Surviving the subprime aftershock

The issues, challenges, and potential outcomes are significantly different for commercial and residential real estate lawyers.

As Canadians watched with shock and awe the havoc that the subprime mortgage fiasco reaped on U.S. property and financial markets, it was easy to be smug about the relative stability and strength of our markets and institutions. It seemed that it couldn’t happen here and it didn’t happen here. But the contagion has now spread and the worldwide credit crunch that followed the U.S. mortgage debacle has debilitated financial markets around the world. It could have a devastating impact on the Canadian economy as a whole and the property market in particular.

Real estate lawyers, many of whom have been struggling to survive even in a booming property market, are watching these developments anxiously. Many are already seeing signs of a slowdown and have started to think about how they will survive a real estate recession. Some still hope the fundamental strengths of the Canadian market will prevail. And others are optimistic that they will find work or find ways to work smarter no matter how the property market evolves.

The issues, challenges, and potential outcomes are significantly different for commercial and residential real estate lawyers. Here are views from both sides:


Commercial: Coping with the credit crunch

As a go-to lawyer for major real estate lenders, Jeffrey Lem doesn’t need a crystal ball to see where commercial property markets are heading.

“A lot of new development projects will come grinding to a halt,” says Lem, a partner at Davies Ward Phillips & Vineberg LLP in Toronto. Even though the subprime mortgage crisis was made in the U.S.A. and Canadian banks are relatively immune from catastrophic failure, there will be a significant knock-on effect north of the border, he says, as funds dry up from large U.S. lenders and Canadian financial institutions become more cautious and vigilant.

He reports that some lenders are already invoking contract clauses that will let them withdraw financing in bad market conditions, while anyone trying to renew a fixed-term loan can expect to be hit with higher interest rates, and some may find they are not able to renew their loans at all. Lem says, “then, they’re going to find it very difficult to refinance because nobody wants new deals these days.

“We’re going to see a lot more power of sale, foreclosure, insolvency, and workout. It’s as simple as that. We’re going to see it and it’s going to happen soon, if it’s not well underway,” he says. And what does this mean for lawyers? “It’s not the end of the world for real estate guys,” says Lem, who is planning to “retool,” placing more emphasis on his insolvency-type practice, while also hoping to do some work with specialty lenders that will likely be offering help to cash-strapped developers with high-interest financing.

Nevertheless, Lem maintains, it’s a myth that lawyers make as much money on the downside of the market as they do in a real estate boom. A good insolvency practice can certainly help ameliorate the losses from lending or merger and acquisition practices, “but it’s second-best as far as volume and profits are concerned.”

Lem therefore predicts that hiring will become an employers’ market. Associates will probably be able to hang on to jobs, he says, “but it will be tighter than it ever was before and I don’t feel well for the students coming through right about now — they’ll have a much tougher time than the guys a few years ahead of them.”

A slowdown in property development will likely mean less work for commercial real estate lawyers, but it could also mean that each project they do work on will be far more labour intensive and require more detailed scrutiny, according to Harry Herskowitz, senior real estate counsel at DelZotto Zorzi LLP in Toronto.

“Everybody’s going to be looking harder at deals,” says Herskowitz, who frequently acts for builders and developers of subdivisions and condominium projects. He observes that the U.S. crisis will certainly result in short-term difficulties in getting development funding.

In the long term, if the market actually moves into a recession, he sees five major impacts:

• There will be greater scrutiny on projects, budgets, and repayment sources. This will include more scrutiny of agreements of purchase and sale, as well as future homeowners’ or condo unit holders’ mortgage approvals. “They may also want more down payments in order to minimize the likelihood of purchasers backing out of the deal.”

• Lenders will want developers to sell more units in advance before they are prepared to finance construction, particularly in high density developments. They will also be concerned about the enforceability of the agreements of purchase and sale, so it will be important to ensure that the developer has not made a material change in the project that would give purchasers a right to get out of the deal. This could include opinion letters from counsel stating that the agreements are fully enforceable and unconditional.

• Lenders will probably require more equity infusion from the developer and possibly more security from guarantors with a more solid asset base than the developer. They may also want restrictions on the developers or their guarantors moving assets without the lenders approval.

• There may be requirements for tighter restrictions on subordinate financing or other outstanding loans that might have an impact on the developer’s cash flow. “They’re going to restrict you from doing anything vis-à -vis the project or incurring debts unrelated to the project, if you’re the borrower or the guarantor of that borrower. They want you exclusively. They don’t want any other impact on your source of funds.”

• If the recession deepens, there may be restrictions on the size and complexity of projects. This is because the risk of having to take over a project before it is finished is “a lender’s worst nightmare” and the more complex the project is the more difficult it is to finish and the more expensive it is to bring in new people.

“I see some of those signs already today and I think they’ll just be more pronounced if we get into a really recessionary real estate market,” says Herskowitz.

If the property market begins to spiral downwards, there is the risk that potential homebuyers will stay out of the market because they hope or fear that prices will keep going down. This, in turn, will make it harder for developers to pre-sell their units and meet the thresholds that lenders will require before they advance construction funds. “This tightening market has a whole bunch of tentacles,” says Herskowitz, noting that various trades, subcontractors, and ancillary businesses will also suffer — “and lawyers act for all of those trades as well.”

“Then the focus on real estate becomes — instead of borrowing — how do I issue power of sale,” he says, noting lots of lawyers are taking refresher courses “in case the worst happens.”

“You will also see more liens registered. Project payments get slower so liens go on faster. They get more nervous. So, instead of waiting the full 45 days to file a lien, maybe they only wait 30 days,” says Herskowitz


Residential: time to be prudent

Ron Usher can already see the impacts of the U.S. financial crisis on clients of his Vancouver real estate practice. “The credit tightening starts to flow through everywhere,” he says, describing the plight of clients who are having difficulty refinancing their expensive Vancouver home because their assets are tied up in a U.S. business they own.

Usher, a partner with the law firm Bell Alliance, also cites the example of other clients from the U.S. who are afraid their bank will go under and they will lose their money. Instead, the clients want to use the money to buy Vancouver real estate. “As quickly as possible, they want to take their U.S. bank money and put it into dirt in B.C. because they feel that is secure,” says Usher. “When people start to get panicky about this stuff all sorts of things start to happen.”

Generally, however, Usher observes that the Vancouver property market has descended from its peak of a year or so ago. In August, for example, sales were down 40 per cent from the previous year. But, he adds, “We have to remember that last August was insane. By any historical standard, Vancouver is a very busy place still and we certainly haven’t seen our file numbers drop off anywhere near that amount.”

Nevertheless, he predicts, “There’s going to be less work to go round. And in B.C. we have competition for this work. The notaries are lawful competition for this kind of practice.”

Yet there are advantages to a quieter market, according to Usher, who spent many years as staff lawyer for the Law Society of British Columbia, providing advice to lawyers on how to improve their practices. “There were times when people engaged in panicky buying and the normal things that a lawyer would recommend in terms of due diligence they let go,” he says, explaining that clients wanted to “just leap in and sign everything.”

Now with property values no longer rising at meteoric rates, there will likely be some distress sales and situations where purchasers are trying to get out of agreements. “And we know from lawyer negligence statistics that in a market like this everybody’s got to take it much more carefully because everybody’s looking at deals with much more scrutiny. In a hot market you get it done and glitches get ignored. So it’s really a time for lawyers to be very prudent, very careful,” says Usher.

Residential real estate lawyers are worried, but don’t believe the roof is about to cave in on their profession. Certainly, house prices are falling. In Toronto, the average resale value fell by a stunning 15 per cent in October, compared to the year before. But even in a recession, people still need to buy and sell homes. The question is whether they will find the financing to close their deals.

And, even though credit is tight, banks are reluctant to stop lending money to homebuyers, since home loans are an important revenue generator for financial institutions. “I don’t think credit is going to dry up, but it’s definitely going to be tighter,” says Toronto lawyer Bob Aaron. “We’re looking at a softening of the real estate market across the board and it’s going to affect everybody in the industry, including lawyers. There could be a lot of belt tightening,” he says.

Nevertheless, Kathleen Waters, president and chief executive officer of the Toronto-based Lawyers Professional Indemnity Co., notes that real estate lawyers’ offices have become quite automated so they can do more with a smaller staff. This means there is little cost and lead time in ramping up or ramping down their activities when the market changes.

“Technology has helped the real estate bar be more resilient and better able to adapt to the fluctuations that are inevitable in real estate,” she says.


Freelance journalist and business writer Kevin Marron can be reached at [email protected]

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