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The only bond stronger than a mother and its baby is the one between rising interest rates and the arson of new homes under construction. Commercial insurer Northbridge Insurance is warning home builders to look out for arsonists. In a letter this week, the firm explained they expect new home arson to rise as financial conditions erode. They suggest increased security measures to prevent and document the incidents, as desperate investors try to pass the costs onto the insurer. Any rise in claims is likely to result in higher premiums, and thus raise the cost of housing even further.
Burning Supply? New Homes Across Canada Are Burning Down Before Completion
This past Saturday, firefighters in the Toronto suburb of Burlington were called to put out a fire at two homes under construction. They made short work of it. Two days later, they were called to the same address, and this time the fire was a lot bigger, ensuring the new homes were burnt to the ground. Police labeled it suspicious, which isn’t a surprise. This is part of a broader trend that’s been recently on the rise.
As home prices began to fall, there was a notable uptick. Some were incredibly brazen.
The issue isn’t exclusive to the Greater Toronto area. Edmonton’s fire department recently stated they put out a suspicious fire of two new homes under construction as well. It’s not even exclusive to the current period of rising rates. Back in 2016, Greater Vancouver saw over $60 million in vacant property burst into flames over just one month. Random arsonists? Investors backing out? The reasons will forever be a mystery since the public is rarely updated on the cause, but it’s a heck of a coincidence.
Canadian Insurer Warns Home Builders That Arson Is Expected To Rise
Northbridge warns it’s not a coincidence, and they expect the number of cases to increase. Building a home leaves a lot of opportunities for accidents that can cause the buildings to ignite. However, many of the recent fires have been much more brazen. The insurance firm is apparently tired of tiptoeing around the issue.
Greater Toronto Mortgage broker Vince Gaetano warns the Northbridge Insurance notice means suspicious fires will raise insurance premiums.
“We’re seeing a quick and noticeable increase in suspicious fires affecting home builders, which may be being exacerbated by current financial and property market conditions,” reads the notice.
We know what you’re thinking—financial conditions cause fires? In a speculative environment they sure can.
Canada’s Speculative Real Estate Market Can Produce Desperate Investors
Pre-construction buyers aren’t buying a home, they’re committing to buying a future home. As a result, they only have to provide the funds for the deposit schedule, not the whole amount. It’s not until the home is fully built that the buyer needs to provide financing and apply for a mortgage. That can be a problem.
The value of a home can change drastically between the pre-sale and the finishing phase. Generally, home values have increased, resulting in more equity and easier financing. When home prices fall the buyer still owes the same amount they committed to, but the lender will only lend on the current value. That can require topping up the deposit with money buyers don’t have.
The problem was compounded by the rise of investors during low rates. Since they don’t have to secure financing for the whole home, speculators have been buying pre-construction to flip before the financing is due. For just a few thousand dollars, they can buy into significant leverage.
A number of projects were sold to investors with math based on the return of the deposit. For example, look at the above investor sales sheet. At first glance the math might seem off. A property’s value increasing from $254k to $425k is a 67% increase, not 300%. The 300% is how many speculators came to view property investment—they do the calculation based on a deposit of ~$42k.
Many investors got the bright idea of getting that leveraged return without actually closing. They would try to flip the property before the completion, potentially landing a leveraged return without qualifying for financing.
When Statistics Canada did the math showing new construction is dominated by investors, they only looked at ownership. That means they missed everyone who bought a pre-construction home and flipped it before it was built. The share of pre-construction owned by investors/speculators is much higher.
As Good As Gold? Insurer Suggests Increased Security, Possibly 24-Hour Guards
When it works out, it works out. If it doesn’t, well… you need a way out. If the house is never completed, you may never have to close on that property. In wild fantasies, you even get your deposit back. That can lead to some desperate moves, and Northridge wants home builders to take measures to prevent this sort of thing.
Amongst the measures suggested are:
- Conducting appraisals to determine if the appraised value is less than the original purchase price;
- Engage with purchasers 4 to 6 months prior to closing, and try to gauge the risk of their ability to close;
- Enhanced security, citing examples like 24 hour guards, 6 foot fences to secure the development perimeter, live camera feeds, end-of-day inspections, securing flammables, and using more flame retardant materials
The suggested measures are just that, suggestions. However, they make a lot of sense. Premiums follow a rise in claims, resulting in increased costs to obtain insurance. Combined with inflation already driving replacement costs higher, that can add a pretty premium to the cost of building. That won’t just cost developers more, but also transfer risk premiums to end users.
In plain english? The home builder won’t lose out. End users will shoulder the costs, meaning more expensive housing.
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