“What’s Really Behind Canada’s Condo Bubble”
Agree or disagree with this story, it’s fantastic insight.
“WHAT’S REALLY BEHIND CANADA’S CONDO BUBBLE By: Diane Francis Financial Post May 5, 2012
The condo bubbles in Toronto and Vancouver are caused by foreign speculation and are making housing unaffordable. This creates financial risk for Canadians in terms of government-insured mortgages. But there’s another issue of vital concern to taxpayers.
There are three times more condo high-rises being built in Toronto than in New York City and seven times more than in Chicago. This boom not the market at work but is manipulation by “hot money” from abroad.
“I have come across something I find astonishing, and which amounts to systemic tax fraud by investors, mostly foreign, on a massive scale,” wrote an investor involved in the industry.
He explained how it works: 1. Foreigners sign an agreement of purchase for a condo unit, or for 50 at a time, and put down a 5% deposit. This buys a right to purchase the unit later at a fixed price. In financial markets, this is known as a derivative.
2. Many developers include in the agreement of purchase the right to “assign” this right to buy at a fixed price. In financial markets, this is called creating a futures market. This assignment of a right to buy at a fixed price turns buyers into speculators (unless they want to move in or rent out the unit) who are set up to flip the units for a profit as prices are pushed upwards.
3. Some developers and intermediaries are in the business of helping speculators flip their rights and pocket a fee for doing so. For instance, Mr. X from Asia pays $15,000 for the right to buy a $300,000 condo. Then, when the price of similar units rises to $400,000, he can assign the right, get his deposit back and make the $100,000 difference. There is a speculation frenzy going on that makes prices escalate so rights can be bought and resold over and over again before a building is completed.
4. The paperwork for these agreements is kept in-house, and my source said one intermediary told him that there are no T-5s issued to the speculator or to the Canada Revenue Agency, something that stock and futures market intermediaries must do so taxes can be paid on the $100,000 trading profits. Instead, the profits vanish, possibly along with the paperwork, and taxes paid will be by the end user if they buy, rent out the unit and make a capital gain down the road.
“[Condo] brokers tell me I can flip my assignment and pay no tax and there is no paper trail. They say, ‘We do it all day long,’ ” said the investor who asked to remain anonymous.
Under CRA rules, foreigners making Canadian-sourced income are fully taxable by the federal and provincial governments. In Ontario or British Columbia, the total tax bill would be 46% or $46,000 in tax for $100,000 profit.
The unpaid taxes could be staggering, said a real estate agent. In Toronto, 20,000 condo units have been sold each year for the past five years. Let’s assume one-quarter were sold to foreign speculators who flipped the assignment and made $100,000 profit without paying taxes. Their Canadian-sourced income would total $500-million a year, and they would owe 46% of that in taxes, or $230-million.
Most condo developers may not be involved in this game, but a few – notably developers with Asian and Middle East owners or backers and buildings located in downtown areas – certainly are.
So this is what must happen. As I argued last week, Ottawa must forbid the purchase by foreigners of any residences in Canada. Australia did this in 2010 after foreign speculation and tax evasion damaged its housing market.
The Canada Revenue Agency should send in auditors to the lawyers and intermediaries and developers who have the lists of those who signed agreements of purchase. If they did not close on those deals, and the deals sold for more money than the agreements, then auditors must work backwards and assess income taxes.
The Ontario and other securities commissions should get involved because what is happening, if these reports hold true, is an unregulated financial futures market is being created using and abusing Canadian residential properties as vehicles. Likewise, the federal and provincial government tax collectors should get involved.
If speculators who owe taxes are long gone – many of them are offshore funds that buy out entire buildings then sell units abroad – then the intermediaries and developers should pay the taxes.
This frenzy is forcing prices upwards. Meanwhile, condos in the suburbs often take months to sell because buyers want them as homes, not as convenient money machines to flip.
The investor who described the tax shenanigans took his information to several politicians and called the CRA hotline, but got nowhere. Tax officials said they needed specific foreigners’ names and addresses to investigate, but this is beyond a simple case. This requires a task force to look into the issue.
A realtor said ordinary foreigners are buying from “funds” that are bundling units in Toronto and promising huge returns.
“Foreigners have been lured into so-called investment products, property units, with promises of high yields,” wrote this real estate professional. “They are often small investors who go to property seminars overseas. Many of these buildings do not allow Canadians to buy these units, obviously, because of the tax implications.”
The Australians were victims of the same shenanigan and shut it down. Now Canada must too.
This is nothing new, to me, at least.
The only difference here is that the astute Ms. Francis has drawn the obvious comparison to a futures market, which is something we’ve had in the Toronto real estate market for quite a long time now.
There is one aspect of the article I disagree with, however, and that is the presumption that the foreign buyer only puts 5% down. The initial deposit might only be 5% (actually it’s $5,000 with the balance of 5% within 30 days), but subsequent 5% deposits are normally staggered around 90 days, 270 days, 360 days, and then upon closing.
Many new developments require upwards of a 25% downpayment before final closing. I don’t know of many developments these days that will let you write up a deal with only 5%.
Years ago, 5% was available, but it rarely is anymore.
The standard was always made out to be 20%, but in actual fact, you could ask the girl at the sales centre to draw up an offer with 10%, and they’d take it. They were fine, so long as all the Joe-Schmoes off the street would sign up for 20-25%.
Over time, developers began to realize that demand was so high, they could stop offering 5-10% deposits, and begin to jack up the rates.
Today, you’d be hard-pressed to find a project that doesn’t want 20% total before occupancy, so perhaps this article is a tiny bit misleading. I just don’t want people to think it’s as easy as it’s made out to be in the article. And in order to make these so-called $100,000 profits that are alluded to in the article, you’d have to hang on for the entire duration of the pre-sales, construction, and occupancy. Well, to be honest, you’d have to get into a time machine and go back to 2007 when pre-construction actually produced $100K profits, but I think I’ve beat that horse to death and beyond…
So if some or many of these foreign investors pulled their money out, would the ‘house of cards’ collapse? Personally, I don’t think so. Not an utter collapse. Sure, prices would drop, but that’s true of any market where supply and demand shift. Is there anybody out there naive enough to say “Less demand doesn’t matter – prices will keep rising”? Well, okay, I’m sure there are, but they’re just pure salespeople and aren’t being honest with themselves, let alone the public.
If foreign investment pulled out, yes, prices would decline. But to what extent is unknown, and who says foreign investment is going to pull out anyways? This article makes no claim on that subject.
The taxation issue is a very interesting point, and it is something I wish our government would chase down. It’s a pipe-dream, but it’s money that ultimately comes out of our pockets as taxpayers. Remember that a capital gain on a primary residence is tax free, so if condo owner sells their $350,000 condo for $450,000, that $100,000 is tax-free. But they paid $350,000 as an assignment to a foreign investor who paid $250,000 to the developer – so there is a $100,000 gain that is unaccounted for, and untaxed.
Revenue Canada: it’s your move…