The dangers of pre-construction sales

January 21, 2020

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Caveat emptor – translated to “buyer beware” – is a legal concept that doubles as a popular warning used by real estate salespeople. The reason for caveat emptor’s popularity is because it’s an important legal rule in resale real estate transactions. Generally, caveat emptor means that the purchaser will buy the existing property in the condition he finds it. The buyer must make himself aware of the condition of the property by doing his own due diligence and he cannot sue the seller if he fails to do his homework. While this warning is heeded by purchasers in the resale market, it is largely ignored in the pre-construction market. This is a mistake.

In 2018, Ontario saw a steep rise in the number of condo projects being cancelled by builders. The numbers are shocking: more than 4,000 units will not be built as a result of project cancellations, beating the 2017 record of 1,678 cancellations. The reason for the cancellations vary – from failure to obtain the number of units desired to make the project feasible to simply underestimating the cost of the build and bankruptcy. While the builders walk and often build elsewhere, the buyers are stuck with a variety of losses.

Buyers who forked over down payments also had to absorb corresponding legal fees. Buyers also no longer have the opportunity to find a home they can afford because prices have increased over the last few years while their money was tied up in a project they once could afford.

Could they launch a lawsuit? Not that simple. Legal recourse is generally quite limited and may be ineffective considering how much buyers would have to pay in legal fees. Even if damages are awarded and lawsuits are won by the buyers, it is unlikely that an insolvent builder would be able to fork over the damages.

Given the risk associated with buying pre-construction, the application of caveat emptor is critical to the pre-construction real estate market; buyers must do their due diligence on the financial health, reputation and history of the builder before they buy. If they don’t, they may suffer the consequences with little recourse.

How to research a builder

1. Check them out with your province’s building regulator:

In Ontario, Tarion Warranty Corporation is the non-profit entity that is empowered by provincial legislation to administer new home warranty protections and to empower consumers when making purchases of new homes. Builders of new homes must be registered with Tarion and Tarion, in turn, collects information about the builder on the Ontario Builder Directory. Searching this directory will ensure that the builder is registered with Tarion, which affords certain protections if the project is cancelled or poorly built. The directory dates back 10 years and provides information about claims against the builder.

2. Online reviews:

While a good place to start, the directory is limited to only 10 years and claims may have occurred years before then. What is more, a builder can hide by changing the name of his company, effectively covering up whether or not lawsuits have been filed or claims have been made against him. Accordingly, it’s prudent to find the names of the management, executive team or the directors of the companies and conduct informal or formal background checks on various court websites and social media.

3. Speak to homeowners:

Talk to homeowners who’ve purchased property built by the builder. Homeowners are an important barometer of the quality of the builder as they – unlike media websites and the builder – have little to lose by telling the truth (unless they’re selling their unit!).

4. Review the financial plan:

The financial plan holds information about whether or not a project is well capitalized or if the builder is running a thin margin (and risky) business. The financial plan will also reveal the quality of materials being used, how many fees you will be responsible for (such as development charges) and if the reserve fund will be healthy and able to withstand any massive repairs. The better capitalized and funded, the less likely a builder will be unable to proceed with the project.

Along with the financial plan, dig deeper into the sale price of the units. If the price is higher than usual, determine if the higher cost is justified or if the builder has not done his homework, putting the project at risk. If the price is lower than justified, the builder may be cutting corners, which will hurt the project and its resale value in the long run.

If you or a client are thinking about preconstruction ownership, dig beneath the surface and investigate who you’re buying from. Don’t get distracted by the glittery finishes because, as the old adage goes, all that glitters it not gold.

Thanks to who published this article By Natalka Falcomer: