In early February, a three-bedroom house in Clarington, Ontario -- a city on the easternmost outskirts of the GTA that has, on a good day, an hour-long commute into downtown Toronto -- sold for $1,035,000. It was on the market for just four days.
Cut to three months later, and that same house, located at 22 Parklawn Drive, came back on the market where it sat for 10 days before selling for just $850,000.
It’s no secret that home prices in the GTA are falling, with the outer suburbs fielding the brunt of this decline. Although this news is likely to set off alarm bells for would-be sellers hoping to cash out on their home in a red hot market, they’re not the only ones coming face-to-face with a bleaker financial outlook.
GTA real estate professionals across the board are reporting noticeably higher rates of buyers backing out of deals months after having their offers accepted and deposits submitted. Sellers, left with no buyer, are forced to re-list in a considerably cooler market where their home will inevitably fetch a lower price.
“It’s a very significant increase," Toronto-based mortgage broker Ron Butler said of buyers reneging on deals. "It's just been climbing for the last four weeks."
Valuations Aren’t Adding Up
Broker and real estate analyst Daniel Foch has made similar observations in recent weeks, noting that the deals falling through right now are for homes that sold when prices peaked earlier this year. The main issue, he says, is that during the typical 60-day closing period, buyers’ financing isn't coming through as lenders look at comparable homes and assign a valuation that's lower than what the buyer offered to pay just one or two months prior.
“In January and February, prices accelerated so quickly that, similar to 2017, there's really no way that valuations can keep up because now there are no closings to substantiate the values,” Foch said.
When a lender’s valuation comes in lower than the sale price, the borrower is responsible for paying the difference between the valuation and the sale price upfront -- an option only accessible to those who have the cash on hand to do so.
"People are typically purchasing at the maximum of their buying power, so in those cases, they typically choose to forfeit their deposit and walk away from the deal,” Foch said. “For buyers who are buying at $800,000 to $1.2M, often they don't have the means. They're not your mid-market buyers where they do have cash laying around.”
But failed financing isn’t the only factor. Butler notes that the sudden turn in the market has left some homeowners who purchased another home during the pricing peak before selling their old home in a sticky financial situation. With their old home less in demand and valued lower than they thought it would be when they submitted an offer on the new home, they’re left without the means to follow through on the purchase.
“If you bought a house and you have to sell your old house, that's an incredibly bad problem,” Butler said. “Now you go through to offer night [on your home] and there are no offers.”
After the Bank of Canada having introduced new rate hikes in recent months, and several more are expected throughout the year, some sellers are likely evaluating whether the higher mortgage payments they’ll be met with in the future, coupled with falling home prices, are big enough deterrents to back out of a deal and leave their deposit on the table.
“Somebody, if they weren't fixed and they're on a variable rate, they might just say, ‘Oh, damn, it might actually be cheaper for me to just walk from the deal and from my deposit,'” Foch said. “People don't have an incentive to close on a deal that they have negative equity on.”
In Ontario, there is no legally required amount for a deposit, but the industry standard is typically 5% of the offer price. If an offer is accepted, the deposit goes towards the down payment.
The decision to walk away, though, is by no means easy. These aspiring homeowners are often panicked, trying to scrape together the money to make the purchase happen -- something Butler says everyone ought to have great sympathy for.
“A lot of times people like to talk about, ‘Oh, they were greedy,’ or ‘Oh, they should have known,’ but that's not true,” Butler said. “These are just ordinary people buying and selling houses. They have everyday jobs... These people are not tuned into the real estate market. They're not looking at Twitter for two hours a day. They're not googling real estate valuations twice a day. We should feel very, very bad for these people that this is very much a financial and nerve racking problem for them.”
Suburban Markets Hit the Hardest
The latest data from the Toronto Regional Real Estate Board revealed a drop in both the number of sales that took place in April -- down 41.2% year-over-year -- and the selling price. Detached houses in the 905 regions in particular saw a significant drop, with average prices falling more than $200,000 from February’s numbers. Semi-detached homes fell by $172,244, townhouses by $121,610, and condo apartments by $33,545. So It comes as no surprise that buyers reneging on deals are largely concentrated in these outer markets.
“I think we're seeing it in suburban markets where price run ups were really really strong,” Foch said. “Toronto seems pretty insulated against it.”
Indeed, comparatively, detached home prices in Toronto fell a more modest $126,000 between February and April. Meanwhile the average price of semi-detached homes dropped by less than $5,000 and condo apartments, which make up an overwhelming majority of sales in Toronto, fell a mere $1,255.
“A lot of that I think is due to what we're calling the reorganization of demand,” Foch said. “As the city starts opening back up, a lot of people are moving back downtown so it’s kind of an unwinding of the suburb. Newmarket and Georgina were hit really hard.”
Butler agreed, saying that although the 416 area is “not totally immune, it’s certainly not the pronounced effect we see in some of the other areas.”
Some Recourse For Burned Sellers
Sellers feeling like they’ve been left in the lurch after a buyer backs out aren’t without recourse. But it’s not a perfect system.
The first and most obvious step would be to keep the buyer’s deposit, but even that can involve several steps. As Toronto-based real estate lawyer Mark Morris explains, the Real Estate and Business Brokers Act stipulates specific conditions under which money can be released from a brokerage trust account where the deposit is held: either on completion of a court order or on mutual release.
A mutual release -- a document signed by both parties agreeing to release the deposit to the seller -- although easier, comes with its own set of drawbacks, particularly if a seller is now having to re-list the home at a much lower price.
“Most mutual releases presented by real estate agents are complete mutual releases, meaning they release all parties from any liability,” Morris said. “That's obviously not advisable if your damages are over and above the deposit…thus, people end up going to court so that they preserve their rights to sue for additional damages.”
But as real estate lawyer Daniel La Gamba explains, deciding to sue a reneging buyer is often a complicated decision with many factors to consider beyond the initial fact that they’ve caused you to lose out on money.
“You always have to factor in whether it’s really worth the extra effort to pursue litigation because it's going to cost you a lot of money up front, you're going to have to hire a litigation lawyer, pay a substantial retainer, and it's going to take a lot of time,” La Gamba said. “I always tell clients that they have to be prepared for a very long battle, and is it really worth pursuing after paying all the legal fees and taking time off of work?”
Legal fees for this type of case can run up to $100,000, La Gamba and Morris say. Morris also noted that who the buyer is will influence a decision as to whether a seller should take them to court.
“No lawyer is going to go down that road unless the buyers seem to have assets,” Morris said. “There's no way to enforce if it’s someone who has like a $30,000 a year job with no assets that we're able to seize.”
Even with substantial losses, enough time and money to go to court, and a buyer that’s worth suing, sellers are required to put in a considerable amount of work to mitigate their losses and keep records proving they’ve done so.
“You have an obligation as a seller who suffered a loss to try to minimize your loss,” La Gamba said. “You can't make that loss greater due to your neglect.”
This means proving you put in a reasonable effort to re-list your home in a timely manner and sell it for the highest price possible. But for sellers that do take their case to court, Morris, who has seen a tremendous increase in these types of cases recently, says the court overwhelmingly rules in the seller’s favour.
Change on the Horizon
Although there's not much that can be done for homeowners already dealing with buyers backing out of deals, there’s some hope for future sellers: reneging is likely to be a temporary phenomenon. Both Foch and Butler are predicting a substantial return of financial conditions to sale agreements -- something that had effectively disappeared from the GTA during the recent run up. In fact, Foch has already seen an increase in the number of sale contracts coming through now that stipulate the buyer has a set number of days post-offer-acceptance to secure financing.
In many suburban areas, bidding wars are already on the way out, with some listings not even receiving a single offer come offer night. Although this may seem like bad news for sellers, it means the likelihood of the price being pushed beyond what a lender will value it at is significantly less.
“Offers will come out at lower prices and eventually the market will sort itself out by the fall,” Butler said. “We won't have these disastrous appraisal failures and instabilities. People will add financing conditions to their offers. We will eventually see an old-fashioned clause in an offer that says I need to sell my own house first, or I can leave this deal if I don't sell my house.”
This type of escape clause, although a standard option available to all realtors drawing up contracts, hasn’t come across Butler's desk in many years.
Although the changing market has inevitably caused headaches and financial strife for buyers and sellers alike, Foch says that it’s a sign of good things to come.
“Returning to a healthy market, the challenge is, in order to get to that healthy balance market, there has to be some pain on the way down,” he said. “From my perspective, now, more than ever, it's important to get good advice and really, be careful and be patient.”
