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Pre-construction Toronto Condos, A Wise Investment?
Dec 05, 2014
ARticle by Carl Langschmidt of condos.ca December 3, 2014 Posted in Investing, Toronto Condos
For the last decade, we’ve been bombarded with tales of pre-construction pots of gold and how the easiest way to turn a profit in Toronto real estate is to buy pre-construction low and sell post-occupancy high. While this may once have been the case, this belief doesn’t hold in the 2014 Toronto condo market.
The Myth of Pre-Construction Toronto Condos
I’ve spoken before about the best value myth and the fact that most Toronto pre-construction condos are overpriced. On average, pre-construction condos in Toronto are overvalued by 10%. But what buyers also need to be aware of is that selling a condo in Toronto too quickly may not just eat away your profits, it could in fact cost you.
Nobody goes into a pre-construction purchase thinking they’ll take a hit. Most buyers of pre-construction condominiums are looking to grow their money faster and/or at a higher rate than they can through Toronto re-sale property. But it pays to take a hard look at re-sale Toronto condos for sale before making a final decision because you may be just as happy with a new building that’s in its early occupancy phase without the inherent risks in pre-construction purchases.
If you’re set on pre-construction condos for sale in Toronto, you need to know the facts about fees. This is particularly true for investors with shorter time horizons for financial returns than end users. Beyond the fact that pre-construction condos are often overpriced, what fees do buyers need to be aware of when calculating the true potential gains or losses in a pre-construction property? Perhaps the most important thing to consider is what happens when it comes time to sell your Toronto investment condo.
Fees that Sellers of Pre-Construction Properties Pay
Remember our previous discussion about hidden costs of pre-construction condos? One of the biggest surprises for re-sellers selling a condo in Toronto that you don’t technically own isn’t always straight-forward and it will cost you.
Registration is when the Condominium Corporation becomes an official legal entity and ownership of the unit is transferred to you, the buyer. You can’t sell your Toronto condo without an additional fee until it’s registered which can take anywhere from a few months to a few years after initial interim occupancy.
Instead, you’ll need to sell through assignment which involves paying a fee and working with the developer. Each is unique; individual developers set the costs and terms of assignment clauses and they’re often dependent on the approval of the builder.
Bottom line: If you sell before you’re on title, plan on an assignment fee of around 1% of the cost of the condo.
Capital Gains and Income Tax
If you sell a pre-construction condo shortly after closing, the principal residency tax exemption may not apply. If you can’t prove you fulfill the requirements of the PRE, you are at a minimum on the hook for capital gains tax. This is not a surprise to most real estate investors but what is not widely known is that you may have to pay income tax instead, costing you even more.
There’s been a barrage of media coverage over the last few years in The Toronto Star, the Financial Post, CBC and other outlets about how the Canada Revenue Agency is cracking down on condo flippers.
The CRA considers quick flips for the intent of making profit an “adventure in the nature of trade” and therefore taxable as income. It’s true that many (likely, most) condo flippers simply dodge the taxes but the CRA is getting tough, investigating hundreds of Toronto flips each year. If you’re caught, not only will you have to pay the taxman, you could get hit with gross negligence penalties.
Bottom line: You can’t outrun the taxman. Educate yourself on the CRA’s real estate taxation laws before buying investment properties.
Crane-scapes have become a fixture in Toronto but is all this condo construction resulting in better values for buyers?
Fees that Pre-Construction Purchasers Pay
You must pay HST on all new residential property purchases in Canada (it’s inclusive in your purchase price; the builder remits it on your behalf). You do not pay HST when buying re-sale property. On a $400,000 pre-construction condo, that’s a whopping total of $52,000. Now you may get a portion of that back at the time of the transaction or after a period of time–but the math is not simple.
Toronto lawyer Mark Youngman of the law firm, Gasee, Cohen & Youngman specializes in real estate law and warns that, although there are HST rebates available, how much of the HST rebate depends on the purchase price of the property and other factors depending on the individual and the circumstances–so don’t count on a sizeable return until you speak with a professional.
“There is an HST rebate for buyers of pre-construction condos–you pay the full 13% to the builder with an adjustment for the rebate which will get netted out on closing. The rebate varies from $0 to $30,300 depending on the price of the property and your particular circumstances.
For example, if you don’t end up occupying the unit as your primary residence, you may have to pay that rebate to the builder on closing. If you choose to rent out the unit instead moving in yourself, you can apply after one year through Canada Revenue Agency for a portion or all of that rebate back.”
Bottom line: You can’t escape the HST on pre-construction although how much you pay will depend on whether or not you flip it or rent it out.
Interim Occupancy Fees
If you move into your Toronto condo during the interim occupancy period before you take ownership, you will be paying the developer the equivalent of rent. The amount is based on a calculation typically including an estimated monthly property tax contribution, maintenance fee and the interest the developer is charging you on your unpaid portion of the purchase price.
That money, often referred to as “phantom rent”, does not go towards your mortgage and is not paying down your debt. You are just paying interest to the builder.
As well, bear in mind that mortgage lenders will not activate your mortgage until you’re on title. Without a mortgage to help you carry the property, you better be making a good income or have that phantom rent saved in advance in order to cover the total interim occupancy period which, as stated before, will certainly take months and possibly years.
Bottom line: You’re burning through money without putting a dent in your debt for at least the first few months of moving in.
Pre-construction condo purchases come with hidden fees and high commissions that take many buyers by surprise. Builder’s costs can include everything from HST on appliances and fixtures to utility connection costs and can vary widely although they’re generally between 1% to 3% of the cost of the property. These fees are typically due upon registration, so make sure you’ve banked enough to cover this.
Bottom line: Plan for 3% of purchase price in fees due upon registration. Better to be over-prepared than caught unaware.
Buyers pay sales commissions as dictated by the developer which can be up to 5%; double that of the industry standard 2.5%. On our $400,000 condo example above, that’s up to an additional $20,000. Remember that when you purchase a re-sale condo, you don’t pay commission as a purchaser; only the seller pays agent commissions. So this is an added cost to pre-construction buyers.
Bottom line: You may be hit with up to an additional 2.5% in agent commissions. Ask the question early on–you have the right to know all sales fees upfront.
There are other fees such as land transfer tax, closing costs and moving costs but these are generally comparable across both new construction and re-sale transactions.
We’ll Give You the Straight-Up Facts
Remember, a good realtor is on your side and can save you money. Most buyers of pre-construction condos forgo consulting an agent first but it doesn’t cost you to have a conversation with one of our experts. Give us a call before jumping onboard with a pre-construction developer and we can help you determine your best real estate investment strategy.
And when in doubt, consult a lawyer who specializes in real estate transactions and tax law.
Mark Youngman is a Toronto lawyer specializing in real estate law who acts for purchasers, vendors and mortgagees for residential and commercial real estate transactions. He became senior counsel in 2008. Mark is a member of the Canadian Bar Association. He is also a member of NARCA (National Association of Retail Collection Attorneys), an international organization for collection lawyers and is a real estate law representative on the Tarion Consumer Advisory Council.