Urban Development Institute No Vacancy: Challenges and Opportunities for New Rental Construction
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No
Vacancy:
Challenges
& Opportunities
for New Rental
Housing Construction
As anyone who has looked for rental housing in BC can
tell you – we have a rental housing shortage. It’s real and it
has serious repercussions, from homelessness to limiting
economic growth. But if demand is strong and rents are
increasing why aren’t more market rental projects breaking
ground? The simple answer is government policy, taxes,
and fees along with rising construction costs make them
difficult to build. In this report, UDI breaks down the data
that investors, banks, and developers use to make these
decisions including sample business cases. The Urban
Development Institute hopes that by providing a window
into these processes, policy makers will be better equipped
to help increase the rental housing supply across BC.
Introduction
In British Columbia, the gap is increasing between the
high demand for rental housing and the low availability
of units. There is already a shortage of rental housing,
and the Expert Panel on the Future of Housing Supply
and Affordability is anticipating the number of all types
of homes needed in Metro Vancouver will be 27,438
per year between 2021 and 2026. Estimating that 30%
of future residents will be renters, that is approximately
8,231 rental units needed in the housing continuum
per year until 2026. According to CMHC’s most recent
Rental Market Report, there was an increase of 1,602
purpose-built rental units added to the rental universe
in 2021. The rental universe takes into account units
that were brought onto the market from new buildings
or completed renovations, and units that were taken
off the market due to renovations and demolition.
The rental universe does not account for the existing
shortfall that is evident through low vacancy rates.
It’s clear that we’re not building enough rental homes
to meet the growing demand in our region. Without
a more efficient process and substantial new supply,
rental housing availability will remain constrained and
the existing market rental rate will rise.
There have been significant changes to the risks
associated with building new rental housing.
Policy changes, increasing government taxes and
fees, and the costs of construction are at the root
of why new housing, especially rental, is difficult to
build in today’s market. This update will analyze three
pro forma scenarios and their sensitivity to risk in
today’s market. The pro forma scenarios illustrate
the new risks associated with building rental housing,
and how these affect the scale, market rents, and
ultimately, the viability of building new purpose-built
rental. These scenarios include a high-density project
near a SkyTrain station, and two lower density projects
that could be built on an arterial street in Vancouver
and Victoria.
We have engaged experienced builders and market
experts to create sample budgets, or pro formas,
to illustrate the impact that rising costs have on the
viability of building market rental. The initial analysis
was conducted in 2019 through the Making Rental
a Reality Report. This analysis re-examines three
locations in Metro Vancouver and the Capital Region
to highlight the changes in fees associated with rental
development between 2019 and today. All three pro
formas are included in the Appendix.
Policy changes, increasing
government taxes and
fees, and the costs of
construction are at the
root of why new housing,
especially rental, is difficult
to build in today’s market.
No Vacancy
Introduction | 3
What do rising
costs mean?
The rents in new rental buildings are reflective of their
location, size, vacancy rates, and the costs to finance
and build. The costs associated with development
are the most unpredictable factor in determining the
viability of new market rental. The amount of new
land available to develop is decreasing, meaning the
majority of new developments will involve redeveloping
a property that is already in use. This adds another
level of uncertainty associated with the development
process. Timing, delays and all other costs related
to the development process from financing to
construction impact the ability to provide units at
market rents.
The Federal Goods and Services Tax (GST) and
Community Amenity Contributions (CACs) are
examples of fees and taxes that make the construction
of new purpose-built rental projects expensive and
risky for builders.
FEDERAL GOODS AND SERVICES TAX (GST)
The Federal Goods and Services Tax (GST) charged
on new homes is not a new cost, but it has a
significant impact on rental development. The
current approach to calculate GST on new homes
can often exceed the costs of all other government
taxes and fees combined. In Scenario 1, a high-
density development near a SkyTrain station, the GST
accounts for $13,685,717 of the total project costs, or
$26,523 per unit, while all other combined government
fees account for $5,879,493, or $11,394 per unit.
While there are rebates available for rental housing
construction, these are based on unit values that have
been set at the national level and do not vary based
on local markets. In addition, the rebate thresholds
have not been tied to inflation and have remained
unchanged since they were introduced over 20
years ago. At that time, most rental units would have
qualified for at least some part of the rebate, however
that is not the case today. Based on historic market
reports, in 2000, when the rebate thresholds for rental
housing were introduced, the average value per suite
was $97,147 (equivalent to $143,057 in 2021, based
on the Bank of Canada’s Inflation Calculator). In 2021,
the average value per suite was $486,688. This is a
direct comparison of older buildings still unable to
meet the $350,000 maximum value estimate for the
rebate, meaning the gap would be substantially wider
for new rental buildings. This shows that the increase
in value has been substantial in the past 20 years,
prompting the need to review the rebate thresholds
to more accurately reflect today’s market values.
The result is that the majority of rental units built in
major urban centres, where rental housing is in high
demand, will not qualify for a rebate. Considering the
amount of purpose-built rental that needs to be built
to accommodate new and existing Metro Vancouver
residents, the GST line item in a project’s financing
can significantly impact a builder’s ability to provide
the necessary units.
No Vacancy
What do rising costs mean? | 4
Vacancy Rate & Rental Supply Projection (High/Low)
Vacancy Rate (to 2021): Vancouver CMA Annual Vacancy Rate, CMHC Rental Market Reports
Inventory (to 2021): Vancouver CMA Number of Private Rental Apartments in the University, CMHC Rental Market Reports
Projection Rationale: The 5-year projection (2021-2026) shows potential high/low inventory growth scenarios to demostrate the level to which vacancy rates may adjust
over the 5-year projection. There are a number of factors that impact vacancy rate in addition to supply, which are not considered in this demonstrative projection.
High Supply: Assumes a hypothetical 10%r net increase per annum to the historical CMHC rental inventory. The vacancy rate projection shows a rising rate under high
inventory growth where supply outweighs demand. Under this assumption, equilirium is achieved at 3.00% vacancy and average rents would be expected to flatten.
Low Supply: Assumes a hypthetical 5% net increase per annum to the historical CMHC rental inventory. The vacancy rate projection shows a decreasing rate under low
inventory growth where demand outweighs supply Under this assumption, vacancy returns to 1.0% and average rents would be expected to continue to rise.
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
200,000
190,000
180,000
170,000
160,000
150,000
140,000
130,000
120,000
110,000
100,000
VACANCY RATE
RENTAL SUPPLY
PROJECTION VACANCY% (High Supply) VACANCY% (Low Supply)
INVENTORY (High Supply) INVENTORY (Low Supply)
The graph below depicts the impact of increasing supply on vacancy rates. Generally, a 3% vacancy rate is
considered a requirement to achieve a balanced market, however the historical vacancy rates shown below are
much lower. The dotted lines in the graph below demonstrate a high and low scenario of new supply, while the
straight lines demonstrate the potential impact to the vacancy rate. The blue line displays a high supply scenario
that could stabilize the vacancy rate over a 5-year forecast.
COMMUNITY AMENITY CONTRIBUTIONS (CACS)
These pro forma scenarios have been completed
without the inclusion of a Community Amenity
Contribution (CAC) calculation; however, this
would typically be considered as part of a real
redevelopment. Without clear government policy,
CACs can be difficult to assess when underwriting a
pro forma and are often negotiated with municipalities
during the rezoning process. CACs are intended
to ensure that new growth contributes to the
development of complete communities for new and
existing residents, but these processes are lengthy
and costly. In some cases, it can take over seven
years to reach a conclusion. This creates a lack of
certainty and delay in the delivery of new housing,
including purpose-built rental. Some builders have
elected not to proceed with their projects based on
CAC expectations set by the municipality, resulting
in projects being paused, re-designed or sold for
alternate uses.
HARD AND SOFT COSTS
Construction materials have also become a key driver of
cost increases over the last two years. Between 2019 and
2021, the hard costs associated with lumber, steel and
wages have increased significantly, and prices remain
volatile, in some cases due to supply chain issues.
In Scenario 3, a 4-6 storey wood-frame development
in Victoria, where 114 suites are being financed, hard
costs have increased by $23,263,000 since 2019.
This is a 74% increase over a two-year period.
Soft costs, including leasing, marketing and other
services associated with the development process have
also risen substantially - up to 19.6% in Scenario 2 - a
4-6 storey development in Vancouver. With the double-
digit percentage increases in both hard and soft costs
over the past two years it has resulted in the need to
recover those costs in order to make a project feasible,
typically requiring higher rents.
In Scenario 3, where 114
suites are being financed,
hard costs have increased
by $23,263,000 since 2019.
This is a 74% increase
over a two-year period.
No Vacancy
What do rising costs mean? | 6
OPERATING EXPENSES
In addition to the rising cost of development, rental
builders must also evaluate the expenses associated
with operating the future building once complete when
determining whether or not a project is viable. As
operational costs rise, it becomes more difficult to make
long-term investments in building rental property as
it reduces the projected Net Operating Income (NOI).
Scenario 3 illustrates that projected operating expenses
have risen substantially since 2019. This is due to
increases in annual property taxes, insurance, salaries
& wages of onsite management and staff, the costs
of repairs, and increases in utilities, such as gas or
electricity.
These expenses are expected to continue to rise
over time, however once units are constructed and
are tenanted, rents can only go up by the maximum
allowable amount each year until unit turnover. Due to
the COVID-19 pandemic, rent increases were frozen
for 2020 and 2021, and only beginning in 2022, were
increases permitted, up to 1.5% per year. Rental
providers have very little ability to control most of these
expenses and cannot consume less of these operating
services. Building management will still be required -
even if salaries rise - insurance and utilities must be paid
and routine maintenance completed.
If operating costs continue to rise much faster than
rents it will make it more difficult to operate rental
housing, and this pressure is part of the decision as
to whether rental builders and lenders go forward
with a new project. If the expenses are increasing
more than the rental rates, the value of the completed
building over time may be insufficient to support the
construction cost and financing.
No Vacancy
What do rising costs mean? | 7
Cap Rate Sensitivities
and Density
In addition to the rental pro forma analyses, a Cap
rate sensitivity analysis has been conducted for all
three scenarios. A Cap rate, or capitalization rate,
is the rate of return that is expected to be generated
on a real estate investment property. It is a measure
of how long it will take a rental provider to recover
the up-front investment in a new property, and is
also used to estimate risk. This is determined by
dividing a property’s net operating income (NOI)
by the market value. The Cap rate analysis outlines
the project’s sensitivity to changes in the market –
both in value and operating costs. Cap rates move
in the same direction as interest rates, and with the
expected increases to interest rates in 2022, there
is more relative risk for rental developments. Rents
are also affected by interest and Cap rate changes;
however they are also heavily impacted by other factors
like supply and demand. The chronic lack of new
rental supply and persistent demand in Vancouver are
contributing factors to the rising rents shown below.
Interest Rate: Bank of Canada Overnight Rate, Bank of Canada
Cap Rate: Multi-Family Residential Cap Rate (High Rise Class A, CBRE Cap Rate & Investment Insights Reports
CMHC Average Rent: City of Vancouver City-Wide Average Rent (all unit types and year built, CMHC Rental Market Reports
2021
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
$1,800
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
$0
PERCENTAGE %
MONTHLY RENT
INTEREST RATE CAP RATE CMHC AVERAGE RENT
Interest, Cap & Rent (2005-2021)
In Scenario 2, a Cap rate increase of 0.25% would
require an additional 1.0 Floor Space Ratio (FSR) to
make the same project viable at a rental rate of $3.75
per square foot. In this scenario, the additional density
is sufficient to accommodate the increased risk, and
rent/per square foot (SF) remains the same. Lower
density projects similar to the examples in Scenario 2
would most effectively be able to incorporate additional
density to offset higher Cap rates. Alternatively, if the
additional density is not permitted, a rent increase of
6.7% would maintain the same viability in this scenario.
In Scenario 1, due to the scale, the impact of
additional density does not materially improve the
feasibility of the project. Scenario 1 is highly sensitive
to Cap rate changes because it is already a high-density
development, and there is a limit to the amount of
density that can be added. Additional FSR is typically
accommodated by increasing the allowable height of
a building, but the scale of the increases required to
offset the Cap rate changes would quickly become
unrealistic to build in this scenario.
Other
Challenges
The risks associated with building rental housing
extend beyond taxes, fees and cost increases, as
municipal approvals also play a significant role in
determining the trajectory and viability of the project.
Recently, builders have seen the unpredictable
outcomes of proposed policies intended to promote
the development of rental housing. In some cases,
limited zoning to deliver housing in transit-oriented
In some cases, limited
zoning to deliver housing
in transit-oriented areas
and the often-protracted
process between
development proposals
and city approvals also
make it more difficult
to build rental homes.
No Vacancy
Other Challenges | 9
areas and the often-protracted process between
development proposals and city approvals also make
it more difficult to build rental homes. On top of this,
builders cannot always count on government funding
or subsidies to assist with creating affordable rental
when it is required by the municipality.
The uncertainty around approval timelines, senior
government funding programs, and rising costs
creates a risky environment for builders to invest
in new rental housing. Incorporating growth targets
into existing municipal policies would help mitigate
this risk by incentivizing local governments to approve
new rental housing when it is proposed, and work
with builders towards the housing delivery goals
through enabling policy that works.
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