Rent Control, Condo Collapse?

An interesting confluence of trends is affecting an almost forgotten segment of the Toronto real estate market. For the longest time, Toronto enjoyed a vibrant and robust “pure” rental market — entire neighbourhoods of apartment buildings purpose-built to be leased for residential uses. While there remain quite a number of these pure rental apartment buildings in the City, they are almost all “mature stock” — most of these apartment buildings were constructed in the Sixties and Seventies. There are very few such purpose-built apartment buildings being constructed today.

Morguard Corporation recently made news with the opening of its 600-unit pure rental apartment complex in the swanky Forest Hill Village neighbourhood in Toronto, but it was newsworthy particularly because it was the first purpose-built rental apartment building in that neighborhood in almost four decades!

Even if factoring-in the phenomenon of new apartment buildings being organized as condominiums for realty tax purposes (but with all of the condominium units owned by a single landlord who, for all intents and purposes, operates it as an apartment building), it seems as if few buildings are purpose-built just for residential rental purposes these days. Instead, it seems as if the province’s rental stock is gradually being replaced by rental condominium units (buildings that are purpose-built for condominium freehold ownership, but which happen to then be rented out by individual investors — the difference being that a condominium rental building will have a variety of different landlords, instead of one single landlord for the entire building).

There are probably a number of reasons for this trend away from traditional apartment buildings towards rental condominium units. A part of it has to be Ontario’s condominium legislation itself, which does not restrict the number of units in any given condominium building that may be rented out. While the legislation is certainly part of the explanation, it does not entirely explain the trend away from apartments towards condominiums. A part of this trend is attributable to the recent attractiveness of Canadian real estate as an investment asset class generally (especially for offshore investors), and how much easier and how much more liquid it is for investors to purchase individual condominium units (sometimes entire floors at a time), than it is for the same investor to buy, alone or in groups, whole apartment buildings.

Furthermore, almost all condominiums in the province are de facto exempt from rent control. Legally, condominiums are no different than rental apartments for the purposes of rent control, but the determinant is chronological (rental stock first introduced before 1991 being subject to rent control, and all rental stock thereafter being exempt from rent control). It just so happens that most of the apartment buildings in the province were built before 1991 and most of the condominium buildings in the province were built after 1991. This makes condominiums far more attractive to investors relative to rental buildings with statutorily capped revenues.

Finally, it is the renters themselves that are increasingly attracted to condominium buildings, whether it is because of their prime locations or because of the ever improving and ever more exotic amenities being built into modern condominium buildings (features that just don’t seem, for whatever reason, to be included in purpose-built apartment buildings).

Regardless of the causes, the irrefutable trend has been for condominiums to become the principal source of rental stock in the province (especially in and around Toronto). It is not clear when exactly this trend changed from a trickle to a torrent, but the trend is here to stay, with many of the condominium projects being constructed today at well over 50 per cent rental right from the start, with some condominium projects being as much as 80 per cent rental. Many developers have found new ways to capitalize on investor demand. For example, more and more developers are creating “rental pools” whereby all rental units in the project are managed by a single entity, usually an affiliate of the developer, for an annual fee. Such “rental pools” are also appealing to foreign investors, who may not have anyone else on the ground to manage their investment properties.

Somewhat lost in the hoopla of the ongoing municipal election race and the recent Provincial election are a couple of Toronto City Council decisions relating to the Residential Tenancies Act that might take a serious bite out of condominium rentals. In one such resolution adopted by Council in 2013, the City asked the province to cancel the exemption from rent control currently available for most condominiums. Since most of Ontario’s condominium buildings were built after 1991 (the effective date of rent control in this province), it means that, if implemented, almost all condominium rentals in the province will become subject to rent control, levelling the playing field between rental apartment buildings and rental condominium units.

In a similar 2014 motion, the City asked the Province to cancel the provisions in the Residential Tenancies Act that permit a residential landlord to recoup necessary capital expenditures from tenants through “Above the Guideline Rent Increases” and requiring, instead, that all landlords maintain a 10 per cent reserve (out of their own rent revenues) for future capital expenditures. Currently, even where a rental unit is subject to rent control, a landlord can, with approval, still charge rent up to 3 per cent above the statutorily permitted cap in order to gradually recoup the costs of needed capital improvements to the building.

According to Daryl Chong, president of the Greater Toronto Apartment Association, if these City of Toronto initiatives are actually acted-upon by the province, “…this would seriously hurt condo investors…” Chong further predicts that, if rental revenues are crimped by rent control and capital expenditures can no longer be recovered through Above the Guideline Rent Increases, condominium investment might feel the crunch, depressing demand and possibly even causing a sell-off of existing condominium investments. While it is fairly obvious to these authors why the condominium development industry and condominium investors would oppose these City initiatives, Chong explains that the issue goes much further, explaining that “…if [investors] divest their units, the entire market will lose value, so even condo owners that occupy their units will feel a huge devaluation of their home’s value…”

In one of the more ironic twists of fate, the City resolutions come at the same time that the Toronto City Council is contemplating almost doubling the development charges that it currently imposes on new building permits. The overwhelming share of the revenue from these development charges would have come from new condominium development in the City, the same condominium development industry that might crumble if changes to the Residential Tenancies Act requested by the City are actually acted upon by the Province.

Of course, municipalities pass resolutions all of the time asking the Province for a variety of statutory reforms. These municipal resolutions have no legal weight vis-a-vis the Province, and there is no suggestion that the City of Toronto is proposing a municipal level rent control regime of its own. That said, it is a well known expression that politics makes strange bedfellows, and with a municipal election coming in the fall, and a now majority government in the Province, it stands to reason that anything can happen when it comes to reform of the Residential Tenancies Act.

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