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Pre-Construction In the Age of Rising Interest Rates

by Corben Grant on 25 Aug 2022

As markets across the country begin to cool from last year's highs, the world of preconstruction is facing its own share of new changes. As interest rates rise and developers and buyers alike reassess their plans, it is becoming increasingly difficult to navigate the space for successful investing - though there is still lots of potential for those who know where to look.

To help shine a light on the changing environment in preconstruction, we spoke to Tony Sbrocchi and Aleksandra Nowak from The Condo House, a real estate team that specializes in preconstruction in and around the GTA. Both Sbrocchi and Nowak have a long history of working both with buyers and developers in precon, providing them with a unique insight into the forces affecting the market today.

What's changed in preconstruction?

The first major factor that began to affect the preconstruction market earlier this year was the changes introduced in the 2022 federal budget. Changes to the way assignments are taxed as well as limits on foreign buyers played a role in cooling demand for preconstruction homes, particularly from investors.

The biggest disruptor though, as is common across so many markets today, is rising interest rates. Higher interest rates increase the carrying costs of mortgages, drive home prices lower, and cause buyers to reevaluate their pre-construction purchasing decisions. This is especially true for those investing with money borrowed from their home equity.

“Right now the Bank of Canada is increasing rates to fight inflation, but the problem is when you raise interest rates it cools the housing market and prices fall,” explained Sbrocchi. “You might think: who cares about the resale market when you're talking about precon? What we need to understand is a lot of buyers in precon are pulling equity from their homes to make a purchase.”

“So what you've done is increased the cost to borrow for that investor, and at the same time reduce the amount they can borrow, because now their properties have lost value. This can make buyers reluctant to move forward, or even unable to do so. Now if you talk to developers, they're mostly in the same boat of pushing to find buyers, which is proving not as easy as before.”

New developments can take years to complete, and developers must price projects based on their best projections. The issue now is that many developers are finding that costs are exceeding their expectations, and buyers are dropping off, which can severely disrupt their plans. While homeowners can usually lower their prices in the event of a market downturn, developers don’t have the same luxury, putting them in a tough place.

There are a few other ways developers can deal with the situation, however. Some projects may simply still have enough demand to move forward. Others may stall while they attempt to find more buyers and raise more funds. A third portion may need to be cancelled altogether, leaving investors with nothing to show for time and money.

“At the end of the day we always need investors in the pre-construction market, because, without them, the builders can’t get projects off the ground. They're the ones who come in at the beginning, put their money down and get the builder to that point that he can get financing – many end-user condo buyers would rather wait until the building is finished.”

How to navigate a changing market

This doesn’t mean that preconstruction is out of the question for investors. Opportunity remains, the key is simply what investors choose to pursue, and where. Understanding what still works in our changing times and investing with reputable developers can help investors to come out positive on the other side. 

“I think for investors at this point in time, depends on the product they're looking at. Condos, anything more than mid-rise, I'd be hesitant about that because we don't know where that marketplace is going right now. Smaller scale projects will tend to do a little better in these type of markets, because the builder is not going to be as dependent on investors.”

The shifting market also gives buyers much more leeway in negotiating with developers. Though developers may not be able to lower prices outright, there are many allowances that can be made at the negotiating table. In this case, it’s ideal to work with agents who have good relationships with the developers.

“Builders can’t just reduce prices across the board beacuse and at the end of the day it’s the builders responsibility to make sure they protect the value of the initial purchasers investments. But, what we're starting to hear in the background is, present us a deal, maybe we can work with it.”

Finally, investors just getting into the market may also see the current conditions as an opportunity to find deals on resale condos outside of preconstruction, according to Nowak.

“I was recently dealing with a condo that in February, they could have gone for 650,000 that now sold for around 580,000. But buyers who bought a few years ago may have already made their profits, and they can afford to lower the price a bit. In that case, it actually was a deal for that investor.

Despite the current turbulence, the pair indicates there is a light at the end of the tunnel. Especially in the area around the GTA, you’re investing into one of the largest and growing areas of the country. Though things may be down for the foreseeable future things will likely turn around and see demand and values rise again. The history of the market at least would bear out this truth based on previous slumps.

“I think long term, there’s obviously going to be a rebound. Precon is going to continue, we're just going to see a bit of a slowdown, as we did in 2012, 2014, or 2017. Builders will just make the decision to put stuff either on the back burner or just not proceed with it to come out unscathed. It’s not about doom and gloom, it's more about stepping back to reassess and then move forward.“
 

In a changing market, it helps to have agents who know their stuff. At The Condo House, you have the opportunity to work with experienced agents who have the unique insider knowledge to make your pre-construction investment go smoothly. To learn more, visit https://www.thecondohouse.ca/ for information on the hottest new projects and listings and to get in touch to find out how they can help you achieve your investment goals.



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