Red-hot markets drive resurgence of rental housing

Rising valuations for units nationwide lead to an increase in proposed projects

How hot is the residential housing market? Well, for the first time in decades, developers are considering building rental housing because they can actually make money — buoyed by consumers priced out of becoming homeowners.

In Toronto’s red-hot housing market, where January prices across existing homes climbed 22.6 per cent from a year ago, consumers have been flooding back to apartments where the vacancy rate was already just 1.3 per cent, according to a Canada Mortgage and Housing Corp. October market survey.

A report from Avison Young suggests that a tight vacancy rate, which the company says is now closer to one per cent, is leading to rising prices that have seen what it calls “challenged” properties go for $150,000 per rental unit and up to $300,000 for premium properties.

The capitalization rate, the ratio of net operating income to property asset value, is now just four per cent on average across the Greater Toronto Area, but as low as 3.25 per cent. The lower the cap rate, the more a property is worth. A four per cent cap rate assumes it will take 25 years for a property to pay for itself based on its income stream.

Valuations, coupled with changes to rent control rules that allow landlords to charge market rates, have created a viable economic option to build. It’s not the golden age of the 1960s and 1970s when most of Canada’s apartments were built, but market conditions are better than they’ve been in three decades.

That has led to a spike in the number of proposed purposebuilt rental units: Developers are currently planning to build 27,812 units, almost triple the number a year ago. That compares to 49 purpose-built rental projects with 8,484 units that have been added to the market since 2005.

David Lieberman, a principal at Avison Young in Toronto, said the turning point for the rental market probably can be traced to 2004 when the housing market took off.

“What is going on in the market right now, talking to various educated people, developers building the condo, selling the condos, there just isn’t much logic right now,” said Lieberman, about rising rental rates. “If you don’t ask (for a higher rent), you don’t get it.”

Urbanation Inc. said the average rent in purpose-built units in the GTA has climbed to $2.77 per square foot in 2016, an 11.6 per cent increase in price from the $2.48 just a year earlier. “We’re at seven-year low for vacancy rates,” says Lieberman, who notes that the vacancy rate in the GTA in the apartment market climbed to almost four per cent in 2004. “What happened there is people just start buying houses (and leaving the apartment market). All the cheap mortgage money had everybody looking to buy. And the market was losing tenants to buyers.”

There is no denying the changes to rent control in Ontario in 1998 suddenly made institutional players such as pension funds and real estate investment trusts see the growth in the sector, Lieberman noted in a recent comment on the market. “Government is always a threat and game changer, a business risk. We had a convergence of things,” he says, referring to easing of rental rules but also the strength of the housing market. “We didn’t have any multi-residential construction for years. Don’t forget we also didn’t have any REIT legislation before either.”

It’s not just Toronto: Valuations for rental units have been going up across the country. Real estate company CBRE said in a year-end report for 2016 that cap rates have been trending up for two years and nationally they now stand at 4.16 per cent for multi-family highrise Class A buildings.

Vancouver is probably the hottest market in the country, as rental apartment valuations operate in the shadow of the housing market.

“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,” said Bob Dugan, chief economist with CMHC.

All the cheap mortgage money had everybody looking to buy. And the market was losing tenants to buyers.