Canadian real estate developers are being squeezed by inflation, and it’s turning ugly. The Hazleton Development Corporation obtained Companies’ Creditor Arrangement Act (CCAA) protection on April 20, 2022. The developer cited rising costs as one of the primary issues putting a 265-home project at completion risk. In this particular case, costs rose less than typical for homebuilding in the area. This can indicate a broader issue will form soon.
Greater Toronto Real Estate Developer Sold Nearly All Units
The project at the center of the developer’s insolvency is the “Highlight of Mississauga.” Filings show 261 of the 265-units at the Dixie Road residential complex had already sold. Clearly not a lack of demand, with the units bringing in $111.63 million (avg. $427k/unit). It might seem cheap, but these units were mostly sold before 2019, when construction began.
Speaking of construction, they began September 2019 — 4 months later than expected. The project was slated for completion on April 30, 2021. A 4 month delay might sound unusual to the average person, but it’s really not. BILD, a Greater Toronto developer group, found 4 in 5 members are delayed between 3 and 6 months. These delays, often not related to the developer, can cost them a whack of money. Since developers pass costs onto consumers, it’s fair to say these delays cost buyers a whack.
Toronto Real Estate Development Is Now At Completion Risk
The filing shows the project is only partially finished and “completion is at risk.” Factors destabilizing the project appear primarily external, such as labor and supply shortages. Public health restrictions, rising construction costs for goods and services, and “the current economics” are also cited.
The cost of construction has climbed significantly since they first planned the project. An original project estimate shows $101.18 million was the forecast cost of building. By November 2021, it increased to $113.70 million, a 12.4% increase since the original estimate. That might sound like a huge overrun, but considering inflation — it’s actually pretty decent.
.“The fundamental economic reality is that the shortfall in revenues relative to costs must be addressed,” reads the Facts section of the filing. “The development is not viable ‘as-is’ and a restructuring, mothballing or sale of the Project is inevitable.”
Soaring Inflation Threatens To Destabilize More Projects Soon
Statistics Canada estimates building costs have soared over the past few years. In Toronto, the construction cost jumped 4.5% in just Q4 2021, with annual growth coming in at a whopping 25.6% increase. Since the project began construction in Q4 2019, the cost of building in Toronto has increased 35.1%. A cost increase of this magnitude would have been unreasonable to forecast. Even the Bank of Canada (BoC) can’t believe the current level of inflation.
Had developers incorporated that level of margin into the cost, buyers would pay for it. Imagine paying a 35% premium as a bet the BoC would keep interest rates too low for too long? A year ago, that would have been a ridiculous consideration.
It’s easy to wonder why this isn’t occurring more frequently if it’s a broad-based issue. The thing is, there’s been signs of this kind of risk for months. More common is developers circling back to buyers to ask for more money. Sometimes as much as $100,000 or more.
We only have a few hundred pages of documents, but the insolvency filing doesn’t appear unusual. In fact, it’s hard not to see this becoming more common in the coming months. Projects are sold years in advance before they’re built, and most likely didn’t account for such high inflation. High inflation is known as a destabilizing force in economics, and this is a typical impact.
Canada’s goal of doubling the pace of home building has invited similar concerns. The builder system is already at the point where construction is inflationary. Canada can’t even grow and cut down trees as fast as it wants to build homes. BMO has warned plans to double the building pace is unlikely for this reason.
A bigger concern is how many of these projects at double the building pace will fail? It’s somewhat reckless and would leave households with a higher risk of buyer failure. Though it’s a similar plan Canada uses with immigrants — failure of a few is just the cost of pursuing aggressive growth.