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Making the Economics of Affordable Housing Pencil Out

5 June 2024

For nearly twenty-five years, there has been a significant lack of new purpose-built rental construction. Instead, condos became the primary source of new rental stock. This divergence in construction activity is largely due to differences in how developers finance their projects and the difference in equity requirements between these types of construction. 

Unlike purpose-built rental apartments, condo projects are sold to individual owners, allowing the construction lender to be repaid with the revenue from these sales. A condo project typically requires only 15% equity, with 70% of the project covered by a construction loan, 10-13% coming from presales, and a portion from direct sales revenues to cover deferred costs. 

In contrast, apartment projects are much more equity-intensive due to the lack of presales and deferred costs, and because the construction loan is repaid differently. Since apartment projects are typically held as rental properties, the construction loan is repaid through a subsequent term loan. The maximum loan size is limited by debt service coverage ratios based on the cash flows available to service the loan. Higher rental fees can support a larger debt load. While the loan-to-project cost ratio can also be a limiting factor, it is rarely a lending constraint except for buildings with very high rental rates.

One of the biggest obstacles to apartment development is the builder’s capacity to carry debt for a given project. To make these projects feasible, costs need to be reduced. Recently, the Minister of Housing has debated with cities over development charges, highlighting that these levies disproportionately affect lower-rent projects. These charges make it more challenging to ensure affordable housing projects are financially viable. Additionally, community benefit fees, application fees, separate school board education charges, and parkland dedication fees further increase the economic barriers to building affordable housing. Moreover, the time required for application processing adds to the carrying costs of a project, as land loans need to be financed during this period.

CMHC’s Apartment Loan Construction Financing program improves the overall economics of apartment development by offering low equity requirements, allowing loan amortization for up to 50 years, and providing CMHC mortgage loan insurance at no cost to the borrower. Despite these benefits, it remains difficult to offer units with below-market rents.

Given that land typically accounts for 20-25% of project costs, the federal government has a significant lever to encourage affordable housing development. The Globe and Mail recently identified 613 parcels of ‘lazy land’ – underutilized federal land – in cities and towns across the country. This land could potentially accommodate around 288,000 housing units for nearly 750,000 Canadians. Additionally, The Globe’s analysis found 154 taller buildings near existing housing that could be considered for residential conversions or development in their large parking lots.

The federal government needs to prioritize properties in areas with the greatest affordability challenges and quickly allocate this land to affordable housing projects. While setting lease rates to keep these projects affordable is possible, the main challenge is speeding up the land transfer process. Taking nearly a decade to repurpose these properties is not feasible.


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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