Canadian Property Development Overview

The Emergence of Leasehold Strata Developments

Two major universities in British Columbia have embarked on large-scale development projects using the leasehold strata development concept as a means of unlocking tremendous value without disposing of their land bases. They have discovered that land developers are willing to pay prices, on a buildable-square-foot basis, for 99-year leasehold interests in land, which are similar to the prices paid by developers for freehold development land in similar locations.

The University of British Columbia ("UBC") has established UBC Properties Trust as a vehicle to lease parcels of campus land for 99 years on a fully prepaid basis to developers that will construct market housing according to guidelines established by UBC. The trust will also build complimentary office, retail and institutional facilities. The scale of the project, known as "University Town," is immense. It is anticipated that eight new residential neighbourhoods with 7,000 housing units will eventually be constructed over the anticipated 25-year life of the project. Revenue from the land leases is expected to raise $500 million for UBC’s endowment fund.

Simon Fraser University ("SFU") has established the SFU Community Trust as a vehicle to lease parcels of land for 99 years, also on a fully prepaid basis, to developers that will construct market housing according to guidelines established by SFU. The trust will also construct complimentary office and retail facilities. The project will include approximately 4,500 residential units and is expected to generate up to $200 million for SFU’s endowment fund over the anticipated 20- to 25-year life of the project.

The key to the success of these projects is market acceptance of the terms of the ground lease, which provide the foundation and framework for leasehold strata development projects. The ground lease gives the owner of the land certain rights to regulate the project, the developer and the eventual strata lot lessees (homeowners). It gives the developer the right to construct the project, create the strata lots by filing a leasehold strata plan and market the individual strata-titled leasehold units. The ground lease typically includes a form of model-strata lot lease as a scheduled attachment which, following registration of the leasehold strata plan, becomes the document which governs the relationship between the strata lot lessees (homeowners) and the landowner.

The form of ground lease used in the UBC and SFU projects are prepaid 99-year leases. At the end of the 99-year term, the landowner will have the right to renew the strata lot leases for a period of at least five years. Rent for the renewal term will be the agreed or arbitrated share (based on the relative assessed values of the strata lots) of current market rental value of the land. If the landowner elects not to renew a lessee’s strata lot lease, the landowner must purchase the lessee’s interest in the strata lot for a purchase price based on the fair market value of the lessee’s interest in the building comprising the strata lot and the lessee’s interest in the common property of the strata plan. Accordingly, depending on the condition of the buildings at the end of the 99-year lease term, and more importantly, the landowner’s desire to redevelop the land (or perhaps re-lease the land to a developer for another 99-year term) or the landowner’s desire to retake possession of the land for internal expansion or other purposes, the landowner will decide whether or not to renew the strata lot leases.

The form of the ground lease used by UBC and SFU is very different from the form of ground lease used by the City of Vancouver (the "City") in the 1970s for the development of 80 acres of land in False Creek. About 375 leasehold strata units were constructed in the 1970s on the False Creek lands. The ground leases were generally for 60 years with rent payable at fixed annual amounts for the first 30 years, subject to increases based on a predetermined formula on each of the 30th-, 40th- and 50th-year anniversaries of the leases. As a result of significantly higher land values in Vancouver, homeowners in these projects are faced with the prospect of significant increases in their annual rent payments based on the formulas set out in the leases. Several years ago, in an effort to appease unhappy leaseholders, the City instituted a voluntary prepayment option, which a number of the leaseholders exercised. However, the valuation used by the City to determine the prepayment amounts has been challenged by a group representing the leaseholders, and there is an ongoing dispute and pending lawsuit between the leaseholders and the City. A leasehold strata project based on a ground lease that provides for a series of rent escalations during the lease term would not, in today’s market, be a competitive product.

By contrast, the 99-year prepaid lease concept has been generally well-accepted by the market. Current projects at UBC and SFU are selling with little or no discount to prices being paid for similarly located freehold title strata projects. Public perception is that these projects are not really all that different from freehold title projects, given the anticipated life expectancy of the buildings being constructed. With the number of leasehold strata developments being constructed at UBC and SFU by many of the well-known and well-established developers in the province, lenders have also become very familiar with the concept and the terms of the ground leases being used for these projects and as a result, financing for these projects has not been difficult to obtain. In fact, there is growing competition among lending institutions to finance these types of projects.

If the high-profile projects at UBC and SFU continue to be successful, other universities and public institutions across Canada will soon begin to consider leasing land to developers for the development of leasehold strata projects. A couple of other universities in Canada are already in the early stages of considering similar projects and there are a number of Crown corporations, public entities and quasi-public entities that own prime waterfront land in many cities across Canada which may, in the near future, consider leasing land for the development of similar projects.

New B.C. Legislation Governing Marketing of Real Estate

In British Columbia, there is new legislation on the horizon that will replace existing legislation governing the marketing of real estate in the province. Bill 42-2004, the Real Estate Development Marketing Act (the "Act"), has received third reading and royal assent and is expected to be in force by early 2005. The Act is intended to streamline the process for developers’ marketing activities and add more certainty and flexibility to the requirements for marketing development property. It also addresses inconsistencies in the current marketing requirements, provides greater opportunity for pre-selling of developments, allows disclosure statements to be filed in all circumstances (eliminating the prospectus requirement that applies in some cases today) and gives developers access to purchasers’ deposit monies if those monies are properly insured. The Superintendent of Real Estate is given increased powers to enforce compliance with the Act and to protect the interests of consumers.

Of particular interest to developers is the change that will permit a developer to access purchasers’ deposit monies for construction and marketing purposes if the developer enters into a "deposit protection contract." A deposit protection contract is an insurance contract that is provided for in consequential amendments to the Insurance Act (British Columbia ). Regulations are likely to prescribe mandatory conditions that must be contained in deposit protection contracts. This new provision could be of significant benefit to developers in helping to finance development projects, provided that:

• the cost of obtaining deposit protection contracts is not prohibitive;
• the terms of the deposit protection contracts, including any requirements for security, are not too onerous; and
• construction lenders do not raise minimum equity invest-ment requirements to offset the benefit to developers of using the deposit funds for construction and marketing purposes.

Ontario ’s New Limitations Act, 2002

On January 1, 2004, a significantly revised Limitations Act took effect in Ontario. Part II (relating to trusts) and Part III (relating to personal actions) of the old Limitations Act were repealed and replaced by the new Limitations Act. The real property provisions contained in both the definitions and Part I of the old Limitations Act remain in effect and are preserved in a separate statute renamed the Real Property Limitations Act ("RPLA").

Among other things, the new Limitations Act introduces a basic limitation period of two years from the day a claim is or reasonably ought to have been discovered as well as an ultimate limitation period of 15 years from the day (subject to certain exceptions) on which the act or omission on which the claim is based took place. A claim is defined in section 1 of the new Limitations Act as a claim to remedy an injury, loss or damage that occurred as a result of an act or omission. In addition, under the new Limitations Act, parties are no longer able to contract out of these statutory limitation periods (other than for agreements that were entered into before January 1, 2004).

Section 2(1)(a) of the new Limitations Act explicitly provides that none of its provisions apply to claims governed by the RPLA. This means that (i) the basic two-year limitation period and the ultimate 15-year limitation period introduced by the new Limitations Act will not apply to claims under the RPLA; (ii) the discoverability principle introduced by the new Limitations Act will not apply to claims under the RPLA (although they may be subject to the common law discoverability rule) and (iii) agreements to vary or exclude statutory limitation periods under the RPLA will continue to be enforceable.

The RPLA focuses exclusively on claims arising from rights and interests in real property. Under the RPLA, the limitation periods contained in Part I of the old Limitations Act remain unchanged and include: (i) a six-year limitation period for landlords/mortgagees to bring an action to recover arrears in rent/interest from the date the amount of rent/interest was due (section 17) and (ii) a ten-year limitation period for mortgagees to recover the mortgaged property from the date the last mortgage payment was made (section 22).

However, claims relating to real property that are not addressed by the RPLA will be governed by the new Limitations Act. This is significant because the RPLA is silent with respect to the enforcement of many contractual obligations contained in real property contracts such as leases, mortgages and asset purchase agreements. For example, in a lease, a tenant typically covenants to maintain and repair the premises. If the tenant fails to repair the premises as required, then the new Limitations Act will be triggered and the landlord will be required to bring an action against the tenant regarding this breach within two years of the date on which the landlord discovered the tenant’s breach.

Commercial Title Insurance

The use of commercial title insurance as an alternative to the traditional lawyer’s opinion on title continues to gain popularity in Canada. There are two types of commercial title insurance policies that may be issued: (i) an owner’s policy, which protects the purchaser against loss or damage arising from disputes regarding property ownership and (ii) a loan policy, which protects the lender against loss or damage arising from the invalidity or unenforceability of the lien of the insured mortgage. Title insurance companies are also developing new products—for example, personal property security insurance is a recent product that insures, among other things, the priority of a lender’s security interest (in non–real estate collateral) under the Personal Property Security Act.

Unlike a traditional lawyer’s opinion on title, title insurance is used to provide protection against hidden risks such as fraud, forgery and errors in information provided by third parties (e.g., a government ministry). Also unlike a traditional lawyer’s opinion on title, title insurance is a strict liability contract—the policyholder is not required to prove that the title insurer has been negligent in order to receive compensation for a covered loss (up to the amount insured, which is typically the purchase price for an owner’s policy and the mortgage amount for a lender’s policy). In the United States, because the cost of title insurance is regulated by many states, additional premiums are commonly paid for endorsements to cover the increased risk and additional diligence costs of the title insurer as well as to protect the policyholder from claims that consideration has not been provided for the additional coverage. By contrast, there is no regulation of title insurance rates in Canada. Instead, policy premiums are negotiated in Canada, and when a premium is paid to the title insurer, such premium constitutes consideration for both the policy and any endorsements.

While the benefits of an owner’s policy remain in effect only as long as the insured owner possesses title to the property, the benefits of a lender’s policy automatically run to the insured lender’s successors and/or assigns, thereby facilitating the sale of mortgages in the secondary market. Interestingly, a key factor in the increasing demand for commercial title insurance has been the growth of the commercial mortgage-backed securities ("CMBS") market in Canada and the fact that financial institutions routinely require title insurance for mortgages that will be included in CMBS products. According to Moody’s Investors Service, the Canadian CMBS market has been growing at an average annual rate of 33% since 2001 and is expected to continue to be one of the fastest-growing markets in Canada.

In Ontario, when advising clients about a real estate conveyance, lawyers are required under Rule 2.02(10) of the Rules of Professional Conduct to discuss the options available to assure title. As a result, lawyers in Ontario must familiarize themselves with title insurance so that they can discuss the benefits and limitations of title insurance with their clients. Also, lawyers in Ontario should be aware of Regulation 666 of the Insurance Act, which prohibits a title insurer from issuing a policy until a lawyer (entitled to practise in Ontario and not under the employ of the insurer) has provided the title insurer with a certificate of title to the property.

Acquisitive Prescription in Quebec

January 1, 2004, marked the tenth anniversary of the coming into force of the Civil Code of Quebec ("CCQ"). The changes brought about by this major legislative reform included profound changes intended to modernize the land registration system in Quebec. Ten years later, new issues are arising that present challenges to real estate practitioners.

Until 1994, the land registration system in Quebec was reference-based, meaning that, unlike the Torrens system or the land titles system found in other Canadian provinces, it allowed for the registration of deeds, not rights, and it offered no guarantee or certification of title. As a consequence, a person acquiring rights in immovable property (civil law terminology for "real property") had to ensure that the rights of the transferor or grantor were valid. This was done by reconstituting the chain of title, a tedious and costly exercise that could often span more than 100 years of transactions on any given property.

The reform was designed to change this, but its implementation was fraught with problems and met considerable resistance from real estate practitioners. One year later, the CCQ was amended and the reference-based system was back. As a result, the practice of title searching described above is still prevalent today.

In the process, however, some principles of the CCQ that were part of the reform survived the 1995 about-face. For example, the 30-year acquisitive prescription was reduced to ten years. Accordingly, since January 1, 2004, it is possible to acquire an immovable following ten years of uninterrupted possession, a concept referred to as "acquisitive prescription." In a reference-based land registration system, acquisitive prescription plays a key role in providing stability by recognizing the importance of peaceful possession during a long period of time. Not surprisingly, prescription is an important factor in determining the appropriate length of a title search. While one would think that the reduction of the length of acquisitive prescription from 30 years to ten years would have reduced the length of title searching, no significant change has occurred in practice, at least in commercial transactions.

More importantly perhaps is the impact of Article 2918 CCQ, which appears to require that a judgment be obtained to declare the validity of a right of ownership acquired by prescription. Such a judgment would have no retroactive effect, meaning that the right of ownership would only take effect on and from the date of the judgment. The practical and indeed significant effect of this provision is that a person who has been in possession of an immovable for over ten years, and therefore has a valid claim to the ownership of the immovable through acquisitive prescription, will have a precarious right until a final judgment is rendered; and until this occurs, it is conceivable that the registered owner could sell the immovable to a third party, granting to that person a valid title.

The courts will eventually be called upon to rule on the interpretation of Article 2918 CCQ, but it may take years before a definitive interpretation can be given, unless Article 2918 CCQ is amended by the legislator—a solution practitioners would undoubtedly welcome.

Unlocking Value: Co-op Conversion of Residential Rental Property in Montreal

Conversion of residential rental property into condominiums is generally prohibited in the city of Montreal. The very worthy aim of this prohibition was to stem the loss of affordable rental housing. Unfortunately, the prohibition also affects high-end residential rental property that might otherwise be converted to highly desirable luxury condos.

Several of the city’s boroughs have adopted by-laws designating sectors or classes of immovables in respect of which an exception to this prohibition may be granted. Where the residential rental property in question does not qualify for such an exception, however, its owner may have been denied an opportunity to maximize the value of his or her investment.

In such circumstances, implementing a New York–style co-op structure may be an attractive alternative to condo conversion.1 As with a condo, the combined price received for the sale of the individual units may prove to be significantly higher than the value of the building as rental property.

Montreal co-ops are typically structured as follows:

• The owner transfers the building to a wholly owned subsidiary ("Newco").
• Purchasers of individual apartment units acquire:

                        • a long-term lease of a particular apartment unit; and
                        • shares in Newco.

The long-term lease would, among other things, include provisions obliging the purchaser to contribute its proportionate share of operating expenses and real estate taxes for the building.

Once all of the units are "sold" in this fashion, the purchasers collectively own all of the shares in Newco and thus indirectly own the real estate. Relations among the purchasers and the rules governing the operation of the co-op are contained in a shareholders’ agreement and the by-laws of Newco, respectively. There are a number of banks and financial institutions in Montreal that are accustomed to financing acquisitions of this type of co-op unit.

One thing to keep in mind is that the purchaser of a co-op unit, unlike the purchaser of a condominium, is not entitled to evict an existing tenant of such unit and repossess it as a residence because he doesn’t directly own the real estate. Newco owns the real estate, and each purchaser is a long-term tenant of Newco. Ordinary tenants whose leases predate the transfer of the building to Newco and who elect not to purchase their units continue to enjoy all of their rights at law, including the right to maintain occupancy and the right to rent control. This means that, at least initially, a unit occupied by a tenant who is not interested in purchasing it may have to be sold to a third party as an investment. Such a third-party investor would thereafter be the existing tenant’s new landlord, entitled to the revenue stream from that unit, but only able to occupy it him/herself following expiry of the tenant’s lease, provided that it is not renewed.

As an alternative to condominium conversion, co-op conversion may allow owners to unlock the value of luxury apartment buildings.

The authors acknowledge the contributions of Stefan Fews and Annie Gagnon-Larocque, associates, and Alexis Wiseman, student-at-law and member of the Bar of New York, to this discussion.

1  Although called a "cooperative," we are not here discussing a "housing cooperative" as such term is used in the Civil Code of  Quebec.