The Greater Toronto Area condominium market is languishing despite interest rate cuts and initiatives by some municipalities to hasten approvals and lower development costs. This means a recent spate of insolvencies in the sector is likely to continue.

While some larger developers and high-profile projects are being caught in the maelstrom, the biggest impact so far has been on smaller, less-well-capitalized development firms, according to several industry insiders who spoke with RENX.

“Where we’re seeing cracks is from the smaller to mid-sized developers, especially ones that may have entered this market as unestablished and knowledgeable than some of our more well-heeled developers,” Mike Czestochowski, CBRE’s vice chairman, told RENX. “They didn’t realize the amount of money and time it takes to build and get approvals. 

“I don’t see our large private and institutional developers getting into trouble, but I see smaller developers getting into trouble.”

For every high-profile condo project receivership such as The One in Toronto and its former lead developer Mizrahi Developments, there are many others involving less well seasoned firms.

This is also creating a trickle-up effect, with major lenders across the condo and other sectors becoming less likely to finance these projects. Several funds have also announced redemption and distribution freezes or reductions as they preserve cash to weather the storm, adding additional liquidity pressure.

Some creative solutions are emerging, including the acquisition of the four-tower Elevate development in Kitchener, Ont. It was acquired by Gentai Capital, Dorr Capital and Elm Developments after the original developer, a numbered Ontario company, went into receivership. All had played roles in the project, and banded together to get it back on the rails.

Condo investors remain on sidelines

In the condo market specifically, Czestochowski added that investors, for many years the backbone of the preconstruction market, got sideswiped by rapid interest rate hikes and remain firmly planted on the sidelines.

“I think the run-up in interest rates caught them off guard at the speed and the amount of the hikes, and that’s (hurt) a lot of condo economics, especially for small investors who do not want to buy today,” he said.

A recent CBRE brochure listed seven completed distressed property transactions or redemptions by the firm over the past 12 months.

Despite the Bank of Canada reversing its higher-interest rate regime in early June - its overnight lending rate had been hiked 10 times since March 2022 - the four consecutive rate cuts so far remain insufficient to entice most investors.

The central bank’s monetary policy isn’t the only inauspicious variable impacting investors and softening the GTA’s high-rise preconstruction market.

Mortgage carrying costs remain too cumbersome, and rental rates have also started falling across the GTA.

Dan Wootton, a partner at Grant Thornton, said condo investors have been divesting properties, creating a glut of inventory on the resale market and making it difficult for new construction projects to launch. 

Developers also face challenges

Developers are faced with several challenges, he said.

“The primary one is their ability to sell their units — a lot of inventory of used units means buyers have choice and the cost of a new unit is generally higher than a used unit,” he said.

The supply-demand seesaw tilts toward the former, and mortgage rates remain too high to make investments work. 

“The cost to borrow money to build over the life of the project is higher, and that’s where it impacts mostly the small- and mid-sized developers,” Wootton said. “The larger developers typically have more cash resources. If you’re a smaller developer, you usually rely on the pre-sale market and you collect deposits from people who buy units on paper and pay deposits.”

The issue arises when savvy buyers don’t pay deposits in excess of what can be insured, because if a project runs into delays or other troubles, it bleeds money.

“If you’re having trouble pre-selling all of your units then you’re not going to have the cash that you’d be relying on to help build-out the project,” Wootton continued. “So if you run into any hiccup in the development process — if it takes longer to get your permits and approvals from the municipality, for example — then you’re going to incur extra costs that you may not have anticipated.”

At-risk developer profile

The type of developer whose properties risk insolvency typically don’t have robust in-house expertise to spearhead projects. If they have entered a joint venture, they may have relinquished enough control that they're at the mercy of a more financially stable partner.

Moreover, it’s no secret there is a trades shortage, which can impact project viability due to the potential impact on development timelines and costs. A neophyte developer, especially, is more likely to have insufficient cash reserves to navigate the GTA’s oft-unpredictable high-rise construction sector. 

“The profile (of a trouble developer) would be one looking to purely outsource all of the work,” Wootton said. “Some of the developers that can withstand a bit of a storm do a lot of things in-house; they have their own crews and they may even have their own equipment. They may have their own in-house engineers and general contractors who have expertise.

“When you outsource everything, you can lose control.”

Another apparent factor at play is that smaller developers sometimes look to cut costs for ostensibly better pro formas. However, Wootton said that actually worsens their risk profile.

“Oftentimes, they’re looking for a good deal from a price-point perspective, and they may hire contractors who are offering to do a component of the project at a lower cost. But in doing so they are compounding their risk because they have even less control,” he said. 

Control of a project even extends to having an internal accounting department to manage costs and working capital needs, and in doing so, ensuring liquidity. 

While most developers outsource at least some aspects of their projects, namely by hiring trades, they tend to also be internally robust in many areas, Wootton concluded.

The delta for the condo sector

Bigger developers endure market headwinds because they have stronger balance sheets and control most variables. That’s why they usually come out on top, Czestochowski said.

“This happens to our market every now and then, where smaller to mid-sized developers get caught up and their properties get purchased by larger developers,” he said, “and the market goes on.”

- With files from Don Wilcox