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CMI Housing Affordability Watch: Show Me the Money – Navigating Financing Challenges for Missing Middle Housing Projects

22 November 2023

CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis

In the late 1970s and 1980s, we saw a continuous decline in purpose-built rental units in Ontario and, to a lesser extent, across the country. However, rental units continued to enter the market in a different form – through the conversion of existing rental units into condominiums and the expansion of investor-owned condominiums. Various factors drove these trends, including alterations in the tax system, high inflation rates, and rent regulations.

For many years, rental housing was tenure-flexible because of the small number of units in a typical rental building. It wasn’t until the 1960s and 70’s that most new additions to the rental stock were large apartment buildings. In the 1980s, this trend reversed. Although some of this reversal stemmed from the conversion of apartments into condominiums, a significant factor was that developing rental properties became riskier and less profitable compared to condo development.

Typically, individuals are more sensitive to capital gains potential than corporations. In the realm of residential rental real estate, capital gains are well protected because properties can be readily sold in either the homeownership market or the rental market. As expected capital gains rise, investors become more willing to accept lower net rents. As a result, individuals become the primary suppliers of new rental properties that can easily transition between the rental and homeowner markets.

Historically, individuals have been able to participate in the single-family rental market because of the range of financing options available. Banks have consistently provided loans to individuals looking to purchase rental properties, and borrowers can also turn to private lenders for financing. Additionally,  mortgage insurers offer products designed specifically for investment properties. This diverse funding ecosystem plays a crucial role in supporting individual investors who buy and then place single family properties (ranging from 1-4 units) in the rental market.

Missing middle housing, which includes medium-density housing somewhere between single-family residential properties and high-rise condominiums, lacks a similar financing framework. Homeowners considering existing conversions (internal reconfigurations to accommodate multiple dwellings within an existing unit) expect to secure a mortgage or a secured line of credit. WithOSFI tightening the rules around HELOCs and qualifying rates above 7%, there is little incentive for eligible investors to engage in this type of activity.

For a new project with less than five units, investors could apply for a draw mortgage to fund the construction. Most construction loans are typically short term (1 year), have a maximum loan-to-value (LTV) of 75%, require a holdback on funds to comply with the Construction Lien Act, set limits on the number of draws allowed, and may charge fees. Borrowers must weigh their options among banks, credit unions, or specialized construction lenders, which charge higher rates but offer more flexible products. Despite being the biggest potential avenue for creating missing middle housing, there isn’t a specific program to support construction financing for this category.

More broadly, any program aiming to support the construction of missing middle housing must encompass a range of funding aspects: land purchase, site development, building construction, construction bridge loan, and the takeout loan once an occupancy permit is received. In the case of strata developments, condo inventory financing is required to supply additional capital post-construction to support the project’s cash flow until condo registration is received. To enable this type of development on a larger scale, the Canada Mortgage and Housing Corporation (CMHC) needs to develop a small investor-oriented version of the RCFI (Rental Construction Financing Initiative) program.

CMHC has established programs for rental projects with five or more units and requiring loans exceeding $1 million. These programs allow up to 95% loan-to-cost ratios, 50-year amortizations, and offer very attractive interest rates. However, they come with stringent eligibility criteria, notably requiring a demonstrated track record in effectively managing such projects. If borrowers lack experience in this specific type of development, they’re unlikely to qualify for the MLI Select (multi-unit mortgage loan insurance) program. CMHC needs to develop a comparable program aimed at small but sophisticated investors to support missing middle housing construction.


Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.

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