This is why you should read the Financial Post and not the Toronto Star. Well, this and about a thousand other reasons, but I digress…
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…
Ralph Cramdown
at 7:24 am
Who does the developer sue if the buyer fails to close and is an offshore buyer or a fund that just declares BK? The banks say they’re protected because they don’t advance money to start digging until the project is 70-75% sold, but there’s a big difference between 70% sold to Canadians who might be sued and a 30/40% split with essentially judgment-proof counterparties. Ah, but what could go wrong?
Potato
at 9:09 am
“The condo bubbles in Toronto and Vancouver are caused by foreign speculation”
She starts off with a very big, unproven premise. Later she tries to quantify the foreign speculation as 25% of the market. The bubbles are caused by speculation, but it’s largely domestic. There’s very little good data about how much foreign speculation there is, but nothing I’ve seen suggests it’s more than single digit percentages.
Then she flubs the tax calculation: less than half that amount would be owing, due to graduated tax brackets and the 50% inclusion rate for capital gains. Even allowing that error, she forgot to multiply 20k units/year by the 5 years she mentions in the text. Her numbers (properly multiplied) would give a $1.1 billion figure.
And finally, unlike what’s said in point 4, no T5s (nor any other tax slip) are issued for buying & selling stocks for capital gains — they’re only issued for dividends and distributions, so it’s not as nefarious as she implies.
Kyle
at 5:00 pm
Totally agree. This article is a prime example of – a little bit of information can be a dangerous thing.
Here’s yet another example:
“…this right to buy at a fixed price. In financial markets, this is called creating a futures market.” – What she is describing is absolutely nothing like a futures market. In a futures market standardized contracts are traded and are guaranteed by the Futures exchange.
Anonymous
at 9:29 am
Tax evasion/fraud. I would say that unfortunately that’s not the only time it happens in the RE industry… For this particular issue, I’m pretty sure that the government knows about it, yet refuses to do anything about it.
In relation to the article, overall I think it’s good. However, there are a few technical errors. For example, the buyer actually has an obligation and not an “option” to buy.
Joe Q.
at 9:49 am
The even larger issue is the rate of investor participation in the condo market (which, by all accounts, is enormous in Toronto) and the degree of per-sq ft price appreciation (especially for new condo developments) relative to market rents.
The “futures market” described in the article is indeed troubling. But at least it’s being reported. The Star’s real-estate reporting lives inside their “Moneyville” website and consists of verbatim regurgitation of TREB and CREA press releases along with stories from inveterate RE pumpers and incredulous or naive columnists.
Agentzerogame
at 10:15 am
What about the assumption that most foreign investors are successfully assigning these units? Do we know exactly how many units listed on assignment are actually transferred/sold? If this number is relatively small than the issue described becomes a moot point.
George
at 10:45 am
I really wish the article would have explained further what happened to “damage” Australia’s market. Hinting at it and then using it as rationale for why Canada should do something is just such a tease. If we can see a potential similarity, then we can learn from their history.
johnny chase
at 10:58 am
Dave it’s much worse than you think… I know merchant banks that will buy 10-20 units in a building before any pre-sales and the developer cuts them a special deal with only 5% down. Even better (worse?) they don’t restrict them in flipping the units like they normally do with the average buyer – becuase these Merchant Banks are the devlopers best customers.
Kyle
at 11:12 am
“So this is what must happen. As I argued last week, Ottawa must forbid the purchase by foreigners of any residences in Canada. ”
Quite possibly the dumbest solution ever.
dave
at 12:55 pm
I agree that a blanket ban on foreign ownership is not the right direction to do, but having said that, any countries have full or partial restrictions or quotas on foreign ownership of residential real estate. The stated intent is usually to stabilize the market for the benefit of the end users (ie residents)
Kyle
at 4:50 pm
Exactly right. If the issue is taxation, address the tax laws. If the issue is price stability, then disincent flipping (more than likely addressing the tax laws will accomplish this). Foreign ownership is not the problem, and an outright ban on foreign ownership actually reduces liquidity, which will ultimately increase volatility.
Pen
at 11:59 am
I wonder why Ms. Francis is pointing the finger of collusion at builders and REALTORS and not the lawyers for both assignor and assignee as well. The former would have to outright lie about the speculator’s non-residency in order to not cause an amount to be withheld from the proceeds and the latter would be placing their buyer not to mention themselves in serious jeopardy if they knowingly went along with the scam.
I’ve no doubt that this type of fraudulent activity does exist, I just doubt it is as extensive as she would imply.
It would appear to me that it would be far easier for a resident to get away with not reporting the profits made on an assignment.
Matt
at 10:38 am
I think you’d find that the initial capital investors (foreign banks) are in fact getting away with only 5% down. This offshore speculative real estate frenzy has occurred and moved from region to region across the globe. We all know how it ends for the bag holders when the music stops. This is the new reality of global capital flows.
Sam
at 1:15 pm
Honestly what is the upside of buying PRESALES? They are pretty much priced in most cases above market prices. Factor in the additional taxes you have to pay by buying new, it does not make sense and profits would be minimal even if the units were to go up.
Anyone who is buying obviously is paying a premium to get in. The benefits? Not having to get a mortgage until completion which is several years down the road. Sorry, but I would rather buy what’s out there, see what I am buying and at least negotiate a better deal.
Scott
at 3:04 pm
“Let’s assume one-quarter were sold to foreign speculators who flipped the assignment…”
That’s a pretty big — and unfounded — assumption there, Ms. Francis….
TrogLuvr69
at 10:11 am
This article is simply wrong.
It’s not ASIANS and MIDDLE-EASTERN people who are driving up prices… it’s actually Trogs from the ZiddleBop Galaxy.
Oh yes, the Canadian government MUST STOP this foreign investment!
Who cares if 1 out of every 900 homes is sold to a Trog. The fact is they paid 400 times the asking price with no conditions and a cash payment! Because of this, every day, hard working, mostly Caucasian Canadians are entering bidding wars to stretch themselves to their financial limits and overpay for homes and condos!
One never knows when all the offers come in on a Thursday at 5PM if there’s a Trog wading in the water, ready to strike! We have no choice but to outbid the Trogs!
It’s a National (Intergalactic?) Tragedy!
These Trogs, you know… we should have killed them all in ‘Nam.
Arnold Handelman
at 10:12 am
Diane Francis is astute and right on as usual. There should be a mechanism to prevent flippers from hiding profits. People casually say, “oh, it’s a capital gain, tax-free.” Capital gains are taxable, at 50% of the profit.
Capital gain tax free is only for personal residences, and would only be available if the flipper put his own house up for sale, made arrangements to move, and did not advertise the pre construction condo for sale–but rather received an unsolicited offer to assign. Otherwise, it’s a “venture in the nature of trade” and fully taxable. Hard to disprove when you can’t prove you were going to live there, such as when you bought three of them or it’s a family of four and the condo is 700 square feet.
One mechanism that might be able to help to capture taxable profit is the Land Transfer Tax. I believe there is a widespread misunderstanding about Land Transfer Tax. The LTT department, years ago, issued two bulletins explaining their policy. If actual real estate is conveyed, LTT is payable. However, if an offer to purchase is assigned, it’s only a sale of a contract and not realty itself. No LTT is payable. The ultimate buyer pays LTT on the original price for the realty. The rest of their purchase price is a fee or consideration for the assignment. For this to work the agreement to purchase needs to be drawn up as an assignment contract. There could be additional information required to complete the Land Transfer Tax affidavit required before title can be transferred, which would isolate and identify assignments and assignment profits over and above the original condo purchase price.
Groperty
at 10:31 am
Speculating is pretty dangerous business when it’s your capital you are putting down… We can only hope that the building slows down and expat levels increase and bring an abundance of foreign capital. Why wouldn’t people move to Canada? Great policies, great reputation and a strong economy.
John Galt
at 11:09 am
That dog don’t hunt.
I think this is the more likely reason…
http://www.wellingtonfund.com/blog/2012/06/20/ottawa-tightening-mortgage-rules-better-late-than-never/#axzz2LGdqUn55
(not the part about amortization, but the firepower u have with rates at 7.25%)