The Toronto housing market stands at the intersection of housing affordability and availability, with asking rents trending higher amid wages that struggle to keep up. While average rental rates for private condominiums (condos) have outpaced increases in wages, so too have rates for purpose-built rentals. Exacerbating the issue further, developers are economically incentivized to build condos, limiting the supply of purpose-built rentals and worsening affordability. These trends improve the credit risk for multi-family lenders by ensuring that occupancies and rents will remain high. Despite recent government initiatives, DBRS, Inc. (DBRS) expects supply and demand to remain “tight,” putting upward pressure on rental prices and pushing residents to seek affordability farther outside the city.
Purpose-Built Rentals versus Condos: Know Your Market
Purpose-built multifamily units are individual residential apartment units leased out by an apartment complex as commercial rental stock. Condos are residential units that are listed for sale but can be rented out as private rental stock by the condo owner. What distinguishes purpose-built rentals from privately owned condos is that purpose-built rentals are designed for the sole intention of being placed on the rental market: They cannot be bought and sold as individual units. Condo owners who choose to rent their properties can also choose to sell their condos on the market and end their tenancy with 60 days’ notice, which, as this commentary explores, can decrease availability.
According to CMHC’s Housing Market Information Portal, the average rental rate for all purpose-built unit types has been steadily trending upward to $1,370 in 2018 from $1,048 in 2010 (Exhibit 1), representing a total markup of 30.7% and a year-over-year (YOY) percentage increase of 3.4%. The largest increase was in 2017 at 5.5%. Purpose-built units tend to be the more affordable option, as privately owned condo rentals have average market rents of $2,310 as of Q4 2018, according to real estate consulting firm Urbanation’s YE2018 rental market research. The rental rates in that category have risen far more dramatically, with a record increase of 9.3% over the course of 2018 alone. These rent increases bring in a higher, more constant cash flow for property owners.
Despite still being the more affordable option, the percentage increase of purpose-built rentals has been outpacing wage growth in the city. According to Statistics Canada, the median total income of households in Toronto was $94,869 in 2015, a 19.9% increase from $79,120 in 2005.1 Over that same period, DBRS estimates that the average rental rates for purpose-built rentals increased by 23.4% to $1,208 in 2015 from $979 in 2005, per CMHC (Exhibit 2). This mismatch has been continuously pricing residents out of city, moving them outward to secondary markets within the Greater Toronto Area (GTA), such as Oshawa and Burlington, Ontario — and quite possibly beyond.
CMHC’s data shows that the vacancy rate for these units has been pinched to 1.1% in 2017 from an already-low percentage of 2.1% in 2010 and that this trend has continued into 2018 (Exhibit 3). Note that these figures do not cover the vacancy rates of privately owned condos. This tight vacancy largely stems from there not being enough developments of this kind in the GTA to keep up with demand. Many developers have voiced concerns about the challenges of developing in Toronto, as they lose ground to condo developers, which develop more profitable units (an average condo rent of $2,310 compared with an average purpose-built rent of $1,370— a 68.6% difference). Developers are now eyeing secondary markets in the GTA, as these markets are also seeing soaring rents and diminishing vacancies, though to a lesser extent than in the city’s core. The tight vacancy in the area, moreover, suggests that they could keep occupancies at their purpose-built properties high.
The development of purpose-built units of any kind has almost flatlined since 2010 (Exhibit 4). Canadian Urban Institute’s January 2019 Toronto Housing Market Analysis describes how the majority of purpose-built developments were constructed in Toronto in the 1960s and 1970s during the post-war urban boom. Of the current purpose-built stock, 93.1% was created before 1980. Recently, Urbanation stated that 1,849 new rental units have come on line since last January — the highest growth in 25 years. However, this comprises just 0.5% of total purpose-built rental stock, demonstrating that while supply has recently improved, it is still not enough to meet demand, as the vacancy rate remains at 1.1%.
The Eviction Effect
A significant side effect of the decision to sell a privately owned condo can be the loss of rental stock in the market. This type of eviction is classified as an L2 eviction (i.e., caused by reasons other than non-payment of rent), which is on the rise. This is distinct from an L1 eviction, which covers cases where the tenant fails to pay rent. L2 evictions can include everything from “renovictions” (where a tenant is evicted by a landlord who performs some tenant improvements before putting the unit back on the market for a marked-up price) to “sellovictions” (a landlord evicts a tenant from their condo once it is sold), among others. From 2017 to 2018, L2 evictions
rose by 22.2%. If landlords are successful in their L2 evictions, the availability of rental stock decreases.
“From 2017 to 2018, L2
evictions rose by 22.2%.”
L2 evictions have become an increasingly popular trend, according to Rachelle Berube, founder of the landlord and property managerial-services company Landlord Rescue. Berube notes that rising property and maintenance fees are tightening profit margins for landlords and, in many cases, even has them operating with a negative cash flow. Trouble with tenants and rent collection are other common issues that prompt condo landlords to sell their rental properties. Weighing into the decision are the high values owners can receive if they sell their units. According to Condos.ca, maintenance fees have risen over the past few years, with increases of
3.99% in 2015, 3.79% in 2016 and 2.52% in 2017. The rising cost of operating condos as rentals while provincial rent controls on current stock only increase by 1.8% YOY means that more landlords are making less. Although the cost of constructing condos and purpose-built rentals is similar, the return on investment for condos is much higher.
Purpose-built developers are struggling to compete with condo developers that have greater access to capital to purchase land, according to investors at the CIBC 24th Annual Real Estate Conference. In primary markets, purpose-built rentals struggle to pick up land for development. The average market cost for land in Toronto (excluding the broader GTA) is $134 per square foot1
(Exhibit 6). Developers and real estate investment trust investors who spoke at the Toronto Real Estate Forum in November 2018 explained that rental units make less sense financially, as the cost of construction far outweighs the possible rents that property owners could achieve, factoring in average land, material and labor costs. According to Urbanation’s Q3 2018 condo market results, the average cost of developing a new project has reached $1,044 psf. It would cost the same to develop a purpose-built unit; however, condo units are in higher demand and their sale generates a higher return. According to Urbanation, 44.0% of condo owners who purchased a unit in 2017 for renting are operating on a negative cash flow, while condo owners who sold realized a return of about 155.0% before closing costs. Therefore, all else being equal, the equity investment returns on a condo that is sold — not rented — are
higher than for purpose-built multifamily housing, which cannot be sold as individual units.
Under the Doug Ford government, the province implemented a plan to remove rent controls on new builds to incentivize purpose-
built construction. Rent controls that were previously put into place under the Ontario Fair Housing Plan were expanded for exist-
ing units. Furthermore, the government plans to provide transparency with regard to cost to make it more predictable for developers
and hasten the approval process, which will cut down the paperwork. According to the April 2019 provincial budget released by the Government of Ontario, the Housing Supply Action Plan intends to “develop the right mix of housing where it is needed, lower the costs of development, make it easier to develop rental housing and address other concerns and opportunities to increase the housing supply.” The initiative complements federal funding provided through the National Housing Strategy, a bilateral agreement between the federal and provincial government to provide $4.0 billion in funding for the Ontario housing sector over the next nine years. It is too soon for DBRS to comment on the effectiveness of this plan toward increasing housing supply or improving affordability.
DBRS CMBS Statistics
As mentioned, these high rent, low unit supply and even lower vacancy trends improve the credit health of the multifamily market for lenders. While there are not many GTA-located purpose-built multifamily properties in the Canadian commercial mortgage-backed securities universe, DBRS has nonetheless identified a handful in its DBRS Viewpoint portfolio. The last reported occupancy remains high at above 90.0%, and generally, the properties are experiencing increases in net cash flow, which is indicative of higher rental rates. If the supply-and-demand imbalance continues, the properties will benefit from improved risk profiles.
Many factors are eroding rental stock in the GTA, thereby increasing demand for purpose-built rental supply, such as the return on investment for private condos being much higher than purpose-built units and the fact that many condos that are rented out are now being converted to own-use properties and sold. This increasing demand is climbing dramatically higher than the stagnant growth of purpose-built supply, driving down vacancy and pushing rental rates up. DBRS expects that this supply-and-demand imbalance
will continue and will monitor and report on these trends as they unfold.