Real estate market storm clouds are gathering

A house for sale in the Annex neighborhood of Toronto on July 18.Fred Lum/The Globe and Mail

Real estate industry professionals who help homeowners deal with rising interest rates and crushing debt are trying to keep up with the volume of new business these days.

“We are aware that the storm is brewing and is likely to get worse,” warns Mark Morris, a Toronto-based real estate lawyer.

Today, credit has tightened, extensions are commonplace and defaults are on the rise, says LegalClosing.ca director. The buying and selling process used to be “very clean” when there was an abundance of money flowing through the system, Mr Morris says, but now that flow has dwindled to a trickle.

Some buyers are asking sellers for more time to find the financing they need to close a deal, and defaults are also on the rise, says the lawyer, who has 15 to 20 problem files on his desk on any given day. Buyers considering relying on a home equity line of credit, or HELOC, to purchase additional property are finding that avenue closed.

Mr. Morris is watching the new construction segment carefully, where he sees dangers ahead. He points to the many people who have signed a contract with a builder before the start of construction on a new project. A number of these buyers expect to be able to sell the contract to another party without ever taking possession of the property.

When prices rose rapidly, speculators often made large profits on so-called cession sales.

He sees complications on the horizon as many of these initial buyers cannot afford to complete the purchase once the unit is complete, especially in today’s economy.

To contain inflation, the Bank of Canada has raised its key rate four times since March to bring it to its current level of 2.5%.

Few will be surprised to learn, Morris says, that lenders have often been lax in extending finance to builders without requiring strong evidence that their buyers in the pre-construction market qualified for the property. .

Investors on fragile financial bases are faced with the completion of their units without the possibility of trading on the unregulated disposal market.

“This market is now illiquid,” says Morris. “Buyers will find they can’t give away the product if they can’t afford it.”

In the current environment, Samantha Brookes, Managing Director of Canada Mortgages, advises potential buyers that they cannot skip any steps to apply for a mortgage pre-approval. Lenders have become much more rigorous in ensuring that a borrower is creditworthy.

“They want documents in advance,” she said. “Consumers need to know they need to have their information ready.”

While interest rates have been much higher in previous decades, today’s consumer debt levels dwarf those of the past, Morris says.Fred Lum/The Globe and Mail

In some cases, Ms. Brookes sees three or four people from the same family apply for a mortgage to buy a property.

“Parents and kids are all on the title just to buy a house,” she says. “They’re trying to make it work.”

Ms Brookes urges buyers in the current market to ensure their offer is conditional on financing.

“Don’t waive any type of funding terms no matter what you’re told,” she says.

Ms Brookes also recommends that buyers have a short closing period of four or five weeks to avoid the problem of the property falling in value before the appraisal is complete.

As rates have skyrocketed, Ms. Brookes says, her business has had to cut back on marketing because it’s overwhelmed with customers who need to refinance an existing mortgage or run into problems when the loan comes up for renewal.

“A lot of people are looking for solutions.”

In the most severe cases, a homeowner may have had a fixed-term mortgage with an interest rate of, say, 1.89%, only to have the lender present them with a rate of 5.89% at renewal.

“A lot of them are already in sticker shock,” she says of consumers renewing today.

Ms Brookes can often find a solution for borrowers by extending the amortization period, which can be up to 40 years, she says.

“We stop bankruptcies quite frequently.”

Some homeowners let things slide as they defaulted on mortgages, received letters from the lender, and eventually had the bank foreclosed.

“We have people coming to us who have already been locked out of their homes by the sheriff,” she says. “They leave it until the last minute.”

Ms Brookes says mortgage brokers can help some borrowers in such dire straits refinance, pay off arrears and deal with the fees and penalties that accrue daily.

She believes that more homeowners will face financial hardship as rates continue to climb and more mortgages need to be renewed.

“I think by September or October we’ll see a lot of people jump ship.”

Mr. Morris sees a significant risk in the heavy debts that many Canadians have accumulated in recent years. People have borrowed against their home’s equity to pay for large expenses in the past, but the practice of drawing HELOCs for day-to-day expenses has accelerated in recent years, he says.

A house for sale in the Annex neighborhood of Toronto on July 18.Fred Lum/The Globe and Mail

“People started using houses as bank accounts five or six years ago,” he says, pointing out that people who borrow to maintain their lifestyles have to continually borrow more. “I’m not sure people understand how much houses have become part of the paycheck,” Morris says.

Household budgets are already under strain, he says, and the Bank of Canada is expected to raise rates further at upcoming meetings.

Many Bay Street economists expect the central bank’s benchmark rate to sit at 3.25% or 3.5% this year as policymakers try to rein in soaring prices. Inflation in Canada hit an annualized rate of 8.1% in June, marking a four-decade high.

The central bank has identified high levels of household debt and high house prices as the two main vulnerabilities in the country’s economy. Bank of Canada Governor Tiff Macklem said his main goal was to bring inflation back to target.

While interest rates have been much higher in previous decades – topping 20% ​​in the early 1980s – today’s consumer debt levels dwarf those of the past, Morris adds.

Mr Morris fears rising debt service charges could lead to a tipping point that forces a wave of people to sell their homes as house prices fall. The combination can lead to a downward spiral, he warns.

Meanwhile, the buyer’s remorse that saw real estate transactions falter before the close subsided after the early spring tumult, he says.

At that time, buyers buying during the heady days of February and March were sometimes distressed to find that prices had fallen in the two to three months between when the deal was made and when the deal was done.

“Suddenly people were caught up in the curve because they had no idea what was going to happen,” he says.

The transition was painful for people who had bought a new home before selling their existing one, he says.

“This type of deal has largely worked its way through the system,” he says, because most of the sales that took place when prices were at their peak have already been done.

Now he faces the upheaval of tight credit and rising rates.

“Rising interest rates are really, really really starting to bite.”

A wave of registrations is already there, he says, adding that the wave is likely to grow.

At the same time, borrowers who have to go to private lenders for a second mortgage face interest rates of 18% or more, Morris says.

Mr. Morris harshly criticized Mr. Macklem and his assurances to Canadian businesses and consumers in July 2020 that interest rates would stay low for a long time.

“People were counting on it,” says Morris. “It was extreme negligence to give the insurance, even with the storm clouds brewing.”

Mr. Macklem recently reiterated his view that a soft landing is possible for the Canadian economy.

Mr. Morris believes that the only scenario that could save the real estate market is a recession. A contraction in the economy may already be underway, he adds, and that in turn could lead the central bank to cut interest rates again.

Yet he does not hope for this dismal outcome as it would cause severe economic hardship.

“It brings hardship to people. It will be very difficult for many Canadians.

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