Apartment rental crisis fuelled by tax changes, rent controls, appeal of
condos and lack of
financing
Garry Marr
Back in October when Amit Gupta moved his Saskatoon high-tech company to Ottawa,
he had no idea the bunk beds being constructed at his firm's downtown offices
could be considered valuable housing.
His young workers putting in long hours could use the beds as a place to crash
instead of heading home, Mr. Gupta figured. The last thing on his mind was the
rental crisis in the capital. But when you consider that for every 1,000
apartments in Ottawa, only two are available for rent, those beds could have
proven to be comfortable. Lucky for Mr. Gupta and his employees, Analog Design
Automation was renting office space from a company that also owned apartment
units downtown. That got him and his
employees to the top of the list.
"Half of the company ended up moving right around the office," said
Mr. Gupta. "You have to move quickly. If you wait [to sign a lease], it
gets away on you."
Not everybody in Ottawa has been so lucky. The city has a staggeringly low 0.2%
vacancy rate, the lowest in the country. Ottawa's vacancy rate was almost 5%
back in 1996.
Nationally, the vacancy rate dropped 38% from October, 1999, to October, 2000.
Across the country, the vacancy rate is now 1.6%, compared to 4.3% in 1996.
Those numbers continue to drop because few developers are building, at least not
the way they did in the 1960s and 1970s. There are about four million rental
housing units in Canada, but since 1992 only about 6,000 units per year have
been added.
The reasons are straightforward. The tax rules have changed for developers, rent
controls or the threat of them have scared off developers, low interest rates
have made buying condos more attractive to would-be renters and the rate of
return on proposed apartment buildings is just too low.
Then there's government financing. There's really none available, in contrast to
30 years ago, when Canada Mortgage and Housing Corp. would provide cheap
financing.
"There's just no money in apartment construction," says Frank Clayton,
a Toronto-based real estate consultant. "The biggest difference is the tax
treatment."
Before 1971, an individual who owned a small rental building could deduct book
losses like depreciation against any other income. Therefore, anyone
constructing a new building would have huge depreciation losses to deduct from
other income, says Mr. Clayton.
Then there's the rent control bogeyman. Six out of the 10 provinces have some
sort of rent control program still in place. A product of the Trudeau years and
wage and price controls, rent controls instituted in 1975 have been slow to come
off in most provinces.
Paul Finkbeiner, chief operating officer of GWL Realty Advisors, and Mitchell
Abrahams, a senior vice-president at GWL, laugh at the notion that there is no
form of rent control in Ontario. Under the law, landlords can only raise rents
once a tenant moves out.
"People feel they have a bargain, so they don't move," said Mr.
Finkbeiner, who says about 20% of the market turns over a year.
But the other factor holding back construction is that it's still cheaper to buy
an existing building than construct a new one. Mr. Finkbeiner says it might cost
$200,000 a unit to build in one of Toronto's prime locations. In those same
tough locations "we can still buy that for $100,000 to $150,000." The
question becomes why build when you can buy.
From where Yazdi Bharucha, chief financial officer of Canadian Apartment Real
Estate Investment Trust, sits, those factors have helped make CAP REIT's
holdings pretty attractive. "The economics of building are not quite there
in terms of the rental levels you can demand," says Mr. Bharucha, whose
company owns about 9,000 suites across the country.
He blames municipalities for part of the dearth of construction, saying realty
taxes can be double for an apartment's owner versus a condo owner. "It
makes no sense for a condo next door to pay [less] taxes than a multi-unit
dwelling," says Mr. Bharucha.
Developers say municipalities should be encouraging construction of high-rent
buildings because of the effect they can have on the overall market. "As
much as politicians are pushing for low-rent housing, it will have to be a
trickle down where you get rental [construction] in some of the best locations
and that gets vacancy in some of the lower rent" districts, says GWL's Mr.
Abrahams.
Like Mr. Bharucha, GWL's Mr. Finkbeiner says cities also need to change their
tax structure because it is helping spur condo construction.
"Some of the sites you would think would be natural for apartment buildings
are being bid up by condo developers," says Mr. Abrahams.
Yet there is some apartment building construction going on and the companies
behind the projects clearly expect to make money.
"I'm not losing money. We don't plan to lose money. I guess we'll find
out," says Bill Malhorta, the president and owner of Ottawa's Claridge
Home. He's constructing a $16-million, 175-unit building in Ottawa's east end.
"It's a big undertaking," says Mr. Malhorta, adding it's been at least
a decade since a private developer constructed an apartment building in the
capital.
In this case, he already owned the land and the city threw in some perks here
and there. He saved $500 a unit for permit fees, plus the GST for apartment
buildings has been cut by the federal government from to 4.5% from 7%.
"People keep saying you must know something that we don't know," he
says. But Mr. Malhorta said the scaling back of rent control has helped boost
rents and that is starting to make some builders consider construction.
The average monthly price for a two-bedroom unit in Ottawa jumped 13.5% from
1999 to 2000, up from $773 to $877. Of the 26 markets surveyed by CMHC, all
recorded gains from 1999 to 2000.
There are those who believe CMHC's low vacancy numbers are not realistic because
they don't take into account the untapped condo rental market or illegal
apartments. It's difficult to say how much higher vacancy rates would be if the
condo rentals were included. CMHC only counts buildings with three or more
units, so all those people renting out one condo do not count.
"There was an article a couple of years ago [done by CMHC] and it found 20%
to 25% of condominiums were rented," says Roger Lewis, an economist with
CMHC. "One study found that market [the secondary market] amounted to
almost 40% of the rental market [in Ontario]."
That might be the only short-term hope to ease the apartment crunch. Even Mr.
Lewis concedes it's going to be tough to convince developers to build.
"They just can't get the rate of return they want," he says.