SAVING Changing the Economics of Rental 4/9/2012 Housing By - - PDF document

WORTH SAVING

4/9/2012

Changing the Economics of Rental Housing

By Jonathan X. Cote

2b

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Worth Saving

C H A N G I N G T H E E C O N O M I C S O F R E N T A L H O U S I N G

Executive Summary

This report examines the economics of rental housing and makes five recommendations to address the financial gap that is creating a barrier to the development of new purpose built rental units in Metro Vancouver. The report argues that rental housing is one of the most important sources of housing for low and moderate income earners in the region. Failure to address the financial gap between purpose built rental and market condo projects will result in demand for rental housing exceeding supply in Metro Vancouver. The social and economic consequences of this could be very detrimental to the region. To address these challenges, municipalities need to implement policies that will make the development of new purpose built rental projects financially feasible. The five recommendations in this report will only be effective if implemented as a whole.

• 1. Rental Land Banking: Municipalities need to implement policies that will limit non

rental development opportunities on sites that are currently occupied by purpose built rental units. Examples of these types of policies include rental land bank, replacement policies or rental zoning.

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• 2. Density Transfer Programs: This policy would allow owners of existing rental

properties to sell their unused density to neighbouring developments. Redevelopment pressures are significantly reduced if excess density entitlements do not exist on a rental property.

• 3. Eliminate minimum parking requirements: Minimum parking requirements should

be eliminated for rental projects that are within 800 meters of a frequent transit

• stop. By allowing the market to determine the appropriate amount of parking

for a site, the financial viability of a rental project would increase substantially.

• 4. Reduction of Development Fees and Levies: Fees and levies should be reduced

to minimum levels needed for municipalities to cover their development processing and essential servicing costs.

• 5. Density Bonus Program: Municipalities should create separate density bonus fee

structures for rental projects. Density bonuses should only occur in areas that have already been pre-planned for increased density.

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Introduction

Over the next 20 years the housing system in Metro Vancouver will face an increasingly daunting task of properly housing low to moderate income earners. At the heart of this problem is the current and future state of rental housing in the region. Metro Vancouver’s current rental stock provides housing for a significant proportion of low to moderate income earners. The rental stock is aging and very few new purpose built rental buildings are being built. The reasons for this are relatively straightforward; the development economics of rental housing do not work for creating new rental housing and cannot compete with market condo developments. Given the important role rental housing plays in the region’s housing system, this report will make several recommendations to alter the economics of rental housing. The majority of the recommendations in this report lie in the purview of municipal governments and illustrate that the economics of rental housing can be addressed at the local level. Each recommendation in this report on its own will likely do very little to improve the region’s pending housing challenges. It is important to recognize that the recommendations need to work together and will not achieve the intended results if adopted in isolation.

Current Situation

In Metro Vancouver there are approximately 100,000 purpose built rental units

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located in 3000 different buildings (Coriolis Consulting, 2011, p.5). These units are not evenly distributed across the region. The vast majority of purpose built rental units are located in Vancouver and account for about 52% of the region’s total (Coriolis Consulting, 2011, pg. 5). Other municipalities with a significant purpose built rental stock include Burnaby (11%), New Westminster (10%), City of North Vancouver (7%), Surrey (5%) and Coquitlam (3%) (Coriolis Consulting, 2011, p.5). It is worth noting that

• lder communities closer to the core of Metro Vancouver tend to have higher

numbers of purpose built rental units. This is important because these communities also generally have higher home

• wnership costs. In these municipalities home ownership is out of the reach of many

low and moderate income earners. The next important characteristic of the existing purpose built rental stock is that it is aging. In Vancouver, 52% of purpose built rental buildings were built between 1961 and 1970 and 80% of low rise rental buildings were

Metro Vancouver Purpose Built Rental Stock

Vancouver 52% Burnaby 11% New Westminster 10% City of North Van 7% Surrey 5% Coquitlam 3% All Other 12%

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31% of purpose built rental buildings surveyed were in poor condition

built before 1970 (Coriolis Consulting, 2009, p.11). In New Westminster, the median age

• f the rental stock is 47 years (Gray & McClanaghan, 2012, p.9). As the stock begins to

age, the building conditions have also started to deteriorate. Altus Group recently completed a random condition assessment of rental buildings in

• Vancouver. The study found that

31% of the buildings surveyed were in poor condition (McClanaghan, 2010, p.58). The report concluded that, “the level of investment observed is not likely to lead to an improvement in the rental stock” (McClanaghan, 2010, p.58). The final important characteristic of the rental market in Metro Vancouver is its low vacancy rate. The 10 year average vacancy rate in Metro Vancouver is 1.4%, which is well below rates that would be considered a healthy rental market (Metro Vancouver, 2011, p.1). This snapshot of the rental market in Metro Vancouver reveals that although the rental market may appear relatively stable it will continue to face ongoing and growing stresses in the coming years.

A Slow Death

Housing systems do not change quickly; rather they evolve slowly over time. Impacts from policy changes are often not realized until decades after

• implementation. The current challenges that are being faced with rental housing are

rooted in policy changes that occurred in the 1960’s and 1970’s. During that time federal tax changes in relation to capital gains were implemented that discouraged

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Growth in Residential Market in last decade: Ownership: +160,620 units Rental: - 2422 units

investment in rental properties. The result has been a, “disparity in tax treatment that has skewed the market to ownership to the detriment of rental sector” (McClanaghan, 2010, p.38). The introduction of condominium forms of ownership has also played a huge role in limiting the growth of the purpose built rental market. In essence, by allowing the stratification of condos, rental-only zoning was eliminated and rental housing came into direct competition with market condos. We are now beginning to see the results of these policy changes. Over the last decade, the ownership market in Metro Vancouver has grown by 160,620 units, while the rental market has seen a net loss of 2422 units (McClanagahan & Gray, 2012, p13). Given the current condition of purpose built rental buildings, this gap will likely accelerate since, “a large share of the wood frame rental properties have reached an age where they have a higher likelihood of being candidates for redevelopment” (Coriolis Consulting, 2011, p.11). Coriolis Consulting recently completed a risk analysis of rental buildings in six municipalities in Metro Vancouver and found that between 16-18% of purpose built rental building were currently at risk for redevelopment (Coriolis Consulting, 2011, p. 51). This number will only continue to grow as the existing stock ages and further pressure increases for redevelopment.

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Only 12% of renters can afford entry level condo

• wnership in

Vancouver

Why Rental Housing Matters

Protecting rental housing for the sake of saving a particular housing tenure is not a justification on its own to warrant government policy changes. To understand why rental housing is so important it is first necessary to examine who the rental market is

• serving. In Metro Vancouver, the average rental household annual income is about

$40,000 which is well below the regional average (Metro Vancouver, 2011, p.1). Approximately 80,000 renter households in Metro Vancouver are spending more than 30% of their gross incomes on rent and over 31,000 are paying more than 50% of their gross income (Metro Vancouver, 2011, p.1). Nationally, there is a huge wealth disparity between renters and homeowners. Homeowners have nearly twice the income of renters and 70 times the amount of total wealth accumulation (Hulchanski, 2004, p.3). The City of Vancouver’s rental strategy concluded that, “as the cost of ownership continues to increase, the private rental market will play an increasingly important role in the overall housing system, as renting becomes a permanent housing tenure for a significant number of households in Vancouver” (McClanaghan, 2010, p. 22). It needs to be acknowledged that home ownership for a variety of reasons will always remain out of the reach of many low and moderate income earners. Based on the average rental income, only 12.1% of renters can afford entry level condominium

• wnership in Vancouver (McClanaghan, 2010, p.21). Rental housing also provides a

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Average Monthly Rents in Vancouver

Average Monthly Rents in Vancouver

more flexible tenure of housing. Many low and moderate income earners work in

• ccupations that are not stable and can require relocation. This can make it difficult

for these individuals to acquire the financing needed for home ownership. Because rental housing plays such an important role in housing low and moderate income earners, it is important that municipalities in Metro Vancouver develop policies that ensure rental housing is not squeezed out by the market. Rental housing needs to be viewed as an asset that contributes to the social and economic diversity of the region.

Life Cycle Rental Rates

It is important to recognize that the affordability of a rental unit changes throughout the life cycle of a building. As a rental building ages it become more and more affordable. This is evident by looking at the average rental rates in Vancouver. For units that are under 10 years of age, the average rental rate is $1631, which does not meet the needs of many low and moderate income earners (McClanaghan, 2010, p.16). However buildings over 10 years of age consistently have rental rates that average around $1000 per month

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Financial gap between rental and strata is estimated to be $31,700 to $111,530 per unit

(McClanaghan, 2010, p.16). This would suggest that there is likely a 10 year lag in terms

• f affordability for purpose built rental units. Although a new purpose built rental unit

may not be overly affordable on day one, that same unit will become an important affordable housing asset, as long as that unit remains rental for its entire life cycle. It is critical that purpose built rental units are assessed on their life cycle rental rates instead

• f focusing solely on their initial rents. This is also the reason that rented condos do not

contribute significantly to the region’s affordable housing supply. The majority of strata condo buildings implement rental restriction bylaws that prevent owners from renting units after units have been sold for the first time (CitySpace Consulting, 2009, p.8). The result is that the majority of rented condos exist only in newer buildings and often charge rents much higher than purpose built rental units.

The Economics of Rental Housing

The underlying problem with rental housing in Metro Vancouver is that the economics to produce new rental housing simply don’t work under current market

• conditions. Market ownership

development far exceeds rental development because there is a significant financial gap between developing a rental project versus a new strata title housing project. The City of Vancouver in their Rental Housing Strategy

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determined that the financial gap between rental and strata title is estimated to be $31,700 to $111,530 per unit (McClanaghan, 2010, p.7). The strategy went on to say, “economic analysis of new purpose built rental housing supply indicates that significant new supply by the private market is unlikely without incentives” (Context Ltd, 2011, p.8). Further work has been done by Coriolis Consulting for the City of Vancouver which has determined that for wood frame buildings the financial gap needed to put rental on a level playing field would be $52 to $129 per square foot (Coriolis Consulting, 2009, p.19). These numbers clearly show why market ownership has far outpaced rental in the development of new housing in the region. Despite these findings, Coriolis Consulting did find that rental housing could become financially attractive if incentives were provided and land acquisition costs were minimized (Coriolis Consulting, 2009, p. 12). Given that the financial gap is not insurmountable, the question then becomes what policies can be implemented to help bridge the financial gap?

Rental Housing Land Bank

It is very clear that market rental housing cannot compete with market strata

• developments. Before analyzing incentives though, one first needs to ask; should these

housing tenures really be in competition in the first place? It is conceivable that two separate housing markets could co-exist; one for rental and the other for strata

• wnership. This could be achieved by implementing policies that would limit the

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Rental Replacement Bylaw in Vancouver has reduced properties at risk for redevelopment from 7% to 3%

development on land that is occupied by purpose built units. Examples of such policies could include a rental housing land bank, a rental replacement bylaw or rental zoning. Ideally such policies would be implemented regionally throughout Metro Vancouver, but it also could be done locally in individual municipalities. The City of Vancouver was the first municipality in the region to look at restricting development on purpose built rental sites. They implemented a rate of change bylaw in 1989 that attempted to stipulate the amount of rental that could be redeveloped each year. This bylaw was largely ineffective because it set the rate of change at a percentage that was well above market demand for redevelopment. This policy was revised in 2007 and the rate of change was set to zero in most areas changing it into a replacement policy. Under the new replacement policy all apartment developments over 5 units have to replace existing rental units on a one for

• ne basis. Coriolis Consulting concluded that this policy has been very effective in

protecting purpose built rental units from redevelopment. They estimate that this policy has reduced the percentage of rental buildings at risk for redevelopment from 7% to 3% in Vancouver (Coriolis Consulting, 2009, p.30). This policy essentially creates a rental land reserve and impairs the economics of redevelopment. Although this policy has not yet led to the development

• f a significant number of new purpose built rental units, it has reduced the pressure for

redevelopment into non-rental uses.

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The impacts of developing a rental replacement bylaw are twofold. First of all they provide an incentive to invest in the current rental stock. By reducing redevelopment pressures, property owners are more likely to protect their existing

• investments. Secondly, over time a rental replacement bylaw will create a separate

land market for properties that are included in the bylaw. As long as a municipality remains consistent with the policy, a separate land market should develop, that accounts for the development encumbrance that has been placed on the site. Conceivably this will adjust the land costs on these sites and make them more attractive to be redeveloped into rental sites once existing buildings have reached the end of their life cycle. Given that the issue of rental housing is a regional one, it would make sense to incorporate a rental land bank bylaw within Metro Vancouver’s Regional Growth

• Strategy. This would provide consistency across the region and ensure that access to

rental housing was provided in most cities in Metro Vancouver. Realistically though, the development of such a policy would likely take a long period of time to implement and involve many challenges in gaining the necessary political buy-in from participating municipalities. Although this should be pursued as a long term goal, the short term focus should be to encourage individual municipalities to develop rental replacement bylaws and incorporate these bylaws within their own Official Community Plans. It may be too late if municipalities wait for Metro Vancouver to address this issue fully.

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Unfortunately, municipalities do not all have the same legislative powers. The City of Vancouver operates under the Vancouver Charter and has greater abilities to limit demolitions and protect rental housing. Other municipalities in the region would not be able to exactly replicate Vancouver’s rental replacement bylaw. These municipalities would likely have to honour existing zoning entitlements regardless of housing tenure. Still, a rental replacement bylaw could be structured that enshrines that no development rezoning or variance would ever be considered unless the development adhered to a city’s rental replacement policy. These policies could be made a lot simpler if municipalities were given the ability to zone for rental housing; however, this would require the provincial government to make changes to the Local Government Act. The greatest opposition to such policy measures will likely be the affected property owners. Flexibility should be incorporated into the policy that provides property owners with a buy-out option to relieve their properties from development

• encumbrances. Rates set for the buy-out option should be closely tied to the financial

gap between rental and strata title developments. Funds collected through this process should be directed to an affordable housing fund, something many municipalities in the region already have in place. These funds could then be used strategically by a municipality to support an affordable housing project at another location. It is also important to recognize that the implementation of a rental replacement bylaw by itself will not be enough to alter development economics. Land costs would

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need to be reduced by approximately 75% to address the financial gap, something even the most stringent rental protection policies would likely not accomplish (City of Vancouver, 2012, p.11). Further incentives need to be implemented to see the development of new purpose built rental units. It cannot be considered fair to implement development encumbrances on a site unless municipalities are also prepared to address the outstanding financial gap that will continue to result in a barrier to the development of new purpose built rental units. It is critical that incentives apply to all properties including those currently occupied by rental buildings. This could be considered contentious as it may lead to the situation where older units are replaced by newer more expensive rental units. However, if the goal is to create a long term supply of rental housing, a rental replacement policy and incentives should work together to create a sustainable land base for rental properties into the future.

Density Transfer Program

Many purpose built rental buildings in Metro Vancouver are not developed to their full zoning capacity. Properties that have unused density are at a greater risk of redevelopment because their existing and current uses are not fully utilizing their zoning potential. Allowing rental properties to sell their unused density to developments at another location would allow rental property owners to realize the value of their unused density without redeveloping their sites into non rental housing. It is important that municipalities maintain their jurisdiction over land use planning

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through this process. This policy should include measures that ensure density transfers

• ccur within close proximity to the donor site and are appropriate to neighbourhood

and community plans. A density transfer program should be implemented in tandem with a rental replacement bylaw. If the rental replacement bylaw is considered the stick, this policy would be the carrot; it allows rental property owners the ability to realize the true value of their properties. This policy does have the potential to come into conflict with municipalities that have density bonus and heritage density transfer

• programs. If municipalities are able to value the importance of rental housing in the

same way they value a heritage building or a community park then such a conflict is not as significant.

Eliminating minimum parking requirements

One way to significantly reduce the cost of developing market rental housing is to eliminate minimum parking requirements for rental buildings. This is not to say that no parking should exist at rental buildings, but instead it puts the requirement on the market to develop the appropriate amount of parking for each development on a site by site basis. Building underground and on-site parking is very expensive and can represent 8% to 25% of the total construction cost of a development (Metro Vancouver, 2012, p.1). The cost to provide underground parking in Metro Vancouver usually ranges between $35,000 and $40,000 per stall (Coriolis Consulting, 2009, p.22). Metro Vancouver has recently completed a draft parking study; the study found that

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Metro Vancouver is

• versupplying parking

for multi-family units by 18% to 36%

the region is providing an oversupply of parking in multi-family units by 18% to 36% (Metro Vancouver, 2012, p.3). The study also found that the number of vehicles per household was 50% higher in strata multi- family units as compared to rental buildings (Metro Vancouver, 2012, p.3). This would suggest that parking requirements for developing new rental properties in the region far exceeds demand and is unnecessarily inhibiting the development of new market rental buildings. Coriolis Consulting found that if parking was fully eliminated from a development project, its costs would be reduced by $46 per square foot (Coriolis Consulting, 2009, p. 22). Given that the minimum financial gap between rental and strata is $52 per square foot, it is clear that parking represents a big opportunity to solve the economic disparity between rental and strata developments. The major reason the demand for parking is far less for rental buildings is that

• ccupants of these building are far more likely to utilize public transportation and are

less likely to own a vehicle. It is important that such a policy be linked to proximity and access to public transportation. The elimination of parking requirements for new rental housing projects should only be considered in areas that are within an 800 meter walking distance from a frequent transit stop. For the purpose of this recommendation, a frequent transit stop should be defined as a stop that provides transit service on at least 15 minutes headways for a minimum of 12 hours per day, 6

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days a week. Parking relaxations should be considered in areas outside this definition, but it would not be prudent to eliminate parking requirements on sites that are not close to frequent transit stops. Based on the results of Metro Vancouver’s recent parking study it would be reasonable to reduce parking requirement for rental building by 30% in location that have access to public transportation but are not located along the frequent transit network.

Reduce Development Fees and Levies

Another way municipalities can improve the economics of producing new rental housing is to reduce city development fees and levies. Most municipalities in Metro Vancouver charge a variety of fees and levies for new development projects. These fees are used to generate revenue for municipalities to pay for infrastructure

• ften linked to population growth. Coriolis Consulting found that these costs work out

to be about $13 to $15 per square foot for the development of a new housing project (Coriolis Consulting, 2009 p.23). Although it would not be advisable to eliminate these fees entirely, it would not be unreasonable to see a reduction in these charges for new purpose built rental developments. The portion of these fees needed to cover the processing costs of development should remain in place. Revenues that are directed to non-essential amenities could easily be reduced or eliminated for rental projects. A reduction in development fees can be justified if we are able to view rental housing as an amenity that contributes positively to a municipality’s housing system. If

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development fees were reduced by 50% this could save an estimated $7 per square foot on new rental projects. Examples of fees that could be amended include development cost charges, permit fees, development approval fees, and servicing

• costs. This incentive alone will not alter the economics of rental housing, but if

combined with other incentive it could tip the scale enough to see the development

• f new rental housing in the region.

Density Bonus Program

One way to provide incentives for the development of new rental buildings is to increase density for projects that include rental housing. This could be a very attractive tool and could have a significant impact on the economic viability of a new rental

• project. Vancouver’s Short Term Incentive for Rental Housing program found that

density bonuses were a key incentive and were utilized by over 75% of the applicants (City of Vancouver, 2012, p. 35). However, this policy could be viewed as superseding proper land use and neighbourhood planning. Appropriate density levels and neighbourhood form and character should be determined on their own merit. This type of a policy would work best in areas that are already pre-planned for increased

• density. A density bonus system could be developed that charges levies on market

condo projects, but leaves rental projects exempt from such levies. This would provide an opportunity to level the playing field between strata and rental without negatively correlating rental projects with unwanted density. It would also be important that this

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policy be developed in sync with the density transfer program discussed above. It would not be seen as equitable if a rental property was able to sell excess density only to receive it back for free during a separate transaction.

Getting Value for Incentives

The purpose of incentives is to provide a long term sustainable supply of affordable housing in the region. Given that older market rental housing contributes the most to affordability, it is important that municipalities ensure that incentives are tied to restrictions on condo conversions. The long term benefit for municipalities will

• nly be accrued if new rental developments are protected for the life of the building.

Incentive need to be linked to a requirement to sign a covenant that would be registered on title ensuring that the building will remain rental. Failure to implement covenants on sites will reduce the ability of municipalities to ensure that the incentive that they have provided will contribute to a long term supply of affordable housing.

Restoring Equity to Metro Vancouver’s Housing System

Unless policy changes are implemented to improve the economics of rental housing, the region’s purpose built rental supply will continue to decline. Given the important role rental housing plays in providing housing for low to moderate income

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earners, it is important that the region address this issue. The majority of government support in our housing system is currently designed to assist homeowners. Through tax subsidies and mortgage insurance, billions of dollars are directed each year to assist homeowners in Canada (Hulchanski, 2004, p.2). Renters on the other hand do not receive the same type of support. The recommendations laid out in this report attempt to bring some balance to these inequities and ensure that low and moderate income earners have a place in Metro Vancouver’s housing system. If the region is serious about addressing the issue of affordable housing then it needs to implement policies that will address the economics of rental housing.

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References

City of Vancouver. (2012). Results of Short Term Incentives for Rental (STIR) Program Presentation to Council. Vancouver, BC. CitySpace Consulting. (2009). Vancouver Condominium Rental Study. Vancouver, BC. Context Ltd. (2011). Vancouver’s Housing and Homelessness Strategy 2012-2021. Vancouver, BC. Coriolis Consulting Corp. (2009). Purpose Built Rental Housing Economics of New

• Supply. Vancouver BC.

Coriolis Consulting Corp. (2009). Purpose Built Rental Housing Inventory and Risk

• Analysis. Vancouver, BC.

Coriolis Consulting Corp. (2011). Metro Vancouver Purpose Built Rental Housing Inventory and Risk Analysis. Vancouver, BC. Gray, C & McClanaghan, D. (2012). Market Rental Assessment. New Westminster, BC. Hulchanski, D. (2007). Canada’s Dual Housing Policy Assisting Owners Neglecting

• Renters. University of Toronto. Toronto, On.

Hulchanski, D &Shapcott, M. (2004). Finding Room. CUCS Press. Toronto, ON. Kraus, D & Woodward, J & Eberle, M & Hurford, D. (2004) Strategies to Preserve the Existing Rental Housing Stock in Greater Vancouver. Vancouver, BC.

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McClaghan, D. (2010). City of Vancouver Rental Housing Strategy Research and Policy Development Synthesis Report. Vancouver, BC. Metro Vancouver. (2011). Q & A Talking Points for Rental Housing in Metro Vancouver. Vancouver, BC. Metro Vancouver. (2007). Metro Vancouver Affordable Housing Strategy. Vancouver, BC. Metro Vancouver. (2012). The Metro Vancouver Apartment Parking Study. Regional Planning Advisory Committee March 23, 2012. Burnaby, BC. Will Dunning Inc. (2009). Rental Housing Strategy – Study 1. Vancouver, BC.