The Office of the Superintendent of Financial Institutions (OFSI) in Ottawa announced this week that they’ve decided to back off from some planned proposals to tighten the mortgage lending rules for the Canadian banking and real estate industry. The proposals were originally brought forward in January when the banking regulator was in the midst of an internal review of their B-20 mortgage underwriting rules.
The OFSI claims that risky loans are getting out of hand, and they threatened to tighten the conditions for “stress tests” among potential borrowers.
As part of the review, the agency solicited feedback from the industry – and not surprisingly, they received little support for new “debt service measures”.
But what’s interesting is that, among all stakeholders, the key concern was the same: as the agency puts it on their website, both industries are worried about the “disproportionate impact that new, industry-wide measures could have on smaller institutions with unique business models”.
Increasingly, these ‘unique business models’ have been essential for survival for any small or mid-sized firm amongst the ballooning prices of consultations, zonings, regulatory reviews, climate upgrades, construction costs, labour and land in Canada’s major cities, particularly Vancouver and Toronto.
Jim Neilas, founder of the Neilas Group of Companies, began a career in real estate in the early 2000s. In order to keep up with the exorbitant costs of commercial real estate development, Neilas, along with dozens of others working to finance developments, created coalitions of businesses and individuals to collectively invest in commercial properties through ‘syndicated mortgage investments’, or SMIs. From 2014 to 2016, the SMI market nearly doubled from $3.6 billion to $6.6 billion in Ontario.
These models are new and are certainly not the ideal means to fund a development project – but for retail investors and lenders who want to enter commercial real estate in Canada’s major cities, there’s really no other option. Because of the amount of parties, “soft costs”, and money involved, the tensions can run high and worries about returns and potential deceptions can run deep. Between 2013 and 2018, the Financial Services Commission of Ontario (FSCO) received more than 183 complaints about syndicated mortgages.
The risks around SMIs were broadly publicized through the Fortress development scandal, in which eight brokers/brokerages had to pay a million dollar settlement and several lost their licenses. The FSCO proved that 35% of Fortress investor funds went to paying commissions or consulting fees. This was not what investors signed up for, of course, when they agreed to become land owners.
In 2019, the FSCO transformed into the Financial Services Regulatory Authority of Ontario (FSRA), specifically to better monitor risky mortgage loans like SMIs.
But for operations like Jim Neilas’ who’ve depended on the SMI model, these suspicions and regulatory oversights have made the cost of doing business too much to handle. The same agencies who’ve made it easier to distort our real estate markets with foreign investments have simultaneously made it virtually impossible for local developers like Neilas to keep up.
Neilas has spent more than a decade creating boutique condominium projects in the downtown core of Toronto. From 2004 to 2017, Neilas originated 24 investments with over 3,000 investors, with successful exits and returns of over 10% on 21 of those investments. However, in 2019, the newly-created FSRA issued a Notice of Proposal (NOP) to his firm, leading to a settlement with several of his investors.
As a result of the settlement, the FSRA conducted examinations of six calendar years of Neilas’ broker documents. Following a thorough review, they identified no contraventions. There was also no proof of financial dishonesty.
After originally proposing a fine of more than $3 million, the regulatory agency and Neilas agreed to a small administrative fine of $38,888 for technical breaches. But the blow to Neilas’ reputation had already been made.
Despite a feeling of vindication, Neilas has decided that the Toronto market, with its reliance on SMIs, is no longer viable for him.
“I decided to leave because of the SMI model,” says Neilas. “Without it, it’s impossible for us to secure the necessary construction debt to complete our projects. But that model comes with too many regulatory risks and uncertainties. The gist is, it’s just no longer profitable, so I’ve decided to look to other markets.”
It’s clear that over-regulation of the mortgage and banking industry is pushing out small and mid-size firms – just as what’s left of the Canadian middle class is being squeezed to the breaking point with inflation and costs of living.
“Canada is too dependent on real estate, and the output here just isn’t able to keep up.” Neilas has set his sights on Austin, TX to re-establish his commercial development firm. “I can see great potential for growth there. The economy is far more diverse and offers more opportunities for development.”
With so much money and capital flowing in from all corners of the globe, and so much concern about proper regulations from the Globe and Mail, firms like Neilas’ will increasingly be forced to wind down their operations.
“As for how I feel about it?”, says Neilas. “It’s hard not to be disappointed.”