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The Boom and Bust of Urban Development
In recent years, urban development has thrived, with inner-city properties like former parking lots, theaters, and unused spaces transforming into high-demand condo projects. These developments catered to both residents and investors, feeding a robust market that saw quick sales and high returns. However, the current economic landscape has turned this trend on its head, presenting numerous challenges for developers.
The Economic Downturn and Its Impact
The economy’s downturn has had a profound impact on the real estate and construction industries. Rising interest rates, surging labor costs, and escalating construction expenses have significantly strained development projects. Over the past five years, construction costs have soared by 40-50%, creating an untenable situation for many developers.
According to Statistics Canada, residential construction costs increased by an average of 46% from 2018 to 2023. Labor shortages and supply chain disruptions during the COVID-19 pandemic have driven these costs higher, significantly impacting developers’ budgets and timelines.
Pandemic-Induced Shifts
The pandemic has further complicated the market dynamics. The demand for small condos, once a lucrative segment, has diminished as people prioritize larger living spaces suitable for remote work. The high cost of living in urban centers like Toronto, coupled with the desire for more spacious homes, has driven many potential buyers to look for alternatives outside the city. This shift has resulted in a surplus of unsold condo units and increased maintenance costs for existing ones. According to the CMHC, Toronto experienced a 55 per cent decline in housing starts year-over-year and had significant declines in multi-unit construction. Multi-unit construction includes condos, apartments, townhomes and semi-detached homes.
Overleveraged Developers and Financing Challenges
Developers, eager to capitalize on the once-thriving market, often overleveraged themselves by acquiring as many sites as possible. This strategy worked well in a booming market but has proven perilous in the current climate. Many developers, unless they have substantial financial reserves, find it challenging to hold onto properties without immediate returns.
In the US, developers often secure financing for construction without pre-sales, relying on third-party or private financing based on property value and projected returns. However, in Canada, financing typically requires 70-80% pre-sales, a model that is becoming increasingly untenable as pre-sales dwindle.
The Risks and Realities of Construction Delays
The extended timelines between pre-sales and actual construction further exacerbate the risks. In Toronto, there is often a significant gap between the signing of contracts and the commencement of construction, sometimes spanning several years. During this period, construction costs can escalate, and market conditions can change dramatically, leaving developers with slim margins and heightened financial risks.
The Distressed Commercial and Retail Market
The commercial and retail property markets have also softened considerably. Demand for office buildings, industrial properties, and retail plazas has plummeted, leading to distressed properties and financial strain on developers. This situation necessitates renegotiations with lenders, seeking reduced interest rates, or additional collateral to secure more favorable terms.
Real-World Examples
- Cresford Developments: One of Toronto’s largest developers, Cresford, faced financial difficulties in 2020, leading to insolvency. Their high-profile projects, including YSL Residences, were halted, leaving buyers and investors in limbo.
- Kingsett Capital: This developer had to pivot its strategy by partnering with other firms to complete its downtown Toronto projects, highlighting the necessity of joint ventures in the current market.
- Urban Capital: The company faced delays and increased costs in its Toronto projects, forcing it to seek additional financing and renegotiate terms with lenders.
- Liberty Development: Liberty Development’s Cosmos Condominiums project in Vaughan was canceled in 2018, impacting over 1,100 purchasers. The company cited rising construction costs and financing challenges as the primary reasons for the cancellation.
- Concord Pacific: Concord Pacific’s redevelopment of Toronto’s waterfront faced significant delays due to increasing construction costs and labor shortages. The project, initially slated for completion in 2022, has been pushed back multiple times, affecting its financial viability.
- Lifetime Developments: In 2023, Lifetime Developments had to halt its Liberty Market Tower project due to unforeseen increases in material costs and financing issues. The project, which had been highly anticipated, left buyers uncertain about the future of their investments.
Potential Solutions for Developers
Developers facing these challenges have several potential avenues to explore:
- Negotiating with Lenders: Developers can engage in early negotiations with lenders to secure lower interest rates or restructure payment terms. This process often necessitates offering additional collateral, such as other properties or assets. It is crucial to initiate these negotiations well in advance to avoid any financial crises.
- Seeking Alternative Financing: Developers can turn to institutions with less stringent lending criteria to obtain necessary funds. These institutions, often seeking higher returns, may be more willing to finance distressed projects. Many over-leveraged projects, especially those with undeveloped value, might attract financiers who are eager to protect their position by funding further development.
- Selling the Property: While not an ideal solution, selling the property can help reduce debt burdens. Developers might consider selling excess land associated with certain projects to preserve cash flow. In some cases, walking away from over-leveraged projects can be a strategic move to maintain financial stability. Retaining some equity in the property may also allow developers to recover part of their investment.
- Joint Ventures: Partnering with general contractors or other developers can provide the resources needed to proceed with the project. This collaborative approach can be beneficial, especially when contractors have idle capacity and resources.
- Changing Property Use: Repurposing properties for affordable housing or rental projects can make them more viable in the current market. These projects can often be brought to market more quickly than traditional condo developments.
- Attracting International Investors: Developers can look for international investors seeking to park funds in Canadian properties. These investors might be attracted to the relatively lower prices compared to other global markets.
Successful Turnarounds
- Menkes Developments: Menkes Developments successfully navigated the economic downturn and the challenges posed by distressed condo projects by restructuring their financing and focusing on mixed-use developments. This strategic pivot allowed them to ensure a steady cash flow from various revenue streams, reducing their reliance on condo sales alone. By diversifying their portfolio and engaging in joint ventures, Menkes mitigated risks and shared costs, enabling them to continue operations and complete projects even in a difficult market.
- Tridel: Tridel managed to survive the economic downturn and the associated challenges by diversifying their project portfolio and focusing on mixed-use developments. By integrating residential, commercial, and retail spaces into single projects, Tridel ensured multiple revenue streams, reducing dependency on condo sales alone. Their approach to sustainable and green building practices also attracted environmentally conscious buyers and investors, which helped stabilize their financial situation during uncertain times. Furthermore, Tridel’s strong relationships with financial institutions and proactive engagement in community partnerships played a crucial role in their resilience.
- DiamondCorp: DiamondCorp navigated the challenging market by leveraging their expertise in complex urban developments and forming strategic partnerships with other developers and financial institutions. This collaborative approach enabled them to share risks and resources, which was critical in completing projects on time and within budget. Additionally, DiamondCorp focused on high-demand areas and diversified their development projects to include a mix of residential, commercial, and retail spaces, ensuring a steady income flow even when one sector experienced downturns.
To navigate these turbulent times, developers should consider incorporating sustainable and green building practices. These not only reduce long-term operational costs but also attract environmentally conscious buyers and investors. Additionally, utilizing advanced construction technologies such as modular building and 3D printing can significantly reduce construction time and costs.
Engaging in community partnerships and understanding local needs can also lead to more resilient and adaptable projects. By focusing on innovation, sustainability, and community engagement, developers can find opportunities to thrive despite current market challenges. Developers, stakeholders, and policymakers must collaborate to find innovative solutions that will drive the future of urban development. The time to act is now.
Zeifmans can help owners of development properties facing financial challenges by creating effective work out plans. We collaborate closely with developers, trades people, and lenders to develop solutions that benefit all parties involved. Addressing financial distress early significantly increases the chances of success.
Sources:
- Toronto Star: Cresford Developments
- CBC News: Cresford Insolvency
- Globe and Mail: Kingsett Capital
- Financial Post: Urban Capital
- CTV News: Liberty Development
- Toronto Life: Concord Pacific
- Toronto Sun: Lifetime Developments
