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The Importance of a Financing Condition in Today’s Real Estate Market

 

I am pleased to introduce Albert Luk, an experienced lawyer who has agreed to blog from time to time. Albert is a lawyer for many fast-growing businesses and the owners of these businesses. You may have read his guest post at The Blunt Bean Counter as well as being quoted in the media about all things legal. Albert and I meet occasionally for lunch and have some fantastic conversations about real estate, investing, and law. I bugged him to share his insights on the blog.

A Real Life Example of Price Disparity in Toronto Condos

In midtown Toronto, two condo units list in the same building. Unit A is 1 bed, 1 bath unit measuring approximately 1,000 square feet. Unit B is located 6 stories higher with 1 bed, 2 bath measuring approximately 850 square feet. Both have one parking spot and the same builder finishes.

All other things being equal, Unit A should list for more Unit B. But would you believe that Unit A was listed for only $4,000 more? Several things could explain the smaller price differentiation. Unit B, for example, could charge a premium for a second bathroom and a higher view of the city. But, on a square foot basis, Unit B is selling for $100 more than Unit A.

Head scratching?

Welcome to a soft condominium market where price uncertainty and disparity exists. The above is a real life example (names withheld to protect the innocent) not uncommon in many Canadian markets. Add in tightening mortgage rules and the result is uncertainty.

Toronto Condo

Uncertainty Increases Legal Risk

From a legal perspective, just like the stock market, uncertainty increases risk. Legal risk to buyers and sellers comes in various shapes and sizes.  But let us take  the most common real estate issues which end up on a lawyer’s desk using the fictional Samuels family:

  1. The Samuels find their dream home. They pay $1 million for it. The bank informs them that it will only provide financing at a valuation of $875,000. The Samuels cannot find and/or raise more money. They cannot close.
  1. Take the example above but with the following changes. The Samuels sell their existing condo for $350,000 to Tania. Remove the financing issue.  The bank supports the valuation. The Samuels have scheduled the sale of their condo and the purchase of the house on the same day. Two weeks before closing, Tania loses her job and she cannot close.
  1. Flip the example. The Samuels are now the sellers of the million dollar home to the Evans. The banks inform the Evans that the house is valued at $875,000 and the Evans cannot close.

Are there solutions to each of the above examples? Yes, but the solutions typically require time, money and level-headedness on the parts of all involved (arguably less in supply than time and money in stressful situations).

First and foremost, in example #1 and #3, the damages are not likely to be $1 million minus the deposit. In Canada, there is a general duty on the part of a person suffering damages (or who have been informed they are about to suffer damages) to mitigate their damages by taking reasonable steps to minimize losses. For example, in each of the examples, the person who cannot close should inform the other side as early as possible. The typical remedies involve renegotiation or the parties agreeing the agreement cannot be performed and the seller having to re-list.

It is not uncommon for the Samuels, Tania and/or the Evans to stick their head in the sand hoping the problem will go away. However, the sooner the problem is brought to light the more time the seller has to attempt to mitigate and, hopefully, to lessen the damages.

How are damages calculated?

Assuming the seller re-lists (and failure to do so may result in the seller not being able to claim full damages), if the property is sold for equal to or greater than the original agreement, the seller has been made whole and no damages can be claimed (the deposit is forfeit regardless).

If the property is sold for less than the original purchase price, the claim for damages is generally the difference between (purchase price agreed to in the original agreement) – (purchase price the property is eventually sold for when relisted) + (legal fees, interest etc).

For sellers, the practical issue is, especially in example #2, a damage claim may exist but is a lawsuit even worthwhile? Unfortunately, the forfeited deposit (minus commissions) may be all that there is to collect realistically.

What Have We Learned?

If you have made it this far without a sinking feeling in the pit of your stomach, what are some key informational takeaways?

  1. Avoid buying without a financing condition. It is the prudent move in a not so scorching hot real estate market.
  1. Spot the problem and communicate it early. If we were supposed to stick our heads in the sand, we would have evolved to be like ostriches.
  1. If you are a seller, getting a higher than market price is great but be wary of the highly leveraged buyer without a financing condition (less likely with the new mortgage rules but still…). If a problem surfaces with closing, act fast, get advice and act decisively. If you are selling and buying at the same time, you cannot afford to waste time. Mitigate early.

Finally, who do you speak to first- real estate agent or lawyer? It depends on the issue. If the problem goes fundamentally to closing (e.g. “I can’t close”), you typically go the lawyer. If it is more ancillary issues such as you  extending closing, an experienced real estate agent can assist.

Thank you for reading. If you have any particular topics you want me to blog on, please send me an email.

Albert Luk is a lawyer at Devry Smith Frank LLP, a Toronto based law firm who act as trusted advisors and advocates for corporations, individuals and small businesses. Albert can be reached directly at albert.luk@devrylaw.ca or @acsluk on Twitter.

The above blog post is for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind. Readers are advised to seek specific legal advice regarding any specific legal issues.

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  3. Clowns to the left of me (real estate), Jokers to the right (bonds), here I am stuck in the middle with you (equities)

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Comments

  1. Mike says:

    One of the pitfalls to condo ownership is that, generally, you can’t recoup your renovation costs. In my case I had demolished a wall and created an open kitchen with new solid-wood cupboards, great appliances, fancy counter, etc. and sure enough, I sold for a record price for the building. Shortly after, my neighbour who had the builders original equipment sold for almost the same price because I had set the $ per sq. ft. standard. Maybe the 2-bathroom 850 sq. ft. unit has been fancied up and the owner is trying to get some of the cost back.

    • Preet says:

      Could be. I wrote a Globe and Mail column about reno ROI’s and one of the experts I interviewed indeed mentioned that condo renos sometimes don’t get the sale valuation that you would find in a house.

  2. rick says:

    Whenever one thinks about buying any real estate property, it would be best for the person to get his financial condition more strong than the required. In any case, if something doesn’t happen differently that extra support could be very helpful.