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Marlon sits down with Colin Doran, EVP of Cost Consulting & Project Management at Altus Group, for a one-on-one discussion on distressed development projects in Canada. Don’t miss this highly informative conversation as Colin covers distressed projects from delays to insolvencies to cancellations, why we’re seeing an uptick, and what key project stakeholders can do to address projects that turn risky.
Welcome to Altus Insights Podcast Series. This podcast brings together some of our leading brainiacs at Altus Group to discuss, debate, and on occasion complain about the evolving state of Canada's residential and commercial real estate. Join Ray Wong, Marlon Bray, and Avi Zelver for monthly podcasts covering the latest market and construction cost trends across major markets in Canada.
Welcome to Altus Insights Podcast series with Ray and Marlon hosted by me, Avi. This podcast will cover monthly market updates and construction cost impacts across major markets in Canada. So today's podcast is a little different, we have a special guest star in Colin Doran. Unfortunately, Avi couldn't make it today, and Ray's too busy playing golf to do actual real work. So we've got Colin. So Colin, one of Colin's areas of expertise as well as being an EVP in our developer group, is around cancellations, insolvencies and whatnot. So today we're going to touch on a little bit of a dark subject, which is basically the market cancellations, insolvencies project, project problem projects and workouts. So maybe it's a start that if you'd listen to our last podcast, we did myself and Ray did last week and we spoke about some of the challenges we had on the market recently. Crazy levels of hard construction escalation, soft cost increases and those timed delays and to projects. So this is a subject that's near and dear to a lot of people's hearts. Maybe Colin you want to give it a little bit of a background to yourself and the work deals where you've got all the experience from. Sure Thanks for the intro Marlon. I'm happy to be here. Yeah, I mean, I think I think right now there's a lot of market factors converging given a little bit of, I guess, a lot of the Lenders are uncomfortable right now, with rising interest rates twinned with cost escalation. I would say unprecedented cost escalation over the last couple of years, you know, delays and projects, the impact of the pandemic on some projects. There's a bit of a concern out there. That over the years, a lot of Lenders here in Canada have been blessed with the fact that with the great market, they may only have been involved in one or two bad deals. And even if it was a bad deal, they got out of it whole when the project was sold or they managed to work out and get fully paid out. There is a bit of a concern, though, that with the things that are impacting the market that we could see, you know, some, you know, some more workout deals and possibly ones that could have resulted in a loss for the lenders. My experience wasn't really in Canada, it was actually in the Caribbean in 2009. It was around the economic downturn. And really, if you think about it in the Caribbean island projects, I worked on probably projects across over 10 islands. It was really a perfect storm of issues down there. The economic downturn, cost overruns, supply chain issues, putting deposits out the door for materials overseas, hoping that they arrive. Defective works. And then when you get a stalled project in the Caribbean, or in Canada, for that matter, if it's stalled for any period of time, you can end up with mold deterioration and you've got to try and put that right through a workout deal. What I had experienced down there, rather than a straight insolvency, was the Lenders preferred to do what was a forbearance agreement. So really like a soft receivership? Not a hard stop to project, but trying to work with the developer or the sponsor and see if he can get additional security or additional collateral and restated loan agreement, and then find a way to put the processes and controls in place to build that project or be mobilized. So basically, you gained early experience in the Caribbean. How's that going to come up here and help? Or do we think we're headed in a similar direction to the Caribbean? Because obviously the market here is probably a little bit more risk averse than the Caribbean, a lot greater level of due diligence, or you still see the potential for stuff to go so horribly. I mean, I think that's correct. I mean, I think we do have a conservative lending community in Canada. I think there's tight controls and I think that's why you've seen less distressed projects in Canada. I would say that I've seen some very similar circumstances and have been involved in them and projects across Canada, where we have had stalled projects and solvent developers mold, re-mobilization, retendering where, say overall or a cost consultant role had to evolve from simply being a QS or a monitor to contract admin and project management and having it on those around and finish a project? And we've done that on a few projects across Canada. I think when people think about insolvencies across Canada, they think about the big ones over the years, right? There was a couple of large developers, maybe even a few large developers who had a portfolio of projects that went into insolvency. They were under default under the loan agreements, and there were other allegations and receiver documents not proven in court. So those are the ones people think back to. I've been tracking insolvencies over the years, I would say, like probably about 25 to 30 real estate and construction related insolvencies we see every year. I'd estimate about 10 of those, probably in real estate, and maybe half of those are significant sized developments on some of those may have started construction this year, we had about 15 insolvencies, five of those of real estate developments. A few of those are significant developments, and I think the difference I'm seeing this year is those developments, particularly putting the issue for being an insolvency down to cost overruns and pandemic induced delays. Yeah, I mean, I think what we do the market presentation, that's one of the things I know we both touch and a lot is that time and that entitlement the improvements. And that seems to be what causes a lot of the issues in the development sold. It takes, you know, six months, 12 months longer than expected to get the planning approvals. Now also and the project ends up underwater because escalations in double digits. And I think a lot of that goes down to just how long the approvals process takes, not just in Toronto, but across a number of the cities in Canada. And that actually doesn't seem to be getting better. So taken into account, it's actually got worse, not better. I used to take 12 months to try and get free spas in Toronto. Now you're up to two or three years. Are we going to see more projects in the have issues that sold, say, 2019 to 2020 still in the ground? Is that the ones we need to start watching across canada? I think so. I mean, I think there was a couple of recent examples over the last month there was a condominium and actually both Mississauga projects are condo and Mississauga 14 story that appears to have been hit with cost overruns, supply chain issues. The majority of units are sold, you know, costs exceed revenue and then ends up in an insolvency position. There's another one in mississauga, recently 45 unit property, semis and detached homes, and that one probably just never made it to construction. So again, probably both sold around the same time to 2019. And that one, the developer ended up selling the project to another party. So both instances, potentially the purchasers lose out. But, you know, and this second instance there, the developer managed to sell the project on for a profit on the land. I mean, I think I think as far as the government goes and the approvals, this has been a hot topic for them, right? I remember there was a couple of council projects that caused, I guess it was when at the time to push and deal with council projects. Through that, they ended up reviewing entirely. They found there was nothing essentially wrong with the entity, but they found that the same entity is enforcing the rules and creating the rules. So optically, that wasn't great. So they created the entity HCRA, who now create the rules entirely and enforce the rules. Doug Ford's obviously been, you know, talking about how he's against cancellations. You know, certainly when it's not the fault of the buyer. And I think it was right that beld come out and agreed would be involved in that process and looking at how we can create better rules than that. But they also mentioned that any penalties for developers have to be balanced with between additional consumer protection and the understanding that cancellations sometimes just happen because projects become unprofitable. And I think to go back to your point there on approvals, it comes back to that. I don't believe any developer purposely goes on a project, want it to be canceled and go back and ask for additional monies. Things happen. They can't execute, they get caught up and planning and approvals, and all these things contribute to canceled projects. So I do believe that approvals process is something that really has to be looked at us. That's what has made projects so risky over the past several years because it takes so long to get through the approvals process. Yeah, and that was in the discussion we had on affordability in the market recently. And I think part of the challenge on cancellations is the developer can't really come out and say it's municipality's fault because they have to deal with the municipality in the future. And we all know municipalities, you know, very forgiving types of people when that sort of stuff happens. So I think it's a challenge we have in the market where the stuff was scenes actually caused not necessarily by the developer, but by often by factors outside of their control when it comes to both approvals for spa. And obviously, the building permits side of things and things just taking so long to they have no choice. And I think that's something that gets missed a lot. Everyone assumes the developers counseling because they're going to make more money. A lot of the times the council goes into single digit profits, if not lower, and they just simply cannot get financing anymore. The bank will not extend money because of the size of risk, which I suppose segues nicely into that sort of the risk side of things, which obviously the Lenders and developers, both focus on risk. How do you see the risk profile changing for both sides now, especially where interest rates have been heading recently? Yeah, I mean, the one thing I would point out there, the last point we just talked about as well is if you look at cancellations, most cancellations. In fact, I would say all cancellations pre 2015, were due to basically the market or the project not being viable. They didn't make enough sales. It was only after 2016 that you started to see in almost all the projects being pre-sold and being held up and canceled because of either 239 00:10:17,560 --> 00:10:19,950 entitlements or cost overruns being held up in the entitlement process And I think this is something you've mentioned in your presentation, no longer is it good enough to be excellent at land acquisition and sales because you can get the sales, you have to be good at everything. You have to be good at the planning and the entitlements. You have to be excellent at execution and closeout as well, right? That's what makes it so challenging. now, and why the TRA guys have continued to be successful. Yeah and I mean, that risk side of the things again, we spoke about. How projects have been cancelled, how that flip over happened in 2015, 2016 to where we are today. So how did the Lenders deal with this in terms of what's the advice to a lender if the state see a project that could go distressed? What's the source? The very basic steps, obviously, without giving away too much. But what's the basic steps they should do whatever than call you? I mean, I think all the questions that would be getting back in a market presentation could be anticipated, right? They look around the QS report and you know, the borrower that the sponsor, you know, that experience and experience to execute where the equity is coming from, is there enough equity in the deal to start with that experience internally, whether they're constructing themselves or using a third party construction manager. And then now that the market's turning a bit, then they have a focus than those committed costs because that's the 70% threshold of 50% on first advance to de-risk the budget. So I think the focus and a lot more heavily on the quality of those commitments and when I see the quality of the commitments, I mean, what level of drawings have been awarded on, have they been awarded on necessary for construction? Is it a dated quote is it an un-executed contract or a contract like all of these items should really be calculated back on the development contingency. or the construction contingency right, if you're sitting with a whole bunch of quotes, then the budget is less de-risked, right? And those are certainly a risk there in today's market. I think we see them focusing a lot on Cancel check reviews and obviously certification of cost deposits. The last thing a developer sorry, a lender wants is they do ended up in a distressed situation and they have an overcertification of costs and they have outstanding payables, right, for several months. That puts the project on the wall and means it's less viable if they do choose to sell it. I think when you run in, certainly I would. I would say when you run into a distressed. Well, it's not quite distressed, but certainly a problem project one that's been delayed. The way I always explain it as an project monitoring role or a QS role, it's no use. Just reporting bad news every month, right? Because the budget its over budget, it's behind schedule. I really feel it's a collaborative effort with the developer and the lender. Sometimes that takes hard conversations with the developer, whether that's on an equity call, whether it's on plugging those gaps, that they have an experience on. Maybe they're missing the project management side of things, that they have some holes delving more into the issues that they can't get occupancy, what are the aims holding them up. What are the supply chain issues that are affecting the project? Because as much as under this QS rule, we monitor, usually when projects go offsite, the flow of information gets less rather than increases. So really, it's a case of having to try and blow that open and get as much information on a project as possible. So as you can understand the issues and turn the project around, as I say, rather than reporting bad news. Yeah, I mean, we've spoken a lot about high rise, and I suppose it's implied you're talking about condo, but we have seen some low rise projects recently, starting to have some trouble, mainly around town homes. That's been in the news, not necessarily our projects. And then obviously, the challenge on the purposeful rental side now is we've been talking a lot about this is cancellations, perhaps or rental. Don't show up as a cancellation. The project just never happens. And I think part of the challenge is we're starting to see now is a number of even the institutional investors are really struggling in the current cost environment to even make purposeful rental work, which probably then leads to a big concern around condo viability as well as we move forward in that the rental guys don't even want to start today, and they've got cost escalation basically through rental increases until the day they stabilized. Obviously, the liberal for rent control, basically the approach to how do you make sure there's zero possible rental bill, which is just asinine. But I think right now it seems to be under threat from all directions. And one of the other points is so we often talk about distressed projects and cancel projects. You'll in Canada we don't have that many, and that's generally because we solve the problem. And that's what I think Colin, you alluded to is don't bury your head in the sand. Let's get together. Let's figure this thing out, and let's get through to the end. There's no point just pulling the plug at day one. You've got to try and come up with solutions based approach versus the panic. Let's all put in equity. If someone is struggling to find that equity, there's got to be other ways of working out. That's right, and it's a long period for that happen and it can be a couple of years, right? Like we at the start of the pandemic, that was not when we were going to see distressed projects. It usually takes from an event like that a couple of years before things worked through the system. If you can think about it, that problem project it sits with their account manager if it doesn't manage to fix itself, then it goes to special loans, special loans don't manage to fix it if it goes in a forbearance agreement and that doesn't work out, then it can potentially go into insolvency. So these projects have been the ones we're seeing now in insolvency have been bubbling for some time, and it's taken a while for them to appear as an insolvency. There's various steps along the way where they can try and be worked out before it reaches that stage. So usually I would say that's interesting at this point, and then she has a favorite final question, which she says what keeps you up at night? So now you have to figure out how to answer that one. She likes to drop it. I mean, really at the end. What keeps me up at night? There's my projects that are in trouble. That's why we use a traffic light system. We're constantly reviewing these projects. Best intentions, you know, some can end up in this position, but I'm hopeful that, you know, as much as we are sometimes called merchants of doom and paid to be pessimists, I'm hopeful that you know with the mature market that Toronto has and across Canada and the strong lending community and developer community, that these should be sort of one off situations, maybe unsophisticated developers and special instances rather than, you know, a whole barrage of projects coming away in insolvency. So it wasn't a bad answer. So Thanks for joining us today, calling definitely more entertaining than Ray unless he has his fireplace in the background. So Thanks very much for joining us.