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Purpose-built rental has been a hot trend, will it get hotter? The affordability issue we're experiencing in some of the major markets are caused by low supply versus increasingly high demand. Luckily, purpose rental has been thriving with new construction. In this episode, we’ll discuss purpose-built rental and why this asset type’s demand is only increasing and how its addressing some of the gaps in the market.
Welcome to Altus Insights Podcast Series. This podcast brings together some of our leading brainiacs at Altus Group to discuss, debate, and on occasion complain about the evolving state of Canada's residential and commercial real estate. Join Ray Wong, Marlon Bray, and Avi Zelver for monthly podcasts covering the latest market and construction cost trends across major markets in Canada.
Welcome to the insights podcast series with Ray and Marlon hosted by me, Avi. This podcast will cover monthly market updates and construction cost impacts across major markets in Canada. Purpose built rental has been a hot trend, will it get hotter? The affordability issue we're experiencing and some of the major markets are caused by low supply versus increasingly high demand. Luckily, purpose rental has been thriving with new construction. Let's dive in and discuss the asset type whose demand is only increasing. And addressing the gaps in the market. Ray, the first question will be for you seeing the 25% of condo purchasers are investors. And there's a shortage in rental and housing product sorry, purpose built rental add supply to the market while providing more options to tenants. We see that there are 200 active development applications with the city of Toronto, with 28 first submissions submitted since November. 2021 and 183 in Vancouver, with 32 first submissions submitted since December of 2021. How else does this project type fill in the gap. And satisfy growing housing needs? You know, it barely does anything because in Canada we have an acute shortage of housing in general. So especially when you look at it from affordability standpoint as well as from the purpose built rental. So some of those elements that you mentioned, Avi with the number of active developers, those 200 active developments. They only represent about 55,800 units. And that's only still a relatively small supply of the close about 400,000 apartment units in the GTA. So when you look at that component of it and you look at Vancouver, there's still a relatively shortage. And especially when you compare the overall vacancy rates across Canada, you can see there's an acute shortage of choices and what you mentioned about the residential condos at 25% I think in our previous discussions, that's more of a national number and the number is probably a little bit higher. And when you look at Toronto and Vancouver, and that's a positive news, adding from investor standpoint, increase number of units to the marketplace, but still relatively shortage. And when you look at from a demand perspective, all you have to look at and this is not any big secret, you look, just look at the demographics and the immigration, the immigration we're anticipating, plus 400,000 people annually over the next couple of years. And you know, if you look at the characteristics of people come to this country, they want to be close to urban areas, they want to be close to public transit because it's not likely or they may not have a car by then. And typically it takes anywhere from 1 to two years to save enough money to purchase their own place. So from a apartment standpoint, that that's going to see a lot more demand, especially when we've seen minimal immigration over the last couple of years with the pandemic. And we look at the retirement side and they have a lot more disposable income. So they're also expecting sort of a better quality of apartments now, granite countertops, a little bit more amenities. And again, they want to be close to public transit and restaurants and retail as well. So there's coming back to that influx of demand in the urban part of it and know that there's been a lot of discussion on the suburban side. But but you have to look at some of those characteristics when we move back more to normal and we the other generation that you look at the Gen Y itself and they want to be close to the activity and based on the affordability of housing right now, sometimes there's not the choice that you want to buy, but just can't afford homes right now. So we're probably going to see a lot more demand and we're seeing in the applications from purpose built rental from investors and institutions. And also you look at the amount of development land that's been sold over the last couple of years. So we're probably going to see a lot more activity in the residential side, but the challenge right now is still very supply constrained. Yeah yeah, I think. I mean, we're going to talk about affordability in the near future, but I think the supply demand constraint has been discussed a lot and purpose built rental fill in the gap. I think it differs depending where you are in the country and a lot of the personal rentals actually not driven by purpose built rental necessarily fill in the gap. I think it was a slew of institutional investment coming into market, looking at long term hauls and then to a degree, existing apartment owners sort of seeing that as an opportunity to release some untapped intensification or funds from their site. So I think we're going to see a little bit of a challenge going forward, albeit the higher numbers on the purpose built rental. And I have to say, ray, it's nice to see you back in the office for once rather than just the fireplace in the background. As I always like, you've basically gone from nice warm fireplace to the jail. So look, we like with the gray and the lines, the bars on the walls that we have with all this. Welcome to Toronto. Well, yeah, I miss the office and I miss I'm just tired of the basement, so this gives me a chance to move around. But when I was driving downtown this morning, I really understood that there's a new definition for TTC. I think it stands for in Toronto, at least take the car because the roads are packed again and you just see the number of people coming downtown. But I also think on the opposite side that we're still seeing a bit of a laggard in the way of public transit or people taking it. I look forward to coming back to the office. IRA, it's nice to see you there, although I loved the fireplace, it was a staple of the podcast. I guess we have a new staple now, but but it's good to see you back there. So the next question Marilyn will be for you. What's the difference when doing a perform on a purpose built rental versus a condo? Is it more complicated to do a perform on a purpose built on a purpose built rental? I think the different goals with a rental, you're looking at a long term hold. I'm not sure it's more complicated. It's an ultimate goal horizon that you're looking at. So rather than looking at an immediate return using the term immediate loosely in Toronto, we know the approvals are appalling. So basically eight years to get a return. I don't know about immediate, but and it varies a lot depending on location. It's not just the same rule in every location, it varies province by province and even varies from city, within city, within the provinces as well. If you've got purchase the land, if you already own the land, if it's intensification, if the financing is structured, et cetera, et cetera. It's just it's a real fun recipe on the rental side versus the condos a little bit more. I wouldn't say straightforward, but it's different. And rentals a long term look like looking at stabilization these days almost makes zero sense whatsoever. You're looking five, 10 years out instead. It's also a lot more sensitive on the pro forma. So right now, in terms of dealing with risks on the condo side is that 15 boats at 50 a square foot to the revenue, you still sell pretty much everywhere. I fixed the problem when you try to look on a rental thing, you're trying to look all of these risk assumptions over a long period of time. So you're looking at rent rates. You look at annual rent growth cap rates. It's not just the cost side of the equation and it's all over this huge long development horizon. And you also then have you got a lease up period. And you've got a hold period? So if you have a 1% shift in rental rates in terms of escalation down or the cap rates don't start staying aggressive, those assumptions can move really quickly. And again again, condo, you fixed the revenue upfront, rental you. It's not fixed until you've actually finished and you've made the capital investment. So your return is known once you spent the money versus before other factors. Often in the proforma, higher equity can be a requirement on the rental side of things. Again, it depends how you structure the finance, the NCMHCE premiums you can pay and there's different financing structures and you don't have deposits, which is cheap money to use. It's a bit of an odd structure. And then the other thing when you rent or you're actually model modeling the operating and holding period. So again, you're looking 10, 20 years out, not just the 5 to six development horizons, why we kind of like we do all our performers in August, state master, just because we love the ability to do those cash flows. And that sensitivity stuff that isn't the sales pitch, by the way. That's just the way we like to do the muscles and intensification works because the land's free for want of a better term. But even now, in the intensification plays in Toronto, we're starting to see the intensification play, go to entitlement and actually flip the land off to a condo go because it's hard to make rental work. And again on the platform, everyone gets really excited about the saving side and the pro forma. I don't need to pay brokers. I save on my marketing. All that money basically just flips into the HST that you pay STM team disposition on a rental building on a condo. The purchase is paying it in the sales price. So I think in Toronto, I'm seeing it a lot harder to make. Rental work is more complex. I think in Montreal right now, seeing a slew of projects, it's a little easier in terms of a cost environment. In Montreal, Ottawa, Calgary's flipped over into condos side Halifax, Edmonton's all the time rental. And then we see Vancouver sort of in between. So again, not really talk to how rental does change. And I think the larger challenge on the revenue side that was already seen in Toronto and to a degree in Vancouver is the top end of the rent versus the bottom end. So the Batman's got room to come up. The problem is, is the top end. Now there's big questions of whether or not we've hit the peak is $5. The peak can we rent for $6 per square foot in toronto? Where do we end up? And again, it's going be interesting to see how the moronic policy of inclusionary zoning starts to have an impact in Toronto on purpose built rental, and it hits the condo side first and then principal rent late. So I don't know if we'll see. A shift into rental in the economics are a little bit trickier or whether or not we'll start to just see, you know, tenants at Queen's Park where people are going to live because housing starts to slow down a little bit. Well, it's interesting, Marlon, with those comments, because what we've seen recently sort of during the pandemic when there is a, I wouldn't say a bit of a panic that we did see some urban or downtown multipurpose rentals move up about, you know, only about 50% to 75% basis points, depending on where you are, but still an increase. And you also saw more sort of inducements and some. Lower rents in with some, especially the ambassador is trying to fill up their space. But what we're seeing now based on some of the renewals because some of them were short term one to two years, there's a big spike up in rents or the asking rents. And I'm not sure there's probably relative to the overall housing prices, because now if you look at the average apartment price in Toronto's North of what, almost $1.2 million and it's about $12,000 a square foot. So are the rents based on the last couple of years? Is that are we going to probably going to see more increase in rents based on the increase in housing costs as well? And how does that sort of impact the performer numbers? If you sort of anticipate that increase in rent numbers is some of the projects? Well, and that's the big question you have right now is if you look if you forma rent right now and you perform over time, usually you're assuming, say, 2 and 1/2 3% per annum rental increase. How much of the condos they're going up seven, 10% a year. I mean, condo rates have almost more than doubled since 2017 in Toronto in particular, and we've seen those condo rates increase significantly in most of the major cities that are condo centric anyway. So I think you could argue the condo rates have significantly exceeded the rental rates. Also, the condo didn't take the same hit during the pandemic. We the downtown cores in cities took a big hit during the pandemic. Using Toronto as an example, a 9 or five Hand rental increases in the pandemic for got hammered, and that's kind of reversed now where the nine or five, I wouldn't say, is level. But compared to the fall in terms of recovery, it hasn't happened at the same pace and you can see that picture in different markets. So I think the argument tends to be that the revenue increase is seen there. And we are seeing in Toronto now where projects have started off as two towers. One's going to be rental ones can be market condo going all condo because again, it's the location now is that I can get $600 a square foot for a condo. Can I get $5 $0.50 a square foot for rent? Well, if it starts to get a little tricky as you get up to that top end of the market. Again So I think rental is going to stay strong. If you look, there is different percentages in each of the markets in what is a rental, but I think the economics are a challenge and revenue has to go up. The problem is where can it go? And then I mentioned earlier, we'll have to talk about affordability another day, but there's major challenges in the market, even though both products are proceeding. Great discussion, thank you, both, so. The next question, I guess, but toward ray, but marlin, if you could add to it as well, please feel free. So we discussed that two bedroom unit types have the highest demand, and markets like Hamilton only have a 4% vacancy rate for this unit type. And we also discussed that investors often target one bedrooms. What are we seeing when we look at the conversions and pipeline in the Western markets versus markets like Halifax and toronto? Are we seeing consistent demand and pipeline in some of those markets, or is there more in some than others? There's a couple of things there because there's been a lot of discussion over the last number of years with converting, especially with respect to Calgary and some of the older office buildings of converting those buildings over to purpose built rental. But the challenge with that and Marlon can get into the costs to make those conversions. It's a little bit more challenging the way of the building make up and what needs to be got it and changed. And so there's additional costs from that perspective and a couple of projects that we've seen, especially with calgary, it's a little bit more targeted toward affordable housing, where there's some subsidies provided by the government to you to make it a little bit more palatable for developers to convert some projects. But if you're looking at a little bit of government help and as well as to address some of the affordability issues, I think we're going to see some of that, especially with there's a lot more pressure on governments to provide more sort of affordable housing. But it's going to be a challenge with some of the conversions. And what we have seen, especially with the investment market the last few years, is purchases of just sites, even though there's an office building or some other or retail use. The intent of it is to knock it down in the next two or three years. And that's why there's a bit of a premium payment being paid on it. So despite the premium that's being paid on this property, such as it makes it more sort of from a financial standpoint, makes more sense to knock it down rather than convert some of these older projects. Yeah, I mean, on the cost side, conversions are really, really expensive. Generally, office is not designed to be turned into residential is inherent challenges on floor plates, floor to floor sizes, trying to accommodate mechanical system washrooms. If the towers of any age, we're running to late and deficiencies natural changes if we've got a reclaimed it half the time, a renovation retrofit will be the same cost as knock it down. New I think part of the challenge with knock it down. New is that then we have to put the employment use back in a lot of areas. And now we've put him back office in an area where it was questionable in the first place. I think there's going to be a real review over that saddle of things. Just because an office was there before doesn't mean it should necessarily be put back based on where we are today versus in the 1960s 1950s when this stuff was built. That's a whole different discussion on the fact that I think the Canadian municipality system half the time is stuck in the 1960s, but the other side on the rental side of things is, I mean, let's not kid ourselves. Renovations are not fun. They always go wrong, always. And there's always a nonsense, not complications. You're not to find many developers who spend $200 million on a retrofit and at the end call it a pleasant experience. It's not. It's long. I mean, the projects are always beautiful at the end, but the people don't get to see the developers that are at home at night curled up in a ball, crying himself to sleep each night, going, why the hell did I decide this was a good idea versus just knocking it down? So they're expensive in the challenging and we get them done. But it's not the easiest solution versus a nice Greenfield site and some of the challenges with these new projects and a couple of the conversions, it doesn't really add additional units to the marketplace. It replaces some of them. And what we're seeing on with some of the existing purposeful rental that have excess land or excess density capacity, they're bringing on new product and higher returns for the investors. But they're not they're not adding to the inventory and they're in certain extent creating less affordability based on repositioning some of these assets. So it'll be interesting to see with all this new development, as you mentioned Abbey earlier with the number of pi projects in the pipeline across Canada. Whether or not that's going to result in what percentage of net new without add to the rental stock across Canada. But yeah, now that's very interesting, and there's so much more to say about permissible parental, and I'm sure in the future will have another episode, but I'm just going to ask one more question, maybe two more, but I think we touched upon it briefly. But if you can expand Ray Howard calibrates looking for purpose built rentals, and which markets would you recommend to investors within canada? Well, I'm hoping Marlin backs me up on this. But with purpose built rentals compared to the existing stock of or to buy an existing asset is that, I think from a purpose built rental perspective that there are higher yields, higher potential returns rather than purchasing existing property that may have some challenges with some capital improvements that need to be put on the site. But what we've seen is very low cap rates and historically we've always seen low cap rates for apartments now. It's interesting. I know this probably is definitely a different topic, but it's interesting how industrial is getting close to the cap rates that we're seeing on the apartment side. But it's interesting with some of the transactions that we're seeing and we're used to seeing, you know, sub three, sub 2 and sometimes the value of risky sub 1 cap rates. But you know, with the transactions we saw in the last year, there's actually lower cap rates being paid for some of the older stock of apartment buildings. And you know that that's going to be redeveloped into either type of mixed use or a knockdown for New York product. So we're still seeing a premium being paid on those type of sites and with some of the newer stock that I'm not, we'll probably see more of a premium being paid for some of these projects. And you're seeing that cap rates are a little bit higher for some of the newer product. But the potential and the growth and the returns on redeveloping and adding value or increase the density of the site is a healthy return. So when you look at. I'm not really sure if you can go wrong with any of the major markets or even secondary markets across Canada and you know, for solid performance. But you can paying a higher price is your Vancouver, Toronto and Montreal, but you're also seeing increased demand and lower cap rates, and not to the same pace as Toronto, Vancouver in markets like Halifax and in Ottawa. I know that's a bit of a general question. It's a bit of a general answer, but we look at the overall shortage in housing. As we said. We said earlier in this podcast, it's not going away anytime soon. So as long as the numbers work out in the way of performance, I think we're going to see this asset continue to be successful. And as well as probably a growing demand, especially in some of the secondary, tertiary markets, as we see the hybrid work from home and providing people a little bit more flexibility to where they work and where they live. And I think the secondary, tertiary markets, they've had a bit of a rise over the past few years in general anyway. So I mean, if you look again, Ontario is an easy one example. Only around 40% of the new construction or starts and rentals actually in Toronto, most of it actually sits outside of Toronto in the rest of the province. Be that kitchener-waterloo, be that London, be that Ottawa. And I think you start to see that pattern emerging now where strong universities, teaching hospitals again, where we see the tech industry go in and stuff, you're starting to see that move now where there is more rent. I think outside of some of the major centers as well, it's not just in the major centres, whereas condos tend to focus on those very, very downtown locations and use the downtown loosely. I mean, like GTA versus moving out. But I think that's the sort of shift you see in the market. Rentals get a much more diverse market it can go to in terms of locations. And again, that bottom up has more room to grow up we've seen earlier. So I think in some of the secondary locations, there's still reasonable returns to be made, albeit I think everyone would like IRR and yield to be a lot higher than it is these days. But we're kind of in that market where there's more money than there is deals, so it's just still going to go ahead. And when you look at the activity last year in the greater golden horseshoe outside of Toronto, we saw $2 billion worth of apartments. So that's right behind industrial still and for the residential land component. But it's still very active. And it's a challenge finding product for investors. So definitely an expanding into the secondary market, as I mentioned earlier, with what's happening with Hamilton and southwestern Ontario and Mali and your comment about the tech side of it. It hits home with respect to southwestern Ontario. And that growth that we're seeing in that area. And as well as the increase in both New homes and existing home prices. So I think even though we're seeing increase in some of the interest rates that I don't think, I don't think it's going to slow down. I think the is just going to keep up, especially with what's happening with what employment growth. Yeah, we definitely do not have a demand problem across most of Canada is definitely a supply side issue. And I think that's the case in pretty much all locations or the vast majority of locations. Hence, unfortunately, revenue is going to go up. So that touches again back to the wonderful affordability discussion we'll have to have in the future. Who the hell can pay for this? No great discussion and very valuable insights, as always, thank you, ray and Marlon. Before we close off any final thoughts, anything keeping you up at night or anything else you want to mention. It closes this off quite nicely. So, marlon? No, I just stayed up all night last night because I made the mistake of having wine for lunch and then scotch before bed. So that was a terrible idea on a Monday, especially with it being one. But that aside, I think right now that my big concern is actually and I think I've touched on this before it, really, I'm starting to have concerns over affordability and where this can go, and especially this demand supply imbalance. And the more we look at, the more it's out of balance. And the challenge you have is I think the cost side of things are going to go absolutely crazy than even we previously had said. What was the last podcast a month for going on about costs? It's already done with the geopolitical challenges and the level of demand we have in the market. Construction costs, especially in the commodity side, are completely out of control. Stuff like nickel was actually stopped trading because it went up so much overnight. They have to stop trading. And that's kind of where we're at right now. So I think it's going to get worse before it gets better, unfortunately. So thank you for the final thought. Marlin and Ray for the inspirational office background. Great to see you there. We know that there are some serious geopolitical factors that are going to cause continued volatility that will provide new perspectives, perspectives weekly, if not daily, and there will be continued critical challenges with nickel and other construction costs. But most importantly, we're hoping for the safety of everyone out in Ukraine. And you know, we're hoping for this to come to a resolution very soon. Our thoughts are with everyone and we really hope for peace and some resolution. Thank you for listening and tune in to our next podcast, where we'll be discussing affordability challenges.