Residential
property developers are facing rising insolvencies as they struggle
with higher borrowing and construction costs – and industry experts warn
the trend is likely to worsen as interest expenses remain elevated.
The
number of insolvent real estate companies and projects has been rapidly
climbing over the past year and is now on track to surpass levels of
the global financial crisis, according to data from the federal Office
of the Superintendent of Bankruptcy.
“This
has been a long time coming,” said Colin Doran, head of development
advisory for commercial real estate firm Altus Group, who has been
providing advice on distressed real estate projects for 15 years.
“There
are no doubt more real estate projects in distress but it’s hard to
tell how many can be worked out before ending up in an insolvency
position. We expect there will continue to be more unsophisticated
developers in trouble,” he said.
From
January to May this year, there was an average of 20 real estate,
rental or leasing insolvencies in Canada every month. Companies either
sought bankruptcy protection or filed creditor proposals to make it
easier for them to manage their debts under the Bankruptcy and
Insolvency Act.
At
this pace, Canada is on track to reach about 240 real estate
insolvencies this year, which would be 57-per-cent higher than 2023 and
13-per-cent higher than 2009, when a wide swath of businesses ran into
problems owing to the financial crisis and global recession.
And
that does not include the number of developers and projects that have
been forced into receivership for not paying bills. The Office of the
Superintendent of Bankruptcy does not include receiverships with its
publicly available bankruptcy statistics. However, insolvency experts
say they are seeing more projects go into receivership.
So
far this year, the real estate sector accounts for 55 per cent of the
receiverships recorded by Insolvency Insider Canada, a website that
tracks the largest insolvencies in the country. That compares to 30 per cent last year and 33 per cent in 2022.
Sam
Mizrahi’s luxury downtown Toronto condo tower The One has been one of
the highest profile projects to default on its loans, with lenders owed
$1.6-billion. And dozens of other developers have faced similar pressure
from their lenders or have filed for bankruptcy protection.
“For
the first time in a really long time in Canada, we are seeing some
stress in the system,” said Syl Apps, who co-heads the Canadian
operations of Hines Interests LP, a Houston-headquartered real estate
firm that owns and manages about 850 properties in 30 countries.
So
far, that stress is being felt amongst the relatively smaller
developers or those that do not have the financial strength to weather
interest costs that have soared since 2022.
Take
Maplequest Ventures, a small developer that had plans to build housing
on two parcels of land in Brampton, Ont. Maplequest took out a
$24-million loan from KingSett Mortgage Corp. in 2017 to develop one of
its Brampton sites into 147 townhouse units, 288 mid-rise apartment
units and 1,599 high-rise apartment units, according to court filings.
The
loan soon had an interest rate that was tied to a major bank’s prime
lending rate, which moves in tandem with the central bank’s benchmark
rate. By 2021, the KingSett loan had an interest rate that was the
bank’s prime lending rate plus 5.8 per cent.
The
loan eventually became much more expensive as the Bank of Canada raised
interest rates from 0.25 per cent to 5 per cent over 2022 and 2023.
During that time, the prime lending rate jumped from 2.45 per cent to
7.2 per cent.
This
year, Maplequest defaulted on its loan to KingSett Mortgage Corp., as
well as another loan with First Source Mortgage Corp., court filings
show. The lenders lost confidence in the developer, triggering them to
apply for a court-appointed receiver to oversee the project.
The court filings did not explain the reasons for Maplequest’s default. The
developer’s CEO and its lawyer did not respond to a request for
comment. KingSett did not immediately respond to a request for comment.
Some
of the current problems in residential development can be traced back
to 2017 when home prices were rising quickly in Toronto and demand
exploded for new condos.
That
year, there were nearly 31,000 preconstruction condo sales in the
Toronto region, according to industry research firm Urbanation Inc. That
was a record level and led to a surge in demand for construction
workers and building materials – which started driving prices up.
The
cost of construction rose 10 per cent from 2017 to 2018 in the Toronto
region and 8 per cent across the country’s major cities, according to Statistics Canada’s residential building construction price index.
Developers
quickly expanded, including less experienced builders who were able to
sell out preconstruction projects as waves of mom-and-pop investors
flooded the market.
At
that point, investors were able to easily make a profit on the condo’s
price appreciation and the majority of them could cover their mortgage
costs by renting their units out.
But
the torrid pace of launches and sales helped mask problems that
developers were starting to face. By 2021, low interest rates were
fuelling the pandemic real estate boom and preconstruction sales soared
to near record highs of 30,550 units in the Toronto region. By then, the
cost of building was 34-per-cent more expensive across the major cities
compared to 2017, according to Statscan data.
Then
the pandemic slowed down development. Construction was hindered because
workers had to socially distance on site. Developers delayed the start
of construction – and they also delayed project launches.
This
all added to the costs. Developers had to carry their mortgages for
longer. Building materials were in short supply. And when the Bank of
Canada raised interest rates, developers had to pay much more for their
loans. Now that mortgages are more expensive, some preconstruction condo
buyers are not able to qualify for the loan needed to close on their
purchase, which is contributing to the malaise in the sector.
Today,
the cost of residential construction is 81-per-cent higher across
Canada’s major cities compared to 2017 and more than double – up 107 per
cent – in the Toronto region, according to Statscan data.
The higher borrowing costs are pushing a growing number of developers over the edge and lenders are no longer patient.
“A
lot of lenders did that to the best of their ability. They entered into
forbearance agreements, accepted some missed payments and basically
worked with the borrowers,” said Jeffrey Berger, managing director with
restructuring and insolvency firm TDB Restructuring Ltd., whose company
is working on between 10 to 15 insolvent real estate projects.
“Two
or three years passed, and then it became clear that this was the new
normal and things were changing and these loans had to be dealt with in
some manner,” he said.
That
is what occurred with two plots of land on King David Inc.’s luxury
condo development site in Markham, Ont. Part of the project is under
construction, according to court documents. King David planned to
continue developing on the other two plots and in December, 2021, it
borrowed $54-million from First Source Financial Management Inc. The
loan had an interest rate of the greater of 8.85 per cent or prime plus
6.4 per cent.
At
the time, prime was 2.45 per cent. But by the time the loan was due in
April, 2023, prime was 6.7 per cent. King David did not repay First
Source by the deadline, according to court documents.
The
lender cut King David some slack and agreed to a forbearance agreement,
which gave the developer more time to repay the loan. The new deadline
was July 8, 2023, the court documents said.
When
the company failed to repay the loan by the new deadline, First Source
provided a second forbearance agreement that extended the loan repayment
deadline to Oct. 8, 2023. Then, when First Source learned that King
David would not meet that deadline either, it provided a third
forbearance agreement with a deadline of Dec. 8, 2023, that required the
borrower to make a monthly interest payment in November.
King
David failed to make that interest payment, according to court
documents, and First Source decided to take action. In early December,
it asked the Ontario Superior Court to appoint a receiver to take over
the undeveloped land.
“The
lender is concerned by the borrower’s failure to advance the project.
The property remains vacant,” First Source chief executive David Mandel
said in an affidavit filed with the court. “Despite having been granted
forbearance since April, 2023, the borrower has been unable to refinance
the loan or bring the loan back into good standing.”
A
lawyer for King David said the company is not insolvent or in
receivership and that only this specific block of land, known as phase 2
and 3 lands, is in receivership. Asked what led King David to default
on payments, the developer’s lawyer, Avi Bourassa, a partner with Ross
Nasseri LLP, declined to comment.
First Source did not respond to a request for comment.
The Bank of Canada
started cutting its benchmark interest rate this summer, but borrowing
remains expensive and there is little demand for preconstruction condos.
Developers
used to be able to pass on their higher costs to buyers but prices have
jumped so much that buyers will not buy the new condo units.
For
those who have already bought investment properties, the purchase price
is now at a point that an overwhelming share of new condo owners are
burning cash because the rent they can charge is not enough to cover
their mortgage payments and other expenses. For example, in the Toronto
region, the asking price of a preconstruction condo has nearly doubled
from 2017 through this year to around $1,345 per square foot, according
to data from Altus. That puts the price of a 550-square foot condo at
$740,000.
“There
is less room for error. In the past, a developer could be good at sales
and make their way to completion. Now they have to be good at all
aspects, including planning and execution,” said Altus’ Mr. Doran.
“If
developers were already struggling with lower margins impacted by
planning delays, construction delays, cost escalation, then the impact
of the rising interest rates were a double whammy to their proforma and
project profitability,” he said.
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