Canada is facing a crisis: Limited new supply of apartment product and a record-low national vacancy rate of 2.4%. Vancouver leads all major markets in Canada with a vacancy rate of 0.8%. How should investors act in this real estate market? To answer this, we examine the current state of the rental market, the key factors impacting it, and then explore new strategies for navigating this environment.
While the “red hot” condo market appears to have cooled over the past twelve months, the fact remains that the price of entry for home ownership is still expensive. Many Canadians may shift or delay their home ownership aspirations and elect to rent versus own. The ownership ratio topped 69% in 2011 according to Statistics Canada. This rate has dropped to 67.8% in 2016 and down to 66.3% as of 2018. This downward trend is in part caused by an increase in the cost of ownership due to higher prices, higher interest rates, and higher mortgage stress test levels.
While the Federal Government’s implementation of the “Mortgage Stress Test” was designed to suppress the market, home ownership remains challenging. This applies equally to the many measures implemented by other levels of government as well.
The new supply of “market” and “affordable” rental housing has not kept pace with demand. Vancouver and Victoria are the two tightest vacancy markets according to the Canada Mortgage and Housing Corporation (CMHC).
For example, a one-bedroom apartment in downtown Vancouver rents for $1,800 to $2,200 per month (not including utilities or parking) and two-bedroom rents for $2,500 to $3,000 per month.
Historical CMHC data shows a 42% increase in Greater Vancouver average rental rates in the last 10 years and a 20% increase in the last three years alone. This increase is better explained when vacancy is placed in context: Vancouver’s vacancy rate has been below 2.0% for almost the last 30 years.
The primary culprit in the lack of new supply for both Vancouver and Victoria is high land prices. From a developer’s standpoint, high land prices make it difficult for rental apartment housing to be profitable making it more enticing for developers to build condos to sell. As shown in the chart below, residential land prices were on a steep rise between 2010 & 2019. However, in the past year, government interventions have cooled the residential condo market in Vancouver thereby reducing the price per buildable square foot.
Higher land prices effectively lead to a requirement for higher rents and lower cap rates. The inverse relationship between multi-family units and cap rates since 2009 is shown in the following graph:
Government intervention or lack thereof
While governments at all levels (Federal, Provincial and Municipal) pay lip service to their desire to make a significant change, they are clearly not aligned to incent developers to build more “market” or “affordable” apartment rental housing. There are only a handful of rental incentive programs for multi-family development projects provided by the City of Vancouver[i]:
- Short-Term Incentive for Rental (STIR) – A time limited program run until December 2011 to incentivize multi-family development during the 2009 recession. This program led to the construction of approximately 1000 affordable units.
- Rental 100 Policy (active) – This policy encourages projects where 100% of the residential rental housing units are secured for 60 years or the life of the building. Eligible incentives include development cost levy waiver, parking requirement reductions, relaxation of unit size to 320 sf, additional density and faster rezoning process.
- Moderate Income Rental Housing Pilot (active) – This policy encourages development proposals for new buildings where 100% of the residential floor area is secured rental housing and at least 20% of the residential floor area is made available to moderate-income households defined as earning $30,000 to $80,000 per year.
The above programs have produced approximately 8,700 units over the last few years. The programs show that the incentives that the City of Vancouver currently provides are absolutely necessary in terms of motivating the delivery of new rental housing. However, it also indicates that more incentives may be needed to bolster supply, especially when the financial margins provided by these programs appear to be very slim.
With several new office towers under construction in downtown Vancouver, many of these new buildings are pre-leased to new tenants expanding and adding new employees. It is estimated that another 25,000 jobs are being created with this office expansion. If we have a slowdown in new condo construction and minimal new rental apartment inventory added, where are these workers going to live?
The real estate industry and in particular developers are disappointed with the lack of government creativity at all levels. They will be supportive of new measures designed to stimulate new apartment rental inventory.
While the government cannot be expected to control land prices, they can contribute in several other areas. These include quicker and more efficient approval processes, higher density, smaller units, government grants, and low-interest rate construction financing to name a few. One example of such an incentive is shown by the City of Winnipeg tax abatement program which provides property tax relief over a given time to incentivize new developments in the city. The Provincial and Municipal governments could contribute in this area.
In addition to a lack of financial incentives, the long rezoning and permit application process is a major issue faced by many developers because it creates uncertainty risk and additional holding costs for developers. Currently, the shortest process time is for Rental 100 Policy applications. This takes approximately 20 months from application submission to public hearing, compared to an average of six to ten months for most other major Canadian cities. By fast-tracking this process, municipal governments could provide cost-saving incentives to the developers.
Another significant trend resulting from low supply and contributing to higher rental costs is the “renoviction” program. This has received a substantial amount of negative press. Landlords evict tenants from older affordable housing and undertake significant upgrades to achieve substantially higher rents. This policy coupled with the capping of allowable annual rent increases at 2.5% in 2019 implemented by the BC Provincial Government has further discouraged developers from building new rental apartment product.
A further area where the Federal Government could make a meaningful contribution to encouraging developers to build new rental apartment product would be to eliminate the GST on new buildings which serves as a deterrent to developing a new rental inventory.
Our Strategic Plays
Nicola Wealth Real Estate follows trends carefully to identify when future opportunities may exist.
The housing shortage for rental apartment product, specifically in the Vancouver and Victoria markets, is an obvious concern and an area for opportunity. The residential apartment rental product is, in our view, the safest asset class, as people will prioritize their home location over many other concerns.
Here is what Nicola Wealth Real Estate has done over the past 18 months to help satisfy the demand:
The James at Harbour Towers in Victoria
In 2016, we acquired Harbour Towers which at the time was an iconic 12 storey 196 room hotel with conference and amenity space. The building was originally constructed in 1968 as an apartment building but at a later date was converted to an operating hotel. Due to the age, the property was in dire need of a significant makeover.
Our strategy was to continue to operate the hotel for two years while we completed the design and secured the permits for a complete restoration and conversion to essentially a new rental apartment building. The James Bay community and the City of Victoria planning department were very supportive of the complete revival as it would bring desperately needed new market rental housing to the area which has a near 0% vacancy rate. The building has been rebranded as “The James” and will comprise 220 units of various sizes and include several attractive amenities for the tenants. The building will be completed and ready for occupancy in November 2019 and currently has 1,200 names registered on an early reservation list. The project is 100% owned by Nicola Wealth Real Estate.
The Rex @ Abbotsford
In Q1 2018, we acquired this property and commenced construction on a new multi-family project comprising over 222 suites spread over three buildings. The project will be completed in early 2020 and will add much needed new rental apartment inventory to this market. The asset is situated in Abbotsford, BC directly off the TransCanada Highway at the McCallum Road Interchange, adjacent to the Abbotsford Events Center and the University of the Fraser Valley. This project is a 50/50 partnership with Primex Investments.
Fifth Street @ Sydney
In Q3 2018, we acquired the Fifth Street property totaling 0.87 acres with zoning that permits a new three storey purpose built rental building with 76 units plus underground parking. This project is expected to be completed by spring 2021 and will add much needed new rental apartment inventory in the Sydney market that has a near 0% vacancy rate. The project is a 50/50 partnership with Primex Investments.
Pandora & Cook @ Victoria
In Q2 2018, we acquired an older two-storey retail/residential heritage building. The site comprises 30,880 sf and is located at the northwest corner of Cook Street & Pandora Avenue in Victoria, BC.
Construction will commence in 2020 and once completed in spring 2022, the project will comprise a mixed-use building with four floors totaling 92 rental apartment units atop a two level commercial podium, which incorporates retention of the façade of the existing heritage building. This project is a 50/50 partnership with Primex Investments.
This presentation contains the current opinions of the presenter and such opinions are subject to change without notice. This material is distributed for informational purposes only and is not intended to provide legal, accounting, tax or specific investment advice. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities’ commissions.