RENTT: The challenges in developing and building purpose-built rental housing
By David Gargaro
Iesteemed n this month’s issue, we asked our RENTT (Rental Executives National Think Tank) panellists, who are private owners, to discuss the challenges of developing purpose-built rental housing in Canada. Our panellists discussed issues that affect developing and building new rental housing, how land costs and government legislation influence their decision-making process, and factors that can raise or lower the cost of building rental properties. They also talked about the impact of government pressures to include a percentage of affordable housing in all new developments, and potential incentives for building more affordable housing.
14 | November 2019
RENTT experts: Nicolas Denux, Partner, Group Denux
Jason Birnboim, President, Beaux Properties
Peter Polley, Owner, Polycorp
RHB: Welcome to RHB Magazine’s RENTT panel. We appreciate the time and effort involved in participating in today’s discussion and sharing your experience. Our readers will benefit from your input. Today we’d like to talk about developing purposebuilt rental properties. What do you feel are the main challenges in developing and building new rental housing in Canada?
Nicolas Denux: Some municipalities are much quicker than others in approving projects due to their existing zoning or approvals for rezoning. This certainty of expediency of projects is a great motivator as an investor of where to invest. For example, in the Victoria area, some municipalities take several years to approve projects. Municipalities need to look at their internal approval processes if they are trying to increase their rental offering. In terms of location, we are not merchant developers who build and resell after. We build to keep and manage, so really looking at the competitive advantage of a location and how the community is currently and will likely evolve at a later date is key.
rentalhousingbusiness.ca | 15
Important are nearby services, shopping, views, employment nodes, transit, schools, and overall desirability. For costs, we are competing with condo developers for sites in many markets. Land prices that work for rental buildings at rent levels that are workable long term is a big challenge. On the construction side, costs have come up a lot in the last 6-7 years in BC so that is also a challenge. Some of the increase is due to exchange rate and some to market activity. We are most active on Vancouver Island and the island factor creates a shallower pool of suppliers and trades when compared to larger cities. Jason Birnboim: I operate mostly in the Greater Toronto Area. There are major challenges, such as the yield on project development cost is too low, which makes it difficult to be economically viable. There are real costs of development, and I employ a conservative pro forma to evaluate those costs. Zoning is a major obstacle when doing site plans and going through final approvals. Toronto and other municipalities have an arduous process, as there are a lot of different layers and a lot of bureaucracy, which is time consuming and expensive. Peter Polley: The key challenge is trying to get the project elements to work. With inflation, labour, materials, and other costs have gone up dramatically. Since we started 20 years ago, we are paying four times as much for drywall hanging and taping, while labour rates for carpenters have doubled. This has greatly outpaced rental rate increases. There is compression on cap rates, while the cost to produce decent quality multi-residential projects has gone up by a factor of three compared to 20 years ago. Rents have not gone up by the same magnitude. There is also quality creep in rental suites. There is an expectation in the marketplace of what units will have for finishes, features, and amenities, which has impacted the cost to build rental units.
RHB: How does the price of land and the cost per square foot to build rental property affect your decision making in developing and building rental housing? Nicolas Denux: As stated previously, it is an important factor. As building owners and managers, we worry about long-term rental sustainability of any new build. If one cannot deliver rental buildings at prices that people can afford, the project will not work, as turnover and vacancy will be too great.
16 | November 2019
Jason Birnboim: Most development opportunities involve land that we already own, and we attribute a nominal cost of the land to the development. You have to factor in the market value of land for new acquisitions or mark to market for existing land. It’s a major factor. Toronto’s rental market is strong, and I understand the market’s frustration, as it’s hard to keep up with rent. But the cost of land is high, and rental developers have to compete with condo developers, who can pay more for land because they can make certain assumptions on sale price. Even though condo development is a risky game, it’s less risky than developing a rental property. Condo developers know their revenue as soon as they start selling, and they know their costs. When building new rentals, you don’t know your total costs or your revenues, as rents are cyclical. Peter Polley: With the rental buildings we’re constructing, we need to plan on owning them for a long time for the economics to make sense. It’s not worth the time, effort, and risk to build if we’re going to sell the building when it’s completed. Of course, there are exceptions. There is not a lot of created value in the cost to construct rental properties. If you’ve already bought the land, rezoning or added density can help to widen the spread. For the typical building paying full retail for land and then developing the building, project economics don’t make sense. It can work with current mortgage rates at 2 per cent, but if they go up to 3 or 4 per cent, it will make a huge difference in project economics.
RHB: How has government legislation or requirements - new or existing - affected your ability or plans to construct new rental housing? Nicolas Denux: Municipal approval times have been mentioned. On the provincial level, we like to see stable Tenancy Act regulations to provide certainty for these multi-year investments. On the financing side, provincial and federal programs, such as CMHC, to encourage private sector purpose-built rental developments are interesting and we are looking at them. But the bureaucracy can be onerous and require a certain commitment in time and effort on the part of the developer. Jason Birnboim: Over the last few years, the government has trended toward facilitating new rental housing, with most incentives geared toward building new affordable rental housing. This has its own dynamics.
“Once rates go back to normal, The supply of rental properties will dry up.” There’s been nothing for new market-rate housing. CMHC has been flexible in financing new market-rate housing, which has made development more affordable and worth looking at projects. Municipalities are giving incentives to build affordable housing, but there is still not enough for private developers to take on affordable housing.
It may or may not tip the scales in favour of affordable housing being mixed into regular developments. If it works, then great, as there is a market for this type of project, and it’s easier to rent when there are affordable units. However, the impediment is always property taxes. Rental properties receive unfair treatment, and all three layers of government need to address it.
Peter Polley: Government legislation is the single biggest issue, as it affects the supply and price of land, development charges, and so on. Most levels of government view the real estate development industry as a giant ATM, and will constantly hit the industry with new fees and development charges. Then they talk about the lack of affordable housing. The biggest problem is determining land price based on supply, and the development approval process. Nova Scotia charges 15 per cent HST for new construction, and offers a token GST rebate for multiresidential. You get 36 per cent of 5 per cent in GST rebate for new rental housing construction, which is a joke compared to other jurisdictions. Nova Scotia has undergone a 10 year regional planning exercises, and the requirements will increase construction costs. Government policies have a huge impact on the cost to produce, the supply of land and units, and rents. Once a development is complete, single family homes have their assessments capped while apartment assessments go up 2 to 10 per cent year, and property taxes are going through the roof. The tax load is getting disproportionately shoved onto the rental housing sector. The only thing saving us right now is that interest rates are close to the lowest point of all time. Once rates go back to normal, the supply of rental properties will dry up.
Peter Polley: Historically, there has been no requirement. There is a new centre plan that includes a density bonus program. It’s supposed to encourage affordable housing. When this planning exercise is started, it was supposed to encourage private development of affordable housing. Now developers have to pay a tax on the land by the square foot, and these fees are given to non-profits and charities to build affordable housing. They cannot operate competitively compared to private developers. It’s like giving money to a church group to develop the infrastructure for a grocery store, rather than talking to grocers to make food more affordable for purchase. Even if we want to develop multi-residential projects that include affordable housing, and enrol in the CMHC’s affordable housing program, as well as the province’s affordable housing program, we would still have to pay the same fees that other developers pay, which is counterproductive.
RHB: If applicable in your area, how has the governments’ new pressure or requirement to include a percentage of affordable housing units in all new developments affected your ability or plans to construct and develop new rental housing? Nicolas Denux: This is not applicable where we are building. Jason Birnboim: We factor this into the pro forma. There are different layers of taxes and quasi-taxes in development.
18 | November 2019
RHB: What incentives or reforms would encourage you to build more rental housing that includes an affordability component? Nicolas Denux: I do not have a single solution, as we are not building in cities like Vancouver and Toronto that have extremely acute rental affordability problems. Reducing developer fees or bonus density for more affordable units may be a solution in some markets. For immediate rent relief, we also believe provincial governments could simply expand their rental assistance programs, as this is much faster than multi-year building of new rental apartments. BC has two programs: the RAP program aimed at working families and the SAFER program targeted at seniors. Quebec also has the “Supplément au Loyer” rental subsidy program for lower income households but it is quite cumbersome administratively for the landlord. So streamlining and expanding
“Development charges are the main expense. We pay the same development charges for different size units. ” this sort of program could help immediately. If governments are serious about affordability, they could expand on these sorts of programs and the private sector will continue to develop rental housing to meet the demand we believe. Jason Birnboim: There needs to be better recognition of property tax factors, which is a big property cost. Municipalities need to relax parking requirements on the construction side. There is a draconian requirement where parking must be below grade. One of my sites had surface parking hidden from view but City planners did not want it. Burying parking increases costs. It’s better for the City to look at sprinkling this parking requirement across the board instead of doing it in clusters. Provide a density bonus based on how many affordable units are added, as this will help to generate more affordable housing. Peter Polley: We did one project through the CMHC’s RCFI program, which let us access higher loan value at a lower interest rate with a reduction in our insurance premiums. This means that capital was not tied up in the project, which allowed us to build more projects. A supply side program would help to increase the supply of rental construction. Let the market sort out the rents. Make financing available to lower the cost of capital. Provide a PST rebate for affordable housing programs. In general, government policies favour single family homes through property taxes, energy efficiency programs, sales tax rebates, and so on. The government views construction businesses as fat cats that don’t need to be treated well. Multi-residential developers are treated worse than single family home developers.
RHB: What government action or reform would help lower the cost of building rental properties, or conversely, what factors increase the cost of developing rental properties? Nicolas Denux: There is not a single factor as rental developers deal with three levels of government. Each has varying impact on costs and income of a project.
22 | November 2019
I believe most developers would like to see a stable, predictable, cost-effective and expedient framework for developments. In BC, maybe exempting new rental buildings from all rent controls would encourage more rental developments in higher land cost markets. At the federal level, reforming the GST credit on new rental construction to have GST 100 per cent deductible on new rental purpose-built apartment buildings would be extra help. Also expanding on the CMHC insured programs for new rental developments would be of help. Unfortunately, and not to be too cynical, politicians prefer shovel turning photo ops and ribbon cuttings to simply adjusting and expanding existing programs. Jason Birnboim: Development charges should be relaxed, and the approval process should be shortened. Property tax abatements would be a huge incentive. Cities should relax parking requirements near transit. The market does not require it, and it’s expensive and hard to maintain. Bicycle parking requirements also drive up the cost, which is ridiculous. The City is vastly overdoing it on green space. Toronto has a lot of parkland, but they are hyper-focused on block-byblock park requirements. It’s challenging to have to dedicate space to parkland. The City should be more sensitive to a building’s surroundings. Peter Polley: Development charges are the main expense. We pay the same development charges for different size units. We try to develop less expensive units but pay the same fees as any other units. The government should waive the fees or right size the fees for affordable housing programs. Tax rebates would be helpful. There is no revenue for the government if we don’t construct the buildings. Having to pay 15 per cent HST on newly constructed rental properties is a lot of money, and this tax has to be financed to be paid, and you have to pay interest on that tax for the life of the building.
RHB: Thank you for your input and participation