Alex McFadyen is back with Denny to talk about presale completions and provide you with valuable insights on how to ensure you are well-prepared for this crucial phase.
Denny and Alex go over the timelines for presale projects and the different rules with primary residence vs investment properties.
This episode will cover how mortgages work with presale properties, the timeline before completion and what you should focus on, the differences between primary residences and investment properties, different rules with different lenders, and unexpected costs when purchasing a presale.
Read the Transcript Here
Hi everyone, I’m James Garbutt. And I’m Denny Dumas. And this is the Garbutt Dumas Real Estate Podcast.
Denny: Back on the GD podcast, our resident mortgage broker, working solely with the GD Team now. Alex McFadyen, thank you very much for coming back. This is a fun one. I feel like maybe our team has had a number of presale completions in the last few months. And so this is a topic that is very fresh on our mind currently and have had some clients completing on pre-sales that have had hiccups with financing.
So I wanted to just share as much info as we can about you know, the differences between resale and pre-sale along with buying new construction is if you purchase an assignment was financing like, how do rates differ, if any, but let’s maybe start with the difficulty of ironing out a completion date.
Often as Realtors we will get hounded, weekly from mortgage brokers, from our office, from notaries like when is the completion and responses is: “I don’t know.” We don’t find out. The challenge with pre-sales is in the contract, typically, you have, you have to get the minimum of 14 days to complete from the developer. Developer towards the end of a project, has a lot of hiccups in terms of finishing the project but also dealing with municipalities and getting occupancy permits. And if there are minor adjustments after that inspection from the municipality, then they gotta wait for someone from the inspector from the municipality come back and do another one. And completions can be extended.
So typically a consumer that buys a pre-sale is only given two weeks notice. How does that affect financing and when should consumers who are buying pre-sales start to reach out to a mortgage broker to arrange financing?
Alex: Loaded question. Lots of questions there. What do I, 1,2,3… The question that you get asked by every single inspector, by appraisers, by mortgage broker is is when is it going to complete? That’s okay I get it because that’s like me, when rates going up or down or these types of things.
But when do you start the process of thinking about how do I qualify for a loan is the same time you’re thinking about buying any property. So if you are thinking of buying a pre-sale or resale, I think you should probably go through at least some type of proper pre-qualification process or talk to somebody at bare minimum. The thought process of buying any property whatsoever without having an understanding your financial situation at this time is to me insane. But I do understand the wavelength for some folks who are buying a pre-sale property three, four or five years down the road. I still think the conversation should be had. However, the conversations are different at those times. So I think what we would want to do for this conversation is to break off the two kind of term lengths. So something that’s two years down the road versus something that’s say three, four or five years down the road, because those conversations are very different.
You see, for somebody who’s buying a pre-sale project two years down the road, they can acquire financing and to get an approval on a property with some lenders 12,18,24 months and yes, there are some further than that. 36 months out so forth, but typically within 18 to 24 months there are a few different options to acquire an actual approval, which means that person should be having a conversation with a mortgage broker ideally in advance of shopping or at least placing an offer during their quote unquote “rescission period” which you can talk about.
Denny: Sure. The, so some lenders will give you an approval up to 24 months in advance.
Denny: What is the, is there any harm in doing that? From a consumer perspective? You’re probably not signing a commitment letter.
Alex: You are. You are. Yeah.
Denny: But that is not, are you able to have that rate?
Alex: But not at that rate.
Denny: Yeah, exactly.
Alex: Okay, so let me explain it. Lenders have what’s called builder approvals. And builders approval, builder approvals vary. Some lenders have approvals with particular properties in case, in this case, for example, there are some buildings where they have lined specifically with TD Bank or RBC bank and those are usually at the site.
In our situation, we’re typically doing a standard builder approval with virtually any new pre-sale property and it’s a hard approval which means the lender will verify their income, they will verify their credit, they will verify their down payment, they will check for things at that time, which is good for a consumer ,you want to make sure you qualify and they will approve you and if you’re approved at that time, you can still be approved at funding. So you can actually be finally approved.
One thing to be clear about all these approvals, it doesn’t mean go quit your job. It doesn’t mean go buy four cars, or you know something like that or take on any debt because let’s say something happened or something changed and you no longer that was about you know, let’s say that approval was no longer the best option for you anymore, then you’re going to want to closer to completion, to be able to be adaptable to change that right.
Or in a situation for example, which we’re probably going to talk more about, but the completion gets delayed. Well now you’re no longer in your 24 months, and you might need to get a new approval right at that time.
Denny: That’s a good point. But to be clear, if the completion does happen in that 24 months with that lender, and you were approved 18 months ago or whatever. They’re not rechecking income documents at the completion date.
Alex: No, they verify income now that’s not for all lenders though some builder approvals, they do recheck, so you want to clarify that with the lender or broker that you’re getting your mortgage approval from, to make sure that that’s the type of approval they have in place.
Denny: Okay. The difference between interest rates if you’re using this pre-sale as a primary residence versus as a rental property.
Alex: So regardless of it being a pre-sale or resale?
Alex: Typically, most lenders have some type of interest rate premium. Now that interest rate premium. First of all, I’ve seen it change and fluctuate at different times of the year depending on the lender but let’s just generally speaking, point .05 to .25% depending on the institution, you know, most of the big banks are like .05% with some of them being for example, Big Red Scotia Bank has a quarter point increase to their rate. Now, Scotia Bank also has the most aggressive or most beneficial rental policy in the big bank marketplace for many circumstances, but they do charge for that right.
Denny: Yeah, Scotia seems like an interesting one for pre-sales because of that increase, right? What I guess what challenges would someone who’s buying a pre-sale as an investment property have with qualifying for mortgages then?
Alex: Right. So if you’re buying a pre-sale for as an investment property, there’s a lot of challenges associated with that, like the first one is not all bad, right? But one of them would be what’s the rental income going to be at that time?
Now, obviously, in the Vancouver area, thankfully, well, not thankfully if you’re a renter, but as an investor, you’ve seen rental rates increase over a period of time and so we can almost guarantee that your actual rental rate could go up, which could offset some considerations, but that isn’t a certainty. And a second consideration around that is what if the government changes some guidelines around the type of rental or what you can do as a rental or the building or something of that nature? Like we just saw a recent situation which actually worked in our favor, but they made everything all of a sudden rental capable, but what if they did the opposite at some point in time, not that they would but that’s just a consideration, right. Think about that.
You know, other things over and above that as a rental as an investment. I don’t think there’s a lot of other really big drawbacks. You just need to make sure that you still qualify. As we mentioned, the rental income is enough to cover whatever qualification scenario you had, and you still have enough cash down payment, 20% minimum, to be able to qualify. One thing to be clear is that it’s possible that lenders can change your lender policies or rental policies between now and one, two or three years from now. For example, if you bought a property 2018, when you were closing on the property today, which there are, I have clients right now, we’re five years out, renter policies have changed significantly in that timeline, and most people don’t have any five year approvals. So a lot of those folks did have to make some adjustments and changes to whatever their qualification scenario was. It was a little bit more aggressive in 2018 than it was than it is today.
Denny: I think the overarching theme of this podcast is if you’re buying a pre-sale, have a conversation right away with the mortgage broker. The other thing to consider is a lot of people who put off this conversation until the completion date, assume that 20% down is good.
Denny: Whereas if, as an investment property, some lenders require more than 20% down.
Denny: So being aware of that early,allows you to plan for that.
Alex: There you go. And something we haven’t even talked about yet, which maybe you’re already going to bring this up, I’m probably prefacing so I’ll get right into it. Property value. What you pay for the unit doesn’t necessarily mean that’s what a, a appraiser will value the unit at.
An example, I’ve got one going on right now Denny, so you brought this up. We have a client who bought a pre-sell property in 2022, right at the height and I feel really bad about this one. You know, knowing the situation, like their Realtor feels terrible. It’s a friend of theirs. Everybody feels terrible, but nobody could have predicted it. Nobody predicted it. They literally were in a bidding situation on a new development property that was a premium luxury unit in South Surrey. Guess what? That market took a real tumble. Right, that particular market took a real tumble in, right after June of this year, last year. And you know, it dipped probably $300,000 in value on a $1.2 million purchase. That’s a lot of money. Right?
It’s so, where we’re at today is the property is probably not going to appraise at value. In fact, it’s likely to be about $100,000 under. Now, if that borrower, who’s already put down $200 grand as deposit, if they walk away from that deposit, not only do they lose their $200 grand but they also are gonna get sued. Because the developer has lost $100 grand, so they will pay a lawyer to go and sue you for that money. Or make sure that you do finally ,you know, you fulfill your obligation and purchase the property that, what you said you were gonna do so, and that’s a real concern that people aren’t thinking about.
So, you know, in those situations, guess what? You might need a larger down payment to cover the extra money because a lender might only land 80% of the market value. So if you bought it for $1.2 Plus tax, let’s just, I’m gonna give you some hypothetical numbers to making clean. Let’s say it was $1.2 after tax, but today it’s only worth $100 grand well the lender is not…
Denny: Let’s say $1.1.
Denny: So that’s only a $100,000 less.
Alex: $100,000 less, thanks for quick fixing that, it’s late tonight. So it’s $100,000 less, thank you, the lender is only going to lend 80% of $1.1. They’re not going to lend that 80% of the $1.2 million so you have a lot of extra cash that you’re going to have to come up with to be able to complete the sale of that property.
I don’t think that’s a common occurrence, but we’ve seen that happen in Burquitlam, in a lot of those condo buildings out there that were four or five years out where they were purchasing primo, premium units at at the time, high prices being told that these prices are going to be way higher in five years. It’s going to be worth way more but then next thing you know there was like five towers. So the property values were changed and it was just saturating the market and the market conditions have changed.
Denny: Issues with appraisals are not specific to pre-sales. But in most resales you’re completing in two or three months and the likelihood of the market value going down significantly in, in a short period of time like that is pretty low. So, we rarely see problems with appraisals and resale. The challenge with pre-sale obviously is you’re buying something two or three years later. So if interest rates go up four and a half percent like they have, if a foreign buyer tax comes in and that time point, if COVID happens and you’re completing in April 2020.
Like overnight when COVID happened, market value went down 10 or 15% right. So keeping in mind that being able to float, a little bit of a buffer when you’re purchasing a pre-sale, I think is a really valuable idea just to have a rainy day fund should four and a half percent interest rate increases happen.
Alex: No doubt. Pre-sales aren’t inherently bad. But preparing to them, preparing for them is absolutely key. And I think in this conversation someone could virtually know all the biggest and most important things about financing pre-sale property and purchasing one in general.
And outside of that, there is another note that I had about appraisals which I think it’s a good time to talk about really quickly. You said that it’s very rare that an appraisal value will come in low. So typically what we try to do when we’re finally, I don’t know what everyone does, but on our team when we’re purchasing a property we want the appraisal to be done and complete before the client removes conditions. Even if there’s a delay because of the appraisal. Typically speaking, we want to make sure the property value is worth what they paid for it.
Well, in 2022, when the market value started shifting, we started to see the cracks form because people were ordering appraisals after that time or they went subject free meaning they bought a property with no conditions on it. And then they would order an appraisal 1,2,3,4,5,6 weeks later, and the property value would have dipped so they would have had to come up with the extra money. So I think again, making sure that you’re working with someone who knows their stuff about financing and getting that thing done right away is so key. I don’t care if you’re buying a property in a high market market or a low market, you want to get that done right away.
Denny: If you’re considering an investment in a presale, don’t call Alex you’re gonna call me. Because I’m gonna help you with that. But early in the process, talk to a, your mortgage broker. If you don’t have one, find Alex @FlowMortgageCo
Alex: I like it.