While we work with clients on both resale as well as new build purchases, we’ve always had a bit of a soft spot when it comes to resale properties. There is certainly value that an experienced real estate agent can bring to a pre-construction purchase, but at the same time, the structure of such deals are almost always significantly more constrained.
Put simply, when you buy a pre-construction unit, the developer sets the terms and conditions and there is extremely little room for negotiation on most aspects of the deal. We can always speak to how the development compares to other options, the neighbourhood and potential upside, but we’re operating at the same point in time as our clients. When such developments and finally built, what you get and the market you’re closing in can be quite different than forecasted.
Back in 2019 we wrote about three big problems with buying from a developer during the pre-construction phase and it stands up pretty well even now.
Given our argument still holds now, we won’t restate the same article here. Instead, we’d like to focus on one of the potential problems we identified before that is now happening on a regular basis – developer insolvency.
If you are facing this challenge right now, we strongly recommend you speak with your lawyer about your options. We’ll give you some background on how and why this happens but we’re not lawyers and your rights and obligations with your contract in this situation needs to be discussed with professionals.
Let’s review.
I bought it, so it’ll get built.
One of the biggest misconceptions when it comes to pre-construction development projects is that they always actually get built.
Whether it is a cruise vacation, a factory built vehicle or a custom tailored set of clothes, we have an expectation that something we agree to buy will in fact be ours at some point.
When it comes to pre-construction purchases from a real estate developer, the building of the development is absolutely intended, but doesn’t always take place. While everyone involved presumably starts with the intention of getting to the finish line, a project is “cancelled” when the developer either decides that the project will not proceed, or the decision is taken away from them – and the project does not proceed. If this occurs, then typically the developer will notify the purchasers that it intends to terminate the purchase agreements.
There are number of reasons for project cancellations include the developer not reaching a minimum unit sales threshold, the developer being unable to secure satisfactory financing for construction and completion of the project and of course the developer being unable to obtain the required approvals from the municipality.
Even without a developer encountering financial difficulties that push them into insolvency or bankruptcy, you have no guarantees that a pre-construction project will in fact make it to the finish line.
If you are considering going ahead with a pre-construction purchase, or even buying a finished but newly-built home, you’d be well served if you looked into the developer. In Ontario, a new home builder or vendor must be licensed by the Home Construction Regulatory Authority (HCRA) and the HCRA has something called the Ontario Builder Directory. This directory provides information such as a builder’s licensing status, the number of years a builder has been active, the number of homes they have built, and conduct concerns including any charges and/or convictions against the builder.
You can (and should) check out any developer you’re considering purchasing through in the OBD directory.
I’m covered though, right?
If a development is cancelled, what happens next depends on a number of factors. As we’ve mentioned, your first step should be to speak with a qualified lawyer to tell you about your rights and responsibilities under the purchase agreement.
In a more general sense, you may be able to find a section of purchase agreement that states the Early Termination Conditions. This will say under what conditions the purchase may be terminated – and you can be certain that the developer will have a lot more opportunities for it to be terminated than you!
Whether you are covered in the event of a cancellation of a development depends on a number of factors, including whether it was a condo or freehold project, the stage of the development, why the cancellation is taking place and even what you define as being “covered” in your situation.
If a project gets cancelled, you may be eligible for deposit protection from Tarion (formerly the Tarion Warranty Corporation). Tarion requires builders to provide a warranty to purchasers of new homes and condominiums and part of this warranty includes protection against deposit loss due to builder default.
If the builder cancels the project, they are required to refund your deposit in full, plus any payments made towards extras/upgrades and any interest. If the builder cancels the project and they do not refund your deposit in full, you can make a claim to Tarion for up to $20,000 in compensation. However, this compensation is subject to certain Tarion eligibility criteria and may not cover the full amount of your deposit.
Reading the above, you may say, hold on, how can they be required to refund the deposit in full, yet then it says if they don’t I can make a claim with Tarion? While the reason for cancellation is important (i.e. was it a failure to meet the requirements to move forward, or did they encounter financial problems) the other aspect is the type of property in question, namely a freehold or a condo property.
Freehold, condo, what’s the difference?
When it comes to deposit coverage in Ontario, it makes a big difference if the development in question is a freehold development or a condo development.
A freehold property is, as the name implied, freely held, with few restrictions on ownership. Freehold ownership means that you own the land and house outright, with no space co-owned or co-managed with owners of adjacent homes. You are also solely responsible for the maintenance and upkeep of your property, and the property taxes associated with it.
A condominium is a specific kind of ownership structure that involves shared ownership of common elements and community decision-making and in Ontario, there are several different types of condo corporations.
The type of ownership of the to be built development is crucial to your rights and protections in Ontario. Currently, if you sign a preconstruction contract to buy a freehold home in Ontario any cash deposits made are not required to be protected by a legal trust and can be spent at will by the developer. In contrast, if you buy a preconstruction condominium, those same kinds of deposits are held in trust and cannot be spent.
If a project moves forward as planned, where your deposit was held doesn’t matter much to you. As long as it is applied to the amount owning when you close on the home, you’re good. However, if a project encounters difficulties and goes into receivership, default or any form of bankruptcy, it matters a great deal if those funds are still in a bank account and able to be returned.
If a condo project is terminated by the builder, the deposit must be returned in full within 10 days. If they don’t, Tarion covers up to $20,000 of your deposit but the rest needs to go through the courts. When it comes to freehold projects, there is no requirement for the deposit to be returned in full within 10 days, but Tarion will, in theory, cover to $100,000.
In either case, the key differentiator is whether the project is cancelled by the choice of the developer, in which case they will have to return deposit funds as specified in the purchase agreement, or whether they have had the cancellation forced upon them via lawsuits and bankruptcy. In the case of the latter, condo developments have more protection than freehold developments, as the developer couldn’t spend those deposit funds and they are still there to be returned.
So, can’t win, don’t try?
Given our focus on how it works when a development is cancelled and how you may or may not have deposit coverage, it can be understandable if you come away from this article saying investing in pre-construction is a sure way to stress yourself out.
While developments being cancelled and builders running into financial difficulties is more common these days, a development being done by a reputable builder with a history of delivering on their promises is still pretty reliable.
Our advice is that if you are considering a pre-construction project these days, you work with realtors who understand potential pitfalls and you hire a law firm that can advise on the risks in the type of project and make recommendations on any ways to mitigate those risks.
If you do want to invest in real estate (either for yourself as a homeowner in the property, or as an income property) then we’d love to go through the options for you both on the pre-construction and resale side of the fence. We’re seeing lots of interesting opportunities in properties out there right now for our investor clients and if you get in touch with us, we’ll be able to review some options.
