Nervous investors looking to offload their pre-construction condos in the secondary market may find themselves out of luck, industry watchers say, as a softening real estate market and rising interest rates send buyers to the sidelines.

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Pre-construction condo flippers may be left holding the bag as buyers disappear Back to video

A number of real estate agents in the Greater Toronto Area told the Financial Post they have been seeing a surge of calls asking about “assignment sales,” a kind of legal transaction in which the original pre-construction condo buyer “assigns” or transfers the rights and obligations of the purchase agreement to another buyer.

Because pre-construction units have not been registered, such sales are not advertised on the MLS system, and comprehensive data on the market is limited.

But those in the industry say stagnating condo prices are making it more difficult for owners to exit their investments.

At Precondo.ca, an online catalogue of pre-construction units across the GTA, investor concern is evident in an increase in chatter about such sales.

The overall share of conversations with the intent to trigger an assignment sale jumped from four per cent in 2017 to 14 per cent this year, based on a sample of 78,000 calls that were screened for the use of the words “assignment,” “assign” or “flip.”

Precondo.ca chief executive and co-founder Jordon Scrinko said he has never seen the assignment market this soft before.

“Within the past three to five years, there is a sizeable chunk of the market of the pre-construction buying pool, who bought units that may never actually intended to close on, and some of them — even more worrying — actually factually cannot afford to close on,” Scrinko said.

Scrinko added that if push came to shove, most of these buyers could afford to close, though they never intended to complete the sale and were hoping to flip the contracts for a profit. A more typical client, by contrast, might be forced to pursue the option because of a life event, such as job loss or divorce, or an inability to get financing as interest rates rise.

Timing will be a big factor in determining which of these investors will see a profit on their pre-construction purchases, Scrinko said.

“If they bought five years ago, they’re still in profit in nine out of 10 cases,” he said. “But if they bought, say 2020 or end of 2019 and … the building’s coming up on occupancy today and they’re trying to flip that contract today — in most cases, those people are not equity-positive.”

Those units are underwater because the prices for pre-construction condos, which used to sell below market rates, have in recent years soared due to rising construction costs, with units now commanding 10 to 20 per cent more per square foot than similar resale condos. With condo prices trading sideways over the past two years, the valuation gap has not closed.

Scrinko also noted interest in new pre-construction condos has been slowing down.

“Early this year, (around) January, February, March, if you launched a condo building, pretty much no matter where it was and no matter what the price was, the market would absorb it pretty quickly,” Scrinko said. “Nowadays, it’s the complete opposite. It’s more of a balanced market where developers can’t expect, in most cases, to sell.”

Real estate organizations have also raised red flags about the pre-construction space recently. Re/Max’s Oct. 12 condominium report noted that pre-sale condo construction has been particularly challenged by the current environment.

“Builders who are too far invested are moving forward, but many of these buildings are now selling at $1,400 to $1,500 per square foot,” the report said. “This, at a time when the resale market rate is $1,100 per square foot. Development costs alone have risen an estimated 18 to 22 per cent in the past year.”

GTA condo prices have been volatile over the past two years, moving from $630,047 in January 2020, peaking at an exuberant $808,566 in March 2022 before calming to $730,818 in the latest September data, according to the Toronto Regional Real Estate Board.

John Pasalis, president at Toronto-based Realosophy Realty, said trouble in the pre-construction condo market could have wider consequences.

“The idea, of course, is the second new housing sales and starts slow down, that ends up having a broader domino effect economically,” he said. “We lose jobs in the construction industry and housing fuels a significant section of our economy. So, there’s massive economic risks.”

“I think the bigger effect would just be a turn to pessimism, and when people become pessimistic, you end up potentially with some more distress, some panic selling, and potentially more downward pressure on prices as well,” he added.

Pasalis wasn’t surprised by the number of investors looking to back out of deals since many of them are having a tough time getting financing given the impact of the stress test as interest rates rise.

The flight of investor capital from the condo segment could also weigh on new supply coming to market since fewer buyers would translate to fewer condo starts, he said.

A recent report from real estate research firm Urbanation Inc. found the Greater Toronto Area’s housing inventory reached crisis levels in the second quarter and that the pipeline of new supply was being disrupted. About 35,000 new condo units had been slated for launch this year but only 16,000 have made it to the finish line and fewer than 10,000 are expected throughout the rest of the year, suggesting 10,000 units will not be completed as planned.

Construction could be further disrupted, Pasalis said, if the dynamic that played out during the global financial crisis — when some investors stopped making their deposits on condos that had become worth less than what they had originally paid — reemerges.

“(This dynamic) could also impact construction buildings that are already in the pipeline,” Pasalis said. “Not to say that that’s going to happen, but it has bigger potential impacts beyond just seeing a lower number of housing starts.”

For Scrinko, those who invest in condos without the intent to close are playing a similar game as options traders.

“Don’t ever buy something you can’t afford to close on,” Scrinko said he advises his clients. “I can understand the allure of options trading … but it’s one of those things where the profit on paper is not reflective of the after-tax, after-commissions and after-legal fees (cost).”

Closing on a property and holding it for the long-term is almost always the right move, he added.

“And of course, it’s better for everybody because you don’t create this level of systemic risk.”

• Email: shughes@postmedia.com | Twitter: StephHughes95