Rocky residential real estate landscape
Joseph and Anna Canuck are retired and living mortgage-free in their 2,100-square-foot bungalow in Vaughan, Ont. After years of home ownership, they have decided to downsize by mov- ing into a condominium. On the advice of their realtor, they list their home for sale on March 10, 2017, asking $710,000 but, in the frenzied real estate market, expect offers over that amount.
Sam and Sheila Koala are international students with Australian citizenship. They are graduating and have found jobs in their field. They have applied for permanent resident status and plan to become Canadian citizens down the road. They have decided to buy their first home in Vaughan and have been looking for some time, but have missed out on a number of opportunities by being outbid or too late. They love the Canuck’s house and, based upon their savings and the maximum amount of their pre-approved mortgage, they offer $850,000, including a $10,000 deposit, within a few hours of the listing being posted. The Canucks consider multiple offers on their home and decide to accept the Koala’s offer as it offers the highest price and is a “firm” offer without any bank financing, home inspection or other conditions. The sale is set to close on May 10, 2017.
Assuming their bungalow is sold, the Canucks purchase a condominium in Richmond Hill, Ont. for $455,000 with a closing date of May 10, 2017. They plan to use the purchase proceeds from the sale of their bungalow to supplement their retirement funds and ensure that they continue living mortgage-free.
On April 20, the Ontario government announces sweeping changes to curb the hot housing market, which affect the Koalas and, therefore, the Canucks.
Because the Koalas are Australian citizens without Canadian citizenship or permanent resident cards, they are considered to be “non-residents” and their purchase of real property in Ontario is now subject to the Non-Resident Speculation Tax (NRST), which is calculated at 15 percent of the purchase price and is payable to the Ministry of Finance in advance of the closing date.
This amounts to an additional cost to the Koalas of $127,500 to purchase a home based on rules that were not in force at the time they contemplated purchasing the home and negotiated their mortgage. The bank will not increase the mortgage. The Koalas can no longer afford the home. However, they have signed a firm and binding contract.
The Koalas inform the Canucks they can no longer afford to close and that they want to terminate the Agreement. After getting advice, the Canucks purchased their new home relying upon the Koalas ability to close and, refuse to terminate the agreement and arrange to re-list their home. However, the market has slowed and prices have dropped. They realize that they must apply for a mortgage to purchase their new home and then carry the costs of two properties until their bungalow is sold.
The Canucks inform the Koalas that if the Canucks are unable to sell and close on their home before May 10, 2017 for at least $850,000, the Canucks will sue the Koalas to recover the losses incurred by the Koala’s failure to close. Those costs will include any shortfall in the purchase proceeds and all additional carrying costs (including utilities, property taxes and hydro) that they would not have to pay if the Koalas completed the purchase. For example, if the Canucks now sell for only $795,000, the Koalas would be sued for the difference of $55,000, plus carrying costs and legal costs.
The Canucks face the additional stress of trying to secure a mortgage from a financial institution when, as retirees, they lack sufficient regular income and do not have a firm offer for the sale of the bungalow. If they are not able to arrange a bridge mortgage or other financing, or negotiate an extension of closing for the condominium, they face the possibility of breaching their obligation to purchase the condominium being sued themselves.
How could the sellers have protected themselves?
Although it is difficult or impossible to prepare for sudden changes in legislation, there are some measures that are helpful to protect the seller in any real estate transaction. For example, the Canucks could have required a larger deposit from the Koalas. Generally, sellers request a deposit of at least 5 percent of the purchase price, which, in this case, would have been $42,500. The agreement of purchase and sale would include a provision that would allow the seller to keep the deposit if the purchaser “walks away” from the purchase. The deposit not only confirms the purchaser’s financial commitment to the purchase, but can be applied immediately to the seller’s carrying costs and any shortfall in sale proceeds resulting from the purchaser’s refusal to close. A forfeited deposit can provide the seller with compensation without having to go to court and incur the related stress and legal costs.
Additionally, even if the seller is going to use closing proceeds to purchase a new home, it is advisable to prequalify for a mortgage in case the sale is delayed or fails to close. It is always easier to negotiate terms when your back is not against the wall.
What could the purchasers have done differently?
The Koalas could have pre-qualified for a mortgage at a higher interest rate. Previously, potential homebuyers were not subject to the “stress test,” whereby financial institutions pre-qualify homebuyers at the posted rate typically between (2-3 percent). Presently, homebuyers have to qualify at the Bank of Canada posted five-year interest rate of 4.64 percent (almost two percentage points higher), therefore reducing their spending power in the purchase of real property. If the Koalas were forced to qualify at a higher rate, they may not have agreed to purchase such an expensive home, instead being more prudent with their savings by possibly investing in a condominium or townhome purchase at a lower price.
Although the non-resident tax was not in place when the deal was made, it was not a completely unforeseen circumstance. A similar provision had been imposed in British Columbia and significant pressure was being put on the Ontario government to impose similar measures. Purchasing a house is a significant financial commitment. It is advisable to research any market before making an investment. In the circumstances, it would have been prudent for the Koalas, as non-residents, to have delayed purchasing a home until their residency status in Canada had been sorted out, thereby eliminating the risk of being subject to a requirement to pay an additional tax.
As of October 2017, the Ontario government has announced that it is considering further measures, including, possibly, a vacant home tax on all properties in the City of Toronto, strictly aimed at forcing homeowners to either rent properties to prospective residents, or sell them to local residents in an effort to end speculators from driving up the real estate prices in the market.
The demand for and prices of new build and re-sale condominiums have soared in contrast to semi-detached and detached homes, partially due to the interest rate increases by the Bank of Canada in July and October 2017 respectively. It is imperative that prospective buyers and sellers understand the ongoing trends in the real estate market and seek professional advice from a realtor, mortgage broker, and lawyer to mitigate their risks when making decisions in the real estate market.