Toronto real estate is facing two very serious issues: on the one hand, affordability is dropping month by month, with home prices escalating very quickly; on the other hand, the housing stock is very low, and demand is very high, which is also partly the cause for prices skyrocketing. Industry experts stated recently for the Financial Post that the solution might be the development of purpose-built rental apartment units, and recent data shows a definite trend in this direction.
1% vacancy in Toronto is driving most ambitious development plans in decades
Built-to-rent projects are becoming profitable again, for the first time in over 30 years, due to the heated state of the Toronto real estate market. Single family homes in Toronto are few and expensive, and even condos in Toronto are becoming hard to obtain for buyers, with an approximate vacancy rate of only 1%. Vacancy rates haven’t been this low in the area in over 7 years.
Developers use the Greater Toronto Area right now, means that it would take 25 years for building costs to be covered by revenue generated. In many places, this rate is as low as 3.25%.
This would normally discourage developers from starting built-to-rent projects, but there are some mitigating circumstances which make the climate a lot more favorable. Most importantly, rent control rule changes allow landlords to charge market rates for units built more recently than 1991.
These changes came into effect in 1998, but it is only now, coupled with the huge valuations of buildings in Toronto, that they are stirring developers’ interest. Essentially, now that the market is so hot, prices for purpose-built rental apartments would allow even units with a low capitalization rate to turn a profit relatively quickly. High potential income stream trumps low cap rate.
Over 27,000 rental apartments to be built in Toronto in 2017
The trend towards more rental projects has been on the rise since 2004, according to David Lieberman, principal at Avison Young Toronto. In the past decade, 49 purpose-built rental projects entered the local market, totaling 8,484 units. This year, however, Toronto developers are planning to build 27,812 new units. Rent per square foot in purpose-built units has also increased by 11.6% since 2016, providing strong motivation for developers to undertake such projects.
Developers are aware any shift in government regulations can completely change the game. However, the same market conditions that are driving purpose-built rental development in Toronto can be seen throughout the country, with an average capitalization rate of 4.16% for multi-family high-rise Class A buildings.
In Vancouver real estate, the cap rate for this type of apartments is 2.75% – the lowest in Canada, according to a CBRE report.
Another aspect driving the proposal for new purpose-built projects is that half of the apartment stock in the country is over 38 years old. The last 15 years have only seen about 180,000 units being developed nationwide, and there is consumer pressure for newer, more up-to-date buildings.
Built-to-rent opportunity attractive to real estate investors, as prices soar to hundreds of millions
In terms of real estate investment, these developments are selling faster and for higher prices than have been seen in decades in Canada. For example, a 739-unit building in Kanata Lakes, near Ottawa, sold recently for $250 million.
Bob Dougan, chief economist for the Canadian Mortgage and Housing Corporation, reinforces the importance of purpose-built units for investors: “We have seen an increase in the completions in the purpose built under construction but the main source of rental growth is still coming from the condo market with investors buying and renting out the units,” he explains.
The trend is gaining traction especially in the Toronto area, where demand is highest and supply is at a record low. As house prices in the Greater Toronto Area will continue to rise, they will likely drive more people towards renting. The situation is similar to the rental market in New York City, where very low affordability is putting the dream of home ownership out of reach for even the most affluent residents. On the other hand, higher competition in the rental market will mean improved customer service for tenants, and a more stable price range in the long run.
