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New construction, new concerns

by Contributor on 31 Jan 2018
As a real estate law solicitor, I’ve seen many clients bring our office a New Construction Condominium Agreement three weeks before closing with no idea of what is about to happen. There are a number of issues facing these buyers, which, if they are buying the condo as an investment property, can significantly diminish their ROI.

Here are five fine-print items an investor should know about the average new-construction condo agreement.

1. The builder’s rights
It is the builder’s right to make changes unilaterally, provided they do not affect market value or the fundamental character of the condominium. Brand-new construction projects are often sold prior to draft plan approval, final engineering approval, final municipal approval and architectural control approval. For this reason, all agreements will contain a very open clause allowing builders to make a variety of changes to the property. Specifically, builders may construct reverse mirror image plans, construct the property with alterations not reflected in the marketing plan, remove or relocate balconies/windows/doors/decks, alter ceiling heights, etc. For this reason, the reputation of the builder is extremely important for condo investors who want to ensure that the builder builds what was promised and marketed in the sales materials.

Area can also be different than what the investor originally expected. Many times, area is not even stated in the agreement at all (only in marketing materials, which do not legally form part of the agreement). In addition, in cases where area is stated, it is measured in accordance with Tarion Bulletin 22, which essentially allows builders to calculate area from concrete to concrete, meaning actual usable floor space will be reduced by insulation, drywall, etc. An investor needs to be comfortable with the possibility of changes in layout and usable floor space in order to make a new-construction condo purchase an ideal investment.

2. Two-stage closing
New-construction condominiums will have a two-stage closing. The ‘occupancy closing’ is when possession is transferred and the investor rents the unit from the builder. The ‘final unit transfer closing’ is when the condominium corporation is registered, the deed will be transferred, and the mortgage will be registered. During the interim occupancy period between the occupancy closing and final unit transfer closing, occupancy rent is payable to the builder and is typically composed of three items:
  • Interest to the builder for the balance of the purchase price owed on final unit transfer closing (interest is currently calculated at 3.14%)
  • Monthly common expense payment
  • Monthly property tax payment
Carrying costs (utilities, cable, etc.) must also be paid by the purchaser during the occupancy period, which is typically six to 12 months in duration. The builder will ultimately provide notice of a final closing. At that point, occupancy rent ceases and regular mortgage payments begin.

Investors should remember that mortgage rates cannot necessarily be locked in at time of occupancy closing, as rates can only be held for 120 days. That said, it is prudent to finalize the mortgage at the time of occupancy, simply for the sake of being able to act quickly when the builder advises of a final closing date. Often there is not sufficient time to start a mortgage application from scratch in the short window of time between the notification of the final closing date and the final closing date itself.

3. Right to lease during occupancy
Most new-construction agreements state that the purchaser has no right to lease or sublease the property during the occupancy period. If the investor will be in a state of occupancy for six to 12 months with no right to rent out the property, the investment becomes far more expensive, and profit will be whittled away. For this reason, it is crucial to negotiate an express right to rent during the 10 day cooling-off period prior to the agreement becoming firm and binding.

Many builders will not grant an express right to rent, but advise purchasers that they will turn a blind eye to the rental during the occupancy period if the investor does not post the rental opportunity on websites such as MLS or Kijiji. On the contrary, some builders have held buyers in default of the Agreement of Purchase and Sale when they attempt to rent the unit out during the occupancy period. Investors ought to investigate and understand where the builder stands on this subject prior to going firm on the agreement.

4. HST rebate
An investor needs to be prepared to pay the HST rebate up front at final closing. This amount usually ranges from $18,000 to $28,000, depending on the price of the condominium. Although the rebate is refunded through the CRA’s New Rental Residential Rebate program for investors who rent out the property for one year after final closing, it is non-refundable for investors who are looking to flip the property after final closing. Make sure to budget for these extra funds.

5. Closing costs
New-construction condominium closing costs can be overwhelming and must be capped at initial signing to avoid surprises. The largest closing costs are items like increases in development charges, public art levies, transportation levies, etc. Other closing costs include, but are not limited to:
  • Real estate tax adjustments
  • Utility meter installations and utility security deposits
  • Contributions to landscaping
  • Deposit administration costs and condominium act compliance costs
  • Status certificate
  • Prepaid taxes for land/structure
  • Tarion warranty enrolment fee
These are all costs in addition to the purchase price, and they can sometimes make the ‘great deal’ of a pre-construction price a virtual illusion.

Investors should ensure that they are aware of the finer points of new construction condominium agreements before diving in. A lack of knowledge can be extremely expensive.

Harpreet Hans is a partner with Gunding & Hans LLP in Milton, Ontario. She practices exclusively and extensively in the area of real estate law and mortgages.

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