What’s the difference between fraud and a bright idea?

Seriously.  I’m asking for a friend…

One might argue that the line between love and hate, right and wrong, and insanity versus normalcy is very thin, and often subjective, and in the case of the financial markets and the lending world, we’ve seen some interesting examples of the “fine line” over the years.

We’ve all read The Big Short and we’ve all seen the movie as well.

We all learned that, during the Financial Crisis in the United States in 2007 and 2008, subprime mortgages were being repackaged and sold as collateralized debt obligations – complete with Triple-A Ratings from the ikes of Moody’s and S & P’s.

Was this fraud?  Or was it just a bright idea?

Who could really tell the difference?

The first time I heard of something called a “blanket appraisal,”  I couldn’t help but wonder how this was legal.

Imagine that you’re purchasing a pre-construction condominium or a house that’s to be built by a developer, and these are closing well into the future.

Now consider the bank that says, “We think this is worth $500,000 today, since that’s the price you paid to buy it, so we’ll guarantee you a mortgage to reflect this price when you close.”

No problem, right?

That is, so long as prices continue to appreciate!

As I have mentioned many, many times before, I got into the real estate industry in 2004 when pre-construction prices were lower than comparable resale.  This seemed to make perfect sense to me.  Pre-construction condos aren’t built yet, and they carry inherent risk!  Surely there should be a reward for purchasing a unit.

Over time, the price of pre-construction condos drew even with comparable resale, and that made no sense to me.

Eventually, as history shows, pre-construction condo prices rose to be higher than comparable resale, and this is when I really began to rant and rave here on Toronto Realty Blog.

I’m of the mindset that the person who paid $1,000 for pre-construction, when prices for resale condos were at $800, is still an idiot when five years later, his condo is worth $1,200 per square foot.  Yes, he’s up 20%, but why did he pay a premium in the first place?

Nevertheless, with pre-construction condos selling out through 2022 and 2023, and with prices rising, this was never a problem.

But as we all know, pre-construction sales have dried up.

Urbanation: “GTHA New Condo Sales In 2024 Were Lowest Since 1996”

Yeah, no kidding.  And as an agent who has never sold a single unit of pre-construction in twenty-one years, I saw this coming a long time ago.

But what happens to people who bought from 2018 through 2023?  What happens when they go to close?

Here’s an article that many of you would have seen last month in the Globe & Mail:

“Toronto Buyers Left In Lurch As Preconstruction Condos Now Worth Less Than Original Value”

As I remarked last month, the market doesn’t have to decline at all for pre-construction condos to leave people underwater once they’re ready.  If you’re paying a 20% premium, then a market that doesn’t increase by 20% leaves you behind.

From the Globe & Mail article:

During the real estate frenzy in late 2020, Joe Baradziej decided to buy a $2.195-million preconstruction condo in his tree-lined neighbourhood of Leaside in midtown Toronto. He provided the developer with a deposit of $439,000, the equivalent of 20 per cent of the purchase price. His two-bedroom place with a grand view of city was on the fifth floor of an eight-floor luxury condo building.

When the building was nearing completion last fall, Mr. Baradziej got the property appraised in order to secure a mortgage. Documents viewed by The Globe and Mail show the appraisal came in at $1.6-million – 27 per cent below his purchase and sales agreement, a legally binding contract with the developer.

Lenders will only provide a mortgage based on the appraised value, so Mr. Baradziej was on the hook to bridge the $595,000 gap. He could not sell the rights to his contract, also known as an assignment sale, until the developer sold 90 per cent of all the building’s units, a common practice in the industry.

We can debate the decision to purchase a 2-bedroom, pre-construction condo for $2,195,000, another day.

Today, let’s look at the fact that his appraisal is 27% below the purchase agreement.

That is the purpose of today’s blog and that is where the concept of a “blanket appraisal” comes into question.

Later in the article, we’re told:

According to documents viewed by The Globe, the developer, Gairloch, sent him an e-mail saying it had partnered with Royal Bank of Canada to offer a so-called blanket appraisal, which would allow buyers such as Mr. Barardziej to secure mortgages for their units by having the bank appraise the unit at the original contracted price. Mr. Baradziej declined.

What’s this?

A blanket appraisal, you say?

Oh, you had my curiosity, but now you have my attention!

A blanket appraisal is a financing agreement where the lender finances the loan based on the original purchase price of a newly-constructed property rather than the property’s current appraised value.

What do we make of this arrangement?

Consider the situation above that was reported in the Globe & Mail.  The buyer paid $2,195,000 for the condo but it was appraised at $1,600,000, and yet the “blanket appraisal” will allow the bank to advance funds based on a value of $2,195,000.

Does this make any sense?

How is this legal?

I spoke to a contact who I know and trust and he said that this has been around for quite some time…

“This has been happening forever, it’s not a new program.  It’s been around for a decade or more and it was never an issue because of how it was used.  RBC was best known for offering this, and they would price a mortgage above market value and basically say, if you want to buy a detached house that’s done in eighteen months, they’ll guarantee the pre-approval but if current rates were 4% they would offer you 4.89% and you’d get the mortgage.  It gave the buyers peace of mind to buy into the future.”

Sure, but what about the risk?

My contact added:

“The credit risk for somebody like a Royal Bank was just fine when prices were going up and buyers weren’t buying at massive premiums to resale.  This was win-win.  The banks get their loans, the buyers get their mortgages, and the developers get the project financed.  Consumers got peace of mind and a guaranteed mortgage, then if the market was better in two years or five years when the property was finished, they could always shop around.  And Royal Bank would get a mortgage with an above market rate while retaining a new borrower.”

But that was then.

And this is now.

So the questions I would ask are these:

1) Why didn’t we plan for a situation where prices are lower and appraisal values are lower?

2) How in the world is this legal?  What does OSFI think about this?

Storeys.com did an excellent piece in February where they interviewed mortgage broker, Ron Butler, and real estate lawyer, Mark Morris.

Here’s the article:

“Experts Caution Against Blanket Appraisals, Calling It A ‘Questionable Practice'”

From the article:

“The risk profile of the transaction, from a bank’s perspective, has increased,” Morris says. “But the interesting question is why. Why is this happening? What do the banks get out of it?”

For today’s condo builds, where you’re looking at a several-year-close in a distressed market no less, blanket appraisals are a different beast entirely. Now, you’re dealing with banks (not just RBC) that are offering these blanket appraisals because they’ve supplied, say, a $500-million construction loan to a condo builder, only to have those projects on the brink of distress because the individual buyers aren’t qualifying for the lending they expected to.

“So the bank says, ‘We have this half-a-billion-dollar loan, we need the condo corporation to close, so we need enough of the buyers to be able to complete their financing in order to close with our builder.’ And therefore, it’s in their best interest to make it easier for buyers to get an individual mortgage,” Butler explains. “It’s about changing one big half-a-billion-dollar problem into 100 or 200 smaller problems, of which some of them will be no problem. And if you’re a bank, that’s risk management.”

Morris points out that if the bank doesn’t offer these blanket mortgages, they end up “on the hook” for the construction financing. “In other words, blanket appraisals can benefit the bank as much as they do consumers who are seeking to avoid breach,” he says. “That’s the nefarious part.”

I think that we can all agree that there are “benefits” to blanket appraisals, but my question is: should there be?

When the market is hot, the blanket appraisals benefit the lender, the borrower, and the developer.  Everybody wins.

But when the market retracts and those inflated pre-construction condo prices from 2020 are nowhere near values in 2025, who really benefits?

Wait, that’s the wrong question.  Because the lender, borrower, and developer still benefit.

Who loses in all this?

The Canadian taxpayer.

Don’t forget, these “insured mortgages” are insured by CMHC.

So what, exactly, is the CMHC insuring?

Consider the purchase of a pre-construction condominium in 2020 for $600,000, which was never worth that amount, but hey – that’s how pre-construction works, right?

Now in 2025 when the condominium is finished, the unit is worth $500,000.  On a good day.  And that’s what the appraisal shows.

But the blanket appraisal allows the lender to advance financing based on a $600,000 “value.”

And what if the buyer is only making a 10% down payment?

The buyer has a mortgage of $540,000 and the condo is worth $500,000.

Who’s on the hook?

The Canadian taxpayer.

How this is legal, I can’t quite figure out.

The Bank Act tells us:

Restriction on residential mortgages

418 (1) A bank shall not make a loan in Canada on the security of residential property in Canada for the purpose of purchasing, renovating, or improving that property, or refinance such a loan, if the amount of the loan, together with the amount then outstanding of any mortgage having an equal or prior claim against the property, would exceed 80 per cent of the value of the property at the time of the loan.

Exception

(2) Subsection (1) does not apply in respect of

(a) a loan made or guaranteed under the National Housing Act or any other Act of Parliament by or pursuant to which a different limit on the value of property on the security of which the bank may make a loan is established;

(b) a loan if repayment of the amount of the loan that exceeds the maximum amount set out in subsection (1) is guaranteed or insured by a government agency or a private insurer approved by the Superintendant

The Office of the Financial Superintendent is silent on this.

Is OSFI okay with a blatant disregard for the Bank Act?

Are they aware that lenders are being creative with the “spirit” of the Bank Act, all in the name of reducing potential losses on a loan?

Because if you ask some people in the industry, they’ll say:

“The Bank Act says ‘value’ and that value can be established by an appraisal, but an appraisal is an opinion.”

So whose opinion are you using?  And from when?

This calls into question the banks’ stated loan to values, in that the “value” might not be accurate.

Consider the scenario above where the condo was bought for $600,000 and appraised for $500,000, and let’s assume the buyer makes a 20% down payment.  The bank’s LTV is 80%, right?  That’s 20% of $600,000.  But the property is worth $500,000, so the LTV is actually 96%.

In the end, I think that banks simply need to provide blanket appraisals, otherwise, the whole house comes crashing down.

Connect the dots here:

*Developers need to offer peace of mind to buyers to get them to purchase.

*Banks want to lock-in future business.

*Banks want to finance condo construction.

*Developers don’t want buyers defaulting upon closing.

*Banks and developers don’t want developers stuck with unsold inventory, or worse – inventory coming back to them.

*Banks don’t want developers finding themselves with a condominium corporation that can’t close, leading to them breaching their loan covenant.

The solution is simple: blanket appraisals.

But note the world there: solution.

Because what I’m left wondering is: what is this the solution to?