Purpose Built Rental In Trouble?

REMI Barbar Carss

Already tight margins in purpose-built rental pro formas have become even more precarious during the COVID-19 pandemic. Developers are now facing escalating material costs, supply chain disruptions, labour shortages and — perhaps most surprisingly from a demand perspective — climbing vacancies and falling rental rates that were not contemplated 18 months ago. Even so, market analysts report that strong fundamentals continue to draw investors to the sector.



“Buying brand new apartment buildings, certainly at scale, is virtually impossible so there’s now this desire to create product. If the initial returns are skinny, I don’t think they care because, down the road, they will own the type of assets that they’d like to own.”

“There’s just an insatiable demand amongst institutional capital to be in the multifamily space, to have a higher allocation to multifamily space than they have traditionally had, and to own really good product,” Paul Morassutti, CBRE Canada’s vice chair, valuation and advisory services, observed during a recent webinar examining Canadian commercial real estate dynamics. “Buying brand new apartment buildings, certainly at scale, is virtually impossible so there’s now this desire to create product. If the initial returns are skinny, I don’t think they care because, down the road, they will own the type of assets that they’d like to own.”

Proponents with shallower resources and/or shorter horizons for investment returns have a tougher business case. Citing a recent report from the consulting firm, Finnegan Marshall, which found that construction costs rose by 53 per cent over the past five years, Morassutti estimated that additional increases in development charges, contributions procured through Section 37 of Ontario’s Planning Act and spiking land prices have actually pushed up costs by as much as 75 per cent since 2016. Typically, developers need about a 3 per cent gain in revenue to balance out a 10 per cent jump in costs.

“On the condo side, revenue has also increased, so the condo industry has been able to absorb a lot of these costs and continue forward,” Morassutti acknowledged. “The pressure has been most acute on the purpose-built rental side and that’s because, even pre-pandemic, the returns for that type of development were very skinny. You have a combination of construction costs going up and revenues not moving so it is really making a lot of these pro formas difficult to pencil out.”

Rental revenue slippage is expected to be short-lived once COVID-18 wanes, and is already climbing back up from pandemic lows. A return to pre-pandemic immigration levels and the resumption of on-campus post-secondary learning should bolster demand for rental accommodation relatively soon. Looking farther into the future, homeownership affordability barriers are likely to keep a growing portion of urban dwellers in rental accommodations.

Morassutti also speculates that many of today’s asset-rich homeowners will feed an uptick in demand for purpose-built projects that offer secure tenure. In particular, he points to a largely uncounted but presumed significant cohort of near-retirees who have inadequate savings for the future.

“I think a lot of those households will cash out of their houses and move into rental product, and they’re not going to move into a 400-square-foot condo with an owner who can evict them at any time,” he submitted.

Meanwhile, Benjamin Tal, deputy chief economist with CIBC World Markets, theorized that the base of prospective renters and owners has been undercounted and that upwards of 165,000 potential permanent residents weren’t identified as new arrivals during the course of the pandemic. That includes about 150,000 international students who became automatically eligible to stay in Canada after their visas expired and 16,000 to 17,000 repatriated citizens who returned from Hong Kong.

“Demographically speaking, we are doing better than advertised,” Tal said.




Multifamily real estate investment trusts could find themselves under fire from a Liberal policy proposal aimed at "excessive profits," part of the governing party's housing platform in the current election.  With a federal vote set for Sept. 20, the Liberals laid out a housing plan that includes a new tax-free savings plan for young buyers, a two-year ban on foreign ownership of housing, a tax on the flipping of houses in the first year, and a plan for what the party calls "excessive profits in the financialization of real estate."

Michael Markidis, an analyst with Desjardins, said while most of the Liberal plan is aimed at making housing more affordable, he predicts the policy proposal could be a near-term overhang for multifamily REITs. "Several commitments are potentially of concern for Canadian multifamily REITs under coverage," said Markidis in a note to investors.

The Liberal policy proposal said it would stop what it calls excessive profits "by reviewing tax treatment of large corporate owners and speculators trying to amass large portfolios of Canadian rental housing, and putting in place policies to curb excessive profits."  REITs qualify annually for an exemption based on specified investment flow-through, or SIFT, rules and do not pay tax on income earned from their Canadian property holdings.

"An amendment to the Income Tax Act (Canada) making qualifying more onerous and/or eliminating the REIT exception for multifamily landlords would almost certainly be negative for public market valuations," said Markidis.

Markidis also noted the Liberal plan targets what it calls "unfair rent increases" from landlords.  "To help better protect renters, we will also stop 'renovictions' by deterring unfair rent increases that fall outside of a normal change in rent," according to the Liberal policy paper.



Real gross domestic product contracted 0.3% in May, following a 0.5% decline in April. Total economic activity was about 2% below the level in February 2020, before the COVID-19 pandemic.

From July to early August 2021, Statistics Canada conducted the Canadian Survey on Business Conditions. This survey collects information on business expectations in the future and the ongoing impact of the pandemic on businesses in Canada.

Over the next three months, over one-quarter of businesses expected their profitability to decrease, 14.8% expected their sales to decrease, over one-fifth expected to increase the prices they charge and nearly four-fifths expected their number of employees to remain the same. Businesses also expected to face a variety of obstacles in the short term.

Over one-quarter (27.2%) of all businesses expected their profitability to decrease over the next three months (see Note to readers), while 13.7% of businesses expected their profitability to increase. Close to three-fifths (56.5%) of businesses expected profitability to remain relatively unchanged. Expectations of future profitability differ by industry. For example, among businesses in accommodation and food services, while nearly two-fifths expected profitability to decrease (39.3%) or remain about the same (38.0%), over one-fifth (22.4%) expected profitability to increase. In addition, over one-third of businesses in transportation and warehousing (35.7%) and in administrative and support, waste management and remediation services (35.1%) expected their profitability to decrease over the next three months. Conversely, more than one-fifth of businesses in retail trade (20.9%) and nearly one-fifth of businesses in wholesale trade (19.3%) expected profitability to increase.

Businesses face a variety of obstacles and future unknowns. The rising cost of inputs, including labour, capital, energy and raw materials, was the most commonly expected obstacle over the next three months (38.5%). This proportion was similar to the 37.8% of businesses that expected this to be an obstacle in the second quarter. The rising cost of inputs was expected to be an obstacle for approximately three in five businesses in manufacturing (65.4%); accommodation and food services (59.6%); and agriculture, forestry, fishing and hunting (58.0%).

Businesses also expected to face obstacles related to the workforce. Recruiting skilled employees was expected to be an obstacle for over one-third (34.6%) of all businesses, led by those in accommodation and food services (55.3%), manufacturing (46.9%), and construction (41.1%). In addition, a labour force shortage was expected to be an obstacle for 30.3% of businesses, while retaining skilled employees was expected to be an obstacle for nearly one-quarter (24.5%) of businesses.

Over one-quarter (27.8%) of businesses anticipated that some of their workforce would continue to primarily telework once the COVID-19 pandemic is over. The businesses most likely to anticipate having some of their staff primarily telework were those in information and cultural industries (53.4%); professional, scientific and technical services (51.5%); and finance and insurance (44.8%). Of the businesses anticipating staff to telework, almost one in six (14.7%) foresaw reducing their office space because more of their workforce would be teleworking.





4750 Bathurst Street - North York - $19,000,000 / $296,875 Per Suite / 2.7% Cap Rate

This property comprises a 64 suite rental apartment building investment on a 1.17 acre parcel of land in central mid Toronto.  It is 3 stories and was built in 1968 and is a concrete structure in decent shape for its age.  There is one elevator in the building and a total of 68 parking spaces inside and out.  The building is heat HWG and is on a sub-meter for hydro program and half the tenants pay their own right now.    The property was fully marketed and with multiple interest and the bid winner was Starlight Investments.

61 Ballantyne Avenue and 70 Albert Street – Cambridge –  $6,200,000 /  $155,000 Per Suite / 3.6% Cap Rate

This property is located in the Cambridge about 100 kms west of Toronto.  It consists of two 20 suite walk up rental apartment buildings constructed in the 1970's.  The bulk of the suite are 2 bedroom and are of modest size.  The buildings are concrete with brick and siding exterior, double windows and some balconies.  The property had below market rents and further upside in sub metering the hydro.  The property was not fully marketed and was purchased through a private investor.

621 Baseline Road, London - $4,044,000 / $175,825 Per Suite / 3.6% Cap Rate

The asset is located in the City of London and is a 3 storey walk up rental apartment building with a total of 23 suites.  It is of frame construction with brick and siding exterior and flat roof.  The assets sits on half an acre and was 30 parking space, 12 two bedrooms and 11 one bedrooms.  Half of the tenants right now are paying hydro.  Heating is hot water gas radiant.  There is over 30% rental upside in the investment.  The property was not fully marketed and the purchaser was a private investor.

186 King Street - London - $13,500,000 / $82,825 Per Suite / 6.25% Cap Rate

Located in downtown London, this property comprises a mid rise mixed use investment which includes 30,000 square feet of retail and office space and 163 rental apartment suites.   Over $5MM has been spent in the asset over the past 7 years.  It is a concrete building with 2 elevators and no on site parking.  It is condo titled and over 85% of the suites have been gutted and totally renovated in the past 5 years.   This is a former hotel which and the suites are considered to be on the small side being mostly bachelors.  The property was fully and openly marketed and sold by The Apartment Group.  The NOI was based on actual in place income and real expenses.  There is huge upside here in apartment rental income and re-positioning the vacant commercial spaces. The Buyer was a private investor.








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