Demystifying URBAN(CORP.) Legends About Investing in Real Estate

Insolvency & Investing Real Estate

Anyone trying to buy real estate in Toronto, the Greater Toronto Area, or anywhere in Canada, knows that prices are constantly rising and the only common theme seems to be bidding wars and shock at how high prices are.  It seems that the only safe investment is real estate.  Does this mean that investing in real estate is always safe?

The recent insolvency of the Urbancorp group of companies shows that real estate is not always a safe for any of the parties – lenders, trades and creditors.  Urbancorp was founded in 1991 to develop, construct and sell residential properties in the Greater Toronto Area.  Urbancorp ran into financial difficulty when it was unable to raise sufficient financing to finish its major projects.  This led to Urbancorp’s insolvency.

One of the effects of Urbancorp’s insolvency was that many home buyers lost deposits.  Tarion (which provides new home warranty protection in Ontario) provides coverage for deposits of up to $20,000 for condominiums and $40,000 for freehold homes.  The actual deposits which home buyers paid to Urbancorp were often in excess of $100,000 which means between $60,000 and $80,000 was not protected by Tarion.

In the case of condominiums the builder’s obligation is to hold the deposit in trust which means that the deposit does not form part of the builder’s assets and is available to be returned to the buyer if there is an insolvency.  Unfortunately when the builder faces financial difficulties and needs additional funds to finish the project, using funds that should be held in trust is often too tempting.  When this happens the deposit is not longer available to be returned.  The situation is even worse in the case of freehold homes where there is no obligation to hold the funds in trust.

The risk is compounded by the fact that the agreement signed with the builder obligates the builder to build a home but does not create any rights to the property.  If the builder does not complete the work the only claim is against the builder, not the property itself.  If the builder has not held the deposit in trust (either in breach of the obligation or because there is no obligation) then the only recourse is to sue.  If the builder is in financial distress it will not be possible to enforce a judgment.

If the market is so strong then how can a builder fail?  There are a number of reasons, often related to the fact that the market is strong.  First, there are many builders.  Some have been around for years and are very experienced.  Others are new and have little to no experience.  Many new builders want to get in on the action but, because of inexperience, fail to manage the project properly.

Even experienced builders can run into problems.  Again, with the market as strong as it is, builders will want to develop as much as possible.  The result can be that a builder will take on too many projects and will not have sufficient funds or experienced staff for each project.  When one project fails the builder breaches its covenants to lenders who lent to that project.  This can in turn lead to problems with other projects.  The projects are usually cross-collateralized which means a breach on any one project is a breach on all the projects.  Suddenly one failure results in lenders to all projects demanding payment.

What are the signs that a builder or a project is running into difficulty?  The first sign will be delays which are often cause by a lack of funds.  The next sign will be that purchasers, lenders or trades are given limited access to the project site so as to hide the fact that there are delays.  Another sign will be project development issues such are changes to the plan or issues with Tarion.  Finally if trades are not being paid, there will be numerous liens registered against the projects.  These are all signs that there is a problem with the project and potentially the builder.

How can purchasers, trades or lenders protect themselves?  It is important to gather as much information about the project and the builder as possible.  Ask about the builder’s past experience and how many other projects the builder has.  If there many projects, ask how they are managed.  The answers will be informative but often the builder’s comfort with these questions will be even more informative.  A builder that is in trouble will want to deflect these questions whereas a builder that is not in financial distress will understand that answering these questions is just part of the business.  

If you have any questions relating to any of the above, please do not hesitate to contact Wojtek Jaskiewicz at wjaskiewicz@kmblaw.com or 905.276.0424.