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Tough New Regulations Could Hit Developers

Canadian Industry Looks at Providing Loans to Consumers Who Can't Close Their Deals Under New Guidelines
December 28, 2017
Tough new federal banking loan rules that kick in Jan. 1, 2018 will leave some consumers scrambling to close purchases and have some Canadian developers considering getting into the mortgage business to make sure deals don’t fall apart.

Industry sources suggest this is now an active consideration for developers who fear the so-called B-20 "guidelines" created by the Office of the Superintendent of Financial Institutions (OSFI) in October will leave them with buyers unable to meet their commitments.

Under the new regime, which federally regulated lenders must adhere to or face repercussions from OSFI, consumers with down payments of 20% or more must qualify for a mortgage based on a rate at least 200 basis points above what is on their contracts -- the resulting larger monthly payment creating less borrowing capacity. Only high ratio mortgages -- those with less than 20% down -- had previously faced this type of regulation.

"It's happening, but just not yet," said Benjamin Tal, deputy chief economist with CIBC World Markets, about developers picking up the lending slack. "They are ready to do this. Developers will come out and play hardball and tell consumers they need to close, borrow from grandmother if you have to. If they cannot close and the deal is at risk, they will go to option B."

Land values continue to soar in the Greater Toronto Area and Metro Vancouver, and this type of tactic is likely to be inflationary for those markets where average detached homes are already selling for slightly less than $1 million and a little more than $1.7 million, respectively.

Tal says buyers after Jan. 1 will be forced to turn to mortgage investment corporations, which charge higher rates, but consumers who already have deals still need to close.

"I think it makes sense (for developers) because it secures a deal, but it's not a long-term solution," says the economist, who thinks the market might be supplying these bridge loans for two to three years because of condo deals in the pipeline over that time frame.

Eli Dadouch, chief executive of Toronto-based Firm Capital Corp., a publicly-traded boutique private equity real estate firm, said the market for land in Toronto is so strong he doesn't expect the new regulations to have a significant impact.

"Sure, if prices don’t go up (by the time a deal closes) developers will take back a mortgage. If prices go up, then they won’t have to do it," Dadouch says, adding a larger valuation means consumers can qualify for an even bigger mortgage than when a deal was first made.

The chief executive says some developers have long had policies for taking back mortgages because of tax advantages they can get back from the federal government. It's not necessarily the norm, and for developers doing it, they need a deep balance sheet.

Rob McLister, founder of ratespy.com, said it's feasible for developers to provide loans this way, but they'd have to be structured a certain way to get around rules that only allow a certain amount of debt relative to household income.

"The first mortgage holders, especially if they are federally regulated, must calculate debt ratio including the second mortgage," says McLister, adding you usually have to prove to a first lender where you are getting the balance of your funds to close. "(Developers) could do a vendor take-back mortgage whereby the debt servicing is low. They might do an interest only (second mortgage)."

Brian Johnston, the COO of Mattamy Homes, said the stricter mortgage regulations in the marketplace are on everyone's minds in the development industry.

"It’s something we are talking about," said Johnston, about providing mortgages to consumers for closing loans. "We have been encouraging consumers to get their financing done beforehand (before the Jan. 1, 2018 changes)."

He said the changes do have the potential to affect deals in the pipeline for the time it takes to get a project done. But like Dadouch, he ultimately doesn't think it will put a dent in land prices.

Garry Marr, Toronto Market Reporter  CoStar Group   
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