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What Sets Resilient Developers Apart in Uncertain Times for the Condo Market

Published On: October 23, 2024  Categories: Viewpoint Articles

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Canada’s real estate market has seen a total of $803 million in distressed property sales in the first half of 2024, according to Colliers International Group, a figure that has more than doubled compared to the same period last year. Some of these include high-profile condo projects totalling thousands of units. The federal Office of The Superintendent of Bankruptcy reported 137 construction and real estate insolvencies.

While these numbers may seem concerning at first glance, it’s essential for investors to interpret them correctly when considering making an investment in condo development. A closer examination reveals valuable insights into the condo market and highlights potentially profitable opportunities, even as fewer cranes silhouette city skylines.

Understanding the current condo market: Why some developers face distress

In recent years, Canadian condo developers have had to adapt to the rising costs of borrowing, construction materials, and labour. Established and reputable firms have successfully navigated these dynamics due to their ability to absorb the costs.

However, the rise in interest rates has also exposed inefficiencies that were previously masked by cheap capital and heated markets. Less prepared and unsophisticated developers faced a number of challenges:

  • New mortgage rules and higher interest rates, which slowed pre-sales and made it more difficult to capitalize new developments.
  • Increased monthly loan payments, which stressed finances for companies without sufficient cash reserves. Many developers rely heavily on leverage and expensive loans to finance land acquisitions.
  • Delays in approvals or execution, further straining financial resources.
  • Undisciplined financial management or inexperience in navigating the cyclical nature of real estate.

    • For smaller, inexperienced, and less diversified condo developers, these issues have been particularly magnified. Some may file for bankruptcy protection, which can lead to insolvency. And when lenders lose confidence in a developer’s ability to repay loans, they can push projects into receivership. For developers — especially those with less experience — the loss of a key project can threaten the entire operation. This dynamic is increasingly evident in recent months.

    Taking a closer look at condo developer receiverships

    However, investors should recognize that insolvency or distress among a few firms does not indicate structural issues across the industry. It’s crucial to avoid generalizations and instead focus on the specific realities of the market.

    For instance, the number of projects in receivership doesn’t necessarily reflect the number of companies in distress. If a developer faces bankruptcy due to a few struggling projects, they may have other high-quality, financially viable developments that could also be impacted, which multiplies the apparent losses.

    It’s also important for investors to distinguish between different sectors and property types, as the dynamics vary significantly. For example, an office or land deal entering receivership says little about the viability of residential condo projects. Similarly, high-rise condo projects, which require higher up-front costs and much longer timelines, have experienced a greater increase in receiverships compared to mid- or low-rise developments.

    Ultimately, the risks facing a condo developer are highly individualized, even within the same sector or region. Though distress in the market should be considered, investors must evaluate expertise, experience, and financial practices at the firm level.

    High-quality developers are well-positioned for success

    A recent Insights from Colin Doran, head of development advisory at Altus Group, describes well the current market reality: “There is less room for error. In the past, a developer could be good at sales and make their way to completion. Now they have to be good at all aspects, including planning and execution.”

    Of course, one could argue this has always been the case. Top-tier developers anticipate down markets and position themselves to thrive, even when challenges arise. These firms not only survive but often find themselves in a stronger position during economic downturns.

    To mitigate market cycles, experienced developers employ several best practices as a matter of course:

  • Purchasing assets for cash, when possible, and holding capital in reserve in anticipation of economic downturns or fluctuating interest rates.
  • Employing project-specific financing to ensure capital is dedicated solely to a project’s completion (rather than other business expenses/projects).
  • Avoiding selling units too far in advance of construction to reduce the risk of mismatched costs and revenues.
  • Taking a conservative approach to sales, costs, and development timelines, with contingencies built in for unexpected challenges.

    • Tapping opportunities in the condo market

    That said, even the current condo market offers opportunities. Despite a notable disconnect between buyers’ expectations of deals at low prices and sellers’ desires to minimize losses, there are attractive opportunities in the market that can allow firms to make accretive purchases. Discipline is key, however — investment firms should focus on purchases that align with their long-term goals, such as diversifying their portfolio or capitalizing on gaps in the market.

    Moreover, experienced developers have the expertise to take over projects at any stage, whether it’s a land-only site or a complex, in-progress development with existing plans and approvals. This flexibility allows them to maximize the potential of distressed assets over the long term.

    A market poised for recovery

    Although receiverships and insolvencies may continue to tick up through the end of the year as real estate companies contend with the lagging impacts of high interest rates, the worst of the high-interest-rate environment is likely behind us.

    With four interest rate cuts already in place and more expected this year, the real estate market is showing signs of recovery. In fact, builders have already broken ground on a larger-than-expected number of units, contributing to an overall strong first half of the year for construction. As well, construction costs have started adjusting downwards in some markets.

    As distressed firms exit the market, the spotlight returns to high-quality builders who have the expertise and resources to bring projects to completion. This shift is expected to lead to a stronger, more resilient market in the years to come.

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