherty announced changes to federal mortgage rules that will take effect on April 19, 2010. These new rules will likely affect all residential real estate purchasers in Canada. In summary, the new rules are: 1. Purchasers must qualify for a five-year, fixed-rate mortgage. Previously, purchasers only had to qualify for the less conservative three-year, fixed-rate mortgage. This may preclude buyers who would have qualified under the old rules, but who cannot qualify for the new ones: for example, a lot of first time home buyers fall into this category. 2. Homeowners may only re-finance up to 90% of their home value rather than the previously permissible 95%. This change is not expected to have a significant effect on pre-sales and is not discussed in this article. 3. A minimum 20% down payment will be required for properties not occupied by their owners. Under the previous rules, the down payment required for such properties was 5%. The minimum down payment of 5% for owner-occupied homes remains at 5%. While there is an abundance of analysis and commentary about the changes readily available on the internet, almost none of it concerns the effect the new rules have on condo pre-sales. Pre-sales and typical home purchases - what’s the difference? The starting point in this discussion must be the difference between pre-sales and the typical purchase and sale of a home. In a typical sale, the vendor and buyer negotiate a purchase price, deposit and closing date. An industry standard four-page agreement is then signed, along with an addendum that includes a number of subjects typically for the benefit of the buyer. The vendor and buyer agree to a date on which all of the subjects must be removed. If the subjects are removed, the agreement becomes a binding contract to complete the purchase and sale on the agreed closing date. If the subjects are not removed, the agreement is canceled and the vendor is free to sell the property to another prospective buyer. The most common subject states that the agreement is subject to the buyer obtaining approval for a new first mortgage on terms set out by the buyer. If the buyer cannot obtain that mortgage approval, the subject is not removed and the deal is cancelled. A pre-sale is very different. The most obvious difference is that the buyer has no opportunity to inspect the property before he or she agrees to buy it. At the time the agreement is entered into, the property is normally nothing more than a vacant lot on which a proposed condominium development is to be constructed. A demonstration unit may be set up in a sales centre, but it may not be an exact replica of the intended final product. A pre-sale contract is much longer than the industry standard contract for residential property. It ranges from about 12 pages to over 30 pages of small print and is written almost entirely in favour of the developer. Its terms - including price - are generally non negotiable. Pre-sale contracts do not contain agreed upon closing dates. They typically contain a target completion date that may be extended many months without penalty to the developer. The buyer may be given as few as 10 days’ notice of the eventual closing date. If the buyer does not close on that date, the developer may keep the deposit and sell the property to someone else. There are no subjects in a pre-sale contract. Notably, the pre-sale contract is not subject to the purchaser obtaining a mortgage. If the buyer cannot obtain a mortgage when it comes time to close, the developer will keep the deposit and sell the property to someone else. Fortunately, all pre-sales are subject to the Real Estate Development Marketing Act (the“Act”), consumer protection legislation that governs the marketing and sale of pre-sales. The Act is a technical statute that imposes various obligations on the developer. If certain obligations are not met, the purchaser may be able to cancel the pre-sale and get his or her deposit back. For example, if the developer fails to notify the purchaser of changes in the condo design, the purchaser may have a way out of the contract. How do the new rules affect pre-sales? A purchaser may have signed a pre-sale contract in 2007 expecting to complete the sale in 2010. The new mortgage rules could throw a significant wrench in those plans. 1. Tougher mortgage qualification standards The requirement to qualify for the conservative five-year, fixed-rate mortgage makes it more difficult for many purchasers to complete on their pre-sale contracts. As the pre-sale purchase is not subject to a mortgage pre-approval, purchasers who are unable to obtain financing will either: a. find a way to assign their pre-sale contract to someone else (usually at a fee payable to the developer); b. find a lawful way to cancel or rescind the pre-sale contract and have the deposit returned; or c. lose the deposit and walk away from the deal. In a declining market as was recently experienced in BC, the risks to purchasers increase. Purchasers who fail to complete may face a lawsuit for additional losses. The purchase price is locked in when the pre-sale contract is signed. If the real estate market declines and the purchaser fails to complete when the unit is ready, the developer will sell the unit for less than the price set out in the pre-sale contract. If the developer ultimately sells the unit for an amount that does not equal: a) the re-sale price plus; b) the deposit already paid by the original purchaser, the developer may sue for the difference. In 2009, some condos were re-sold for 40% less than the agreed upon purchase price. If the original purchaser paid a 15% deposit, the developer still loses 25% of the money it expected to receive. Many developers have sued the original purchasers for that 25% difference and the deposit paid. Purchasers who have already lost significant deposits are being asked to pay even more. 2. Increased down payment for investment properties Perhaps the most worrisome rule change for pre-sale purchasers is the quadrupling of the minimum down payment from 5% to 20% for non owner-occupied properties. Pre-sales have been a popular form of investment since the 1990’s. In addition to gains in equity, completed condos can serve as a valuable income-generating asset. Minister Flaherty refers to those who purchase pre-sales as an investment as ‘speculators’. They are more accurately called investors. Most investors enter into pre-sale agreements with the belief that their investment will increase in value. They will pay a deposit to the developer (typically 10% - 15% of the purchase price) and, if all goes well, the unit will be worth more at closing. Obtaining a mortgage for the balance of the purchase price (including 5% GST) will be fairly easy. If the value of the unit does not change, the new rules will require the purchaser to obtain a further 5% - 10% (on top of their original 10% - 15% deposit), plus 5% GST to qualify for a mortgage. On a $500,000 condo, this would mean obtaining $50,000 - $75,000 cash on as little as 10 days’ notice, plus still having to qualify for the mortgage. The implementation of the HST means that figure will only increase. Of course, things don’t always go as planned. Under the old rules many purchasers – both investors and those purchasing a home – have been confronted with a situation in which the value of the unit is now equal to or less than the price they agreed to pay. If the unit has dropped significantly in value, it may be worth less than the purchase price minus the deposit. From a bank’s perspective, there will have been no down payment even though the purchaser paid a 15% deposit to the developer. The purchasers would be forced to come up with additional cash to meet the current minimum 5% down payment. This is a difficult proposition for many. When the minimum down payment quadruples, it will be impossible. Using the example above, the purchaser would be required to come up with at least $100,000 cash at closing in addition to qualifying for a mortgage. An illustration: No change in the market or mortgage rules: Original pre-sale purchase price $500,000 Minus 15% deposit paid to developer - $75,000 GST on purchase price $25,000 Amount owing $450,000 Market value: $500,000 Amount bank will finance (95% of market value plus GST) $498,750 Amount of cash purchaser will need at closing $ 0 No change in the market, new mortgage rules: Original pre-sale purchase price $500,000 Minus 15% deposit paid to developer - $75,000 GST on purchase price $ 25,000 Amount owing $450,000 Market value $500,000 Amount bank will finance (80% of market value plus GST) $420,000 Amount of cash purchaser needs at closing $ 30,000 15% decline in market, old mortgage rules: Original pre-sale purchase price $500,000 Minus 15% deposit paid to developer - $75,000 GST on purchase price $ 25,000 Amount owing $450,000 Market value: $425,000 Amount bank will finance (95% of market value plus GST) $423,938 Cash purchaser needs at closing $ 26,062 15% decline in market, new mortgage rules: Original pre-sale purchase price $500,000 Minus 15% deposit paid to developer - $75,000 GST on purchase price $ 25,000 Amount owing $450,000 Market value $425,000 Amount bank will finance (80% of market value + GST) $357,000 Cash purchaser needs at closing $ 93,000 Under the old mortgage rules, if an investor paid a 15% deposit on a $500,000 pre-sale and the market dropped by 15%, the investor would need approximately $26,000 cash at closing. Under the new rules and in the same circumstances, the investor would need $93,000 cash at closing before being considered for a mortgage. What to do As noted earlier, all pre-sales are subject to the Act. Most purchasers who cannot or will not close do not obtain legal advice until the time of closing or even after that date. While the Act confers important rights on to purchasers, many of those rights can be significantly eroded or disappear through the passage of time. If you are concerned that you cannot or will not be able to close on your pre-sale, you should seek legal advice as soon as possible in order to ensure the preservation of your rights. Article Directory: http://www.articledashboard.com Wesley J. McMillan is an associate with Harper Grey LLP in Vancouver. He has significant experience helping pre-sale purchasers and in many other types of real estate, small business and construction litigation. If you have questions about a strata property or other real estate matter, you are welcome to contact Wesley at any time via phone (604 895 2843) or email: wmcmillan@harpergrey.com |
|