Rents Are Climbing — Even For Purpose-Built Rentals

Rents Are Climbing — Even For Purpose-Built Rentals

Purpose-built rentals are considered an essential ingredient in the housing mix, because they provide affordable shelter for those who are priced out of the ownership market or prefer to rent than own. Such rental stock is also usually cheaper than renting a unit in a condo building, which are often newer and offer better amenities.

But recent data from Toronto revealed rents in purpose-built rentals (PBR) are climbing at a faster rate and narrowing the gap with rental condominiums, so the assumption that they will remain cheaper than condos might need reexamining.

The rental dynamics in populous cities across Canada are characterized by low vacancy rates and rising rents. Why rental markets are becoming relatively more expensive and what can be done to address it are important considerations for maintaining balanced housing markets.

A recent analysis of listings on rentals.ca by Bullpen Consulting revealed that average monthly condominium rents in the central parts of Toronto were stable at approximately $2,600 between October 2018 and June 2019. But average rents for rental apartments increased to more than $2,100 from less than $2,000.

An increase in the demand for rental units is the apparent cause of rising rents. Stricter mortgage regulations along with higher housing prices, among other reasons, have kept a segment of renters, who would have otherwise transitioned to home ownership, in rental units longer than usual. Rental vacancy rates have, therefore, declined to result in a large number of new renters competing for shrinking available rental stock.

The logical response to low vacancy rates and escalating rents is to increase the supply of rental units, either as condominiums or PBR. The primary advantage of PBR is the tenure security for long-term renters. Condo renters are always at risk of being forced to move should the landlord require the unit for personal use.

However, PBR construction faces more challenges than other residential types.

Market fundamentals and construction finance, among other reasons, do not entice builders to choose PBR over condominiums or homeowner units. Often, lenders feel more comfortable financing condominium construction since they require developers to have presold a sizeable chunk of the planned development.

Thus, there is certainty in condominium lending, because the developer leverages the commitment to purchase pre-built units and deposits from prospective buyers.

PBR construction, by comparison, carries uncertainty. The developer or the owner must complete the construction before leasing the units. The uncertainty about future rent structures and the ability to fully lease the building makes PBR construction financing more challenging.

Those reasons have helped condominium construction in Ontario dominate the residential construction sector in communities of at least 50,000 inhabitants. From January 2018 to June 2019, Ontario recorded 48,934 condominium starts compared to 42,370 homeowner and 12,412 rental starts, according to Statistics Canada.

Yet rental units dominate residential construction in Quebec. From January 2018 to June 2019, there were 31,538 rental starts, more than the homeowner and condo starts put together.

The diversity in housing market outcomes, as is evidenced by the difference in tenure of new construction between Ontario and Quebec, requires housing policy and strategy to align with local dynamics.

Better city building paradigms adopted by PBR developers are contributing to the improved lending environment for rental apartment construction. Some developers are constructing mixed-use rental buildings with retail or offices at grade, and residential units above grade to build socially cohesive communities.

Jonathan Gitlin, president and chief operating officer of RioCan Real Estate Investment Trust, believes that mixed-use developments make better planning sense because they create balanced communities that are “animated throughout the day” and provide amenities for the community at large.

He also believes that the increase in construction financing support by Canada Mortgage and Housing Corp., the federal housing agency, has also helped PBR development.

The federal Liberals have invested more than $13 billion to support housing in Canada. The 2019 federal budget introduced provisions to support the construction of 42,500 new dwellings in markets with limited rental supply. The government supplemented the Rental Construction Financing Initiative with “an additional $10 billion in financing over nine years.”

If left to their own devices, urban land markets will select the highest and best use for development, even if it might not be socially optimal. Hence, governments have a role in promoting stability and diversity in housing markets.

Governments must, therefore, consider additional measures to incentivize the construction of rental apartments in populous cities where market fundamentals might favour the construction of other housing types.