The Decibel - Why the condo slump matters for the housing crisis

Episode Date: August 19, 2024

A recent report said that condo sales in Toronto are at a 27-year low. Insolvencies amongst condo developers are rising and set to be 57-per-cent higher than 2023 and 13-per-cent higher than 2009. This means there are a glut of units for sale. And yet, prices aren’t really going down.So what’s happening here? Rachelle Younglai, a real estate reporter for The Globe and Mail, explains why the pre-construction market is in ‘recessionary territory’ and how all of this could make Canada’s housing affordability crisis worse over the next few years.Questions? Comments? Ideas? E-mail us at [e-mail]

Canada's booming housing market has simmered down in the last few months. The newest numbers from the Canadian Real Estate Association show that sales fell 0.7% in July. And that's adjusted for the fact that sales typically slow down in the summer. And the condo market in particular is really struggling. In fact, some parts of this market are slumping in ways that we haven't seen in nearly three decades. One report said it was in recessionary territory. And what's happening right now with condos might actually make housing affordability worse in the long run. Today, The Globe's real estate reporter, Rachel Younglie, is here to break down exactly what's happening with this market for developers, sellers, and buyers.

I'm Mainika Raman-Wilms, and this is The Decibel from The Globe and Mail. Rachel, thanks so much for coming back on the show. Thanks for having me. So we're talking about the condo market today, and this consists of condos that are sold before they're built, which are the pre-construction condos, as well as people who are selling condos that they already own, and that's the resale market. So in Canada, Rachel, how important is the condo market? It's pretty significant. It makes up a huge part of our new construction, our new builds. And it also makes up a fairly significant part of our rental market.

Across Canada, it makes up close to 20% of the rental market. And in Toronto, it makes up 35.5%. So it's significant. Yeah. And of course, in Canada, we talk about affordability a lot, because this is a huge issue. So I guess I wonder, how do condos fit into that bigger picture? Do they help with affordability? Well, condos definitely contribute supply. And developers and even our federal housing agency will say that more supply will eventually mean that housing will be more affordable.

So in that respect, they add supply. And if there's enough and it floods the market with more supply, then presumably the rents would become cheaper or the cost of a condo could become cheaper. Yeah, so I guess the idea is like even if condos are more expensive, some people can get into the condo market, therefore freeing up places that are cheaper rent, I guess, for other people to move in? Theoretically, yes. Okay. But not everyone agrees with that, I guess. Not everyone agrees with that because condos aren't built for every type of tenant or homeowner. So a lot of the condos are built for a single person because they're quite small and studios with just one room. So not everyone

agrees with that. Okay. So let's look at the state of the condo market then overall, Rachel. In terms of sales, where are we at? So in terms of pre-construction sales, we're down dramatically in the city of Toronto. We're at a 27-year low. We're well below the 10-year average in other cities in the country. We're also down, not by that much, but we're down quite significantly. In terms of the resale market, which you talked about, resale condos, we're also down overall. And is this just in the big cities like Toronto and Vancouver? Are we seeing this elsewhere too? We're seeing it also in places like Calgary and Edmonton and Montreal, but it's really a Toronto and Vancouver phenomena right

now where we're seeing this massive drop in condo sales on the pre-construction side. Okay. We're going to get into some of the problems that are plaguing the condo market, of course, Rachel, and really some of the details of why these trends that we're seeing are actually happening. But before we get into that, can we just start by explaining how condo developments are supposed to work in terms of their financing? So like when everything is going smoothly, how does this process work? So before the condo is built, the developer will go out and buy the land. Usually they'll take out a mortgage to buy that land. Then they will get the city's approval to build whatever they want to build. And then after they get that approval, then they will launch the project. And they will have to

sell a minimum of 70% of that condo building's units in order to get financing. So 70% is pretty significant. Yeah, it's significant. Yeah. I would say that if you are a very experienced developer, and you've been around for decades, and you've built dozens of condo buildings, you probably don't have to get quite to the 70%. But most developers, as a rule of thumb, try to get to the minimum 70%. And then the lender will provide financing so they can start digging and building the condo. Okay, so then what happens? So you get all this money from the pre-sales, essentially. What happens with that money?

What happens next? So the pre-construction sales, your buyer will put down a deposit, and then that deposit will go in trust. So as a developer, you're not allowed to use those deposits to build. But that tells the bank that you have sold enough of the condo so that you're not going to be left with this empty building when you finish constructing the building. And then the lender will lend you money to start construction. And that construction loan is typically a floating rate loan, so a variable rate loan, which means it moves in line with the Bank of Canada's benchmark interest rate. Okay. And so I guess in a happy world, then they start construction, the building gets built, people move in, that works out.

Yes. Yes, in the happy world, yes. Yeah, in the happy world. So we're not seeing that these days, though, necessarily. What are we seeing now? Well, right now we're seeing that some projects are stalled, some projects they haven't been able to break ground, some projects some of the work has started and developers are running into issues because borrowing costs are so high and they're not able

to make their payments to their lender. And the lender is saying, OK, that's enough. You have to start paying me. And the lender is either pushing them into something called receivership, where they ask another entity to take control of the construction of the project. Or the developer itself is filing for bankruptcy protection so that it has a break and some relief as it works out its finances. Wow. Do we have a sense of how big this problem is? So we're up quite significantly from last year with the number of condo projects or real estate projects, real estate developments that are insolvent or are facing problems. We're up significantly year over year, and we're up

from the financial crisis. And that happened 2008, 2009, when there was also a global recession, and a lot of businesses were in trouble. So yeah, it's up. Wow. So insolvencies, essentially, you can't pay your bills then? Yes. And so you're saying this is actually worse than the 2008 financial crisis, the state we're in right now, in terms of number of insolvencies? Yes, for real estate companies, yes. Wow. So in terms of bankruptcies, we're seeing an average of 20 per month this year. And that might not sound like very much, but it's up

quite a bit, like I think about 50% compared to 2023 and up about 10% compared to the financial crisis. And that doesn't even include the projects and the companies that are being pushed into receivership. That only includes the bankruptcies. Are there specific types of development, Rachel, that I guess are more at risk of this? Like, do we see any trends here? Yeah, I mean, if you look at the projects that have been placed into receivership, you will see that the developers are, they're not the big names. They are less known. They're not as high profile. I spoke to one expert who described them as unsophisticated developers.

So developers who, you know, maybe this is their first project or maybe it's their second project or maybe they've only been around for five or six years. So they were really benefiting from the boom in the real estate industry. And they're also developers that don't have deep pockets. So if you think of developers with deep pockets, you think of the Canadian pension funds or really large institutional developers like that. Okay. Yeah. Is there an example, I guess, of this that we can look to to understand how this happens? I mean, there's one developer called MapleQuest Ventures. It's a small developer.

They wanted to build housing in Brampton. They bought this land in 2017. They took out a loan, a $24 million loan from a lender to build townhouses, apartments, apartment units, a high-rise apartment unit. And their construction loan or their loan, it went from being a fixed loan to a variable rate loan. And then the interest rate jumped. Quite significantly. Quite significantly. Yes. And so then they weren't able to make their debt payments. And then their

lender asked a court to appoint a receiver. And now they're in receivership. So that's that's one example. But there are examples like this all over the country. Okay. We've kind of, I guess, set out the problem here, Rachel. Let's Let's actually unpack this a little bit now and look at the factors behind the reasons for these trends. So what are the reasons that have led to an increase in insolvencies for condo developers? The main issue are construction costs, delays brought on by the pandemic, and then, of course, the interest rates. Borrowing costs are up significantly. Okay, so one factor that you mentioned, Rachel, is around the cost of construction. So how much has it increased by?

It's up double across the country. In the city of Toronto, it's more than double. The construction costs are up over the past seven years. And that includes things like materials, so concrete, copper, stainless steel, wood, labor costs. I would loop that in with construction costs. So your construction workers, electricians, plumbers, carpenters, all of that is up. So when there's more demand, then contractors can charge more. And that's what has happened. And when did this, I guess, the rise in costs start?

Is this just kind of as a result of the pandemic or did we see this before? Yeah, we definitely saw this before. We can really trace this back to 2017. And what happened in 2017 was there were record sales of pre-construction condos in the city of Toronto. And that just triggered this massive demand for material and labor. And so starting in 2017, you can really see these costs like just continuously go up year after year after year. Interesting. Yeah. Something else you mentioned is delayed projects and this being an issue here. What's causing the delays in building?

One of the delays was the pandemic. So even though construction was considered essential work, there were still delays there because of the social distancing requirements. So for example, construction workers could not all pile into an elevator and go up at the same time. They could only go up two at a time, for example. Or if they were all on a site, they had to socially distance. Then there were all those disinfecting a site, they had to socially distance. Then there were all those disinfecting requirements, so everything had to be wiped down. So all of that added to delays and prolonged the construction process. We'll be back after this message.

So, Rachel, let's talk about what happens once a project has been deemed insolvent. I'd like to walk through the example of The One, which is a building under construction in Toronto. Tell me about that. The One is this luxury condo tower in downtown Toronto. The owner, Sam Mizrahi, bought the land back in 2014 and only got city approval a few years later, then started selling the project. And then there were just all these delays. It's a very, very complicated project. It's being built on top of a subway line. This is right at Yonge and Bloor, so two intersecting subway lines. Exactly. So very complicated site and also

the plan was and is for it to be the super tall condo building, so 84 stories. So very high, very complicated and then they started missing debt payments and then their lender asked a court to appoint a receiver

because the lender no longer had confidence in Sam and his co-developer to develop the project. So now the project is being overseen by a receiver. The construction is being carried out by another construction company, not Sam's anymore. The receiver has put it up for sale. They are trying to sell it. The lenders want a minimum of $1.2 billion for the project. Just to put that into context, the lenders are owed $1.5 billion, so they're willing to take a loss. Help me understand this, Rachel. Why would a different

developer want to buy it? Why would someone buy such a struggling project? Once it's built, it's prime real estate right in the middle of the city, like close to a very high-end part of the city called Yorkville. I mean, it's a great piece of real estate. So the idea is maybe you can get a deal, I guess, on a good piece of real estate. I could get a deal, and it would be a trophy asset for any developer. But it's complicated. It's very complicated, and it's expensive. And so I've spoken to experienced condo developers, and a lot of them had said, no way, they're not going to bid on this. They're not interested because it is so complicated,

and it's halfway done. Some developers do like to go in and scoop up a troubled project. Some very experienced developers would go in and say, well, we have this huge pot of cash and we bring our expertise. We have, you know, years, decades of expertise in building condos. And so they could easily finish something like that. Or it could be a consortium of investors that come in. And what would happen if the receivers can't find a buyer? Well, in this case, the receiver has said, or the lenders have said, they will finish this project, even if they don't get that $1.2 billion that they're asking. For the one. Yeah. And the reason why is that the lenders will not make their money back if the project sits half finished. They have to finish. They have to complete it in order to get their

money back. So that's their motivation to finish it. But for other projects, some projects that are up for sale right now and are in trouble, they might just sit there for years. What's the situation then if you're a person who bought one of those units? Yeah, you'd be waiting for a long time. If we look at, I guess, the condo market broadly here, Rachel, it sounds like this is a market that is struggling. And when markets struggle, prices can drop, right? That's kind of how things work. So when we step back and look at this trend here of insolvencies, what does that mean for people who want to buy a new condo? It could mean a drop in prices, but it hasn't meant a drop in prices yet.

They haven't come down. Not on the pre-construction side, not really. They're pretty stable. And on the resale side, they also haven't really come down. They're pretty stable. And on the resale side, they also haven't really come down. They're also stable. So sellers aren't really budging on prices. So we haven't seen that drop yet. Do we know why not? Like, why aren't we seeing a drop in prices? Okay, well, on the pre-construction side, the reason why we're not seeing a drop is that developers can't afford to drop the price because it costs so much to build or developments that

they're not going to drop the price. They just can't make it work if they drop the price. On the resale side, it could be that these owners can hang on to their properties for a bit longer and they're waiting for Bank of Canada to cut rates a bit more so that more buyers will come in. All I can say is right now we're not seeing a drop in prices. And in terms of resale condos, are we seeing a lot of those condos on the market right now? Yes, yes, yes. Record number of resale condos are on the market right now. Do we know, I guess, do we know why?

I think, I mean, it's a combination probably of a few things. So one reason is we had very slow sales last year. So people just held on to their properties waiting for the Bank of Canada to make a move. And now we're, you know, a year later. And so they if they wanted to sell last year, and they couldn't now they're putting their condo up for sale. Another reason could be that, you know, it actually is a good time to buy if you have the cash, it's a good time to buy because there's a lot of there are a lot of options on the market. So if they're moving up to a house, they might want to put their condo on the market. And the other reason could be that they can't charge high enough rent to cover the costs of their condo. So that could be happening too, all those three reasons. You mentioned how sellers were waiting for the Bank of Canada to start cutting interest rates a little bit before they put it on the market because there'd be more interest, people are ready to buy. This is starting to happen. We're seeing interest rates slowly going down. So are we seeing

buyers come back to the market now? No, we're not. Such a strange time that we're in here. So why not? There are a few reasons for that. Even though interest rates have come down by 50 basis points, mortgage rates are still too high for a lot of buyers. So that's one of them. The other reason is that there is a lot of supply on the market. So buyers don't feel pressure to buy. And they're waiting. They're waiting. Yeah, because interest rates were at 5%, right?

We're now at 4.5. But that's still pretty high. Yeah, it's still pretty high for a lot of residential buyers. Yeah, because interest rates were at 5%, right? We're now at 4.5, but that's still pretty high. Yeah, it's still pretty high for a lot of residential buyers. Yeah. So just before we end here, Rachel, let's just look at the ramifications of all of this. What are the consequences? If this trend in not selling pre-construction condos continues, what are we going to see as a result here? We're going to see less building in the future. So, you know, this year, for the first half of the year, we had, what, 3,000 pre-construction sales in the greater Toronto area.

And that means three years from now, we're going to see fewer condos being built, which means less supply, which means that will aggravate the housing supply problem that we are currently facing. Yeah. Is there anything that we can do, anything that can be done to counter this then and stop making our housing situation worse here? Developers would say cut construction costs. And one way they would like costs to come down is for municipalities to charge them less in development charges. But overall, if construction costs were lower, then they could offer a lower price. And then it would be more affordable for people to buy pre-construction. Always so interesting to talk to you, Rachel. Thank you so much for being here.

Thank you. That's it for today. I'm Mainika Raman-Wel wilms our producers are madeline white rachel levy mclaughlin and michal stein david crosby edits the show adrian chung is our senior producer and matt franer is our managing editor thanks so much for listening and i'll talk to you tomorrow