Purpose-built rental housing is tapped to be a favoured investment asset for awhile yet. Industry analysts cite Canada’s demographic trends and seemingly chronic housing supply-demand imbalance as two fundamentals that should drive robust returns well into the future despite the complications of inflated construction costs and higher interest rates.
Speaking last week during an online overview of current commercial real estate dynamics, Peter Norman, chief economist with Altus Group, underscored the expanding market share that purpose-built supply could capture. Over the next five years, it’s projected that, Canada-wide, about 85,000 newly formed households will be taking up the search for accommodations every year — coming into a market where the national vacancy rate sat at 2 per cent in the fall of 2022 and is expected to slip lower.
“It’s for good reason that we’re seeing new supply coming on. It continues to be a market that provides some promise,” Norman said. “It continues to be a market that provides a return and it’s also one that shows that there is further demand for more growth.”
New household formation is actually ebbing from an earlier pace of nearly 100,000 new entrants annually while the millennial age cohort was absorbed into the rental market, but Norman argues there is still a lucrative void for purpose-built rental to fill. Now ascendant Gen Z renters are less numerous than their immediate predecessors, but growth is expected to exceed the levels of the 1990s and early 2000s. It’s also instructive to consider where new renter households are settling, as about one third took over tenancy of single-family homes over the past five years.
“That is actually the rental asset class which is exploding the fastest right now,” Norman reported. “It is below a lot of people’s radars. A lot of it is repurposing of what were previously owned homes, but it might be investors buying new homes. There are a variety of experiences in that segment.”
Across Canada, 68,000 new purpose-built rental housing starts last year demonstrated a dramatic uptick in development momentum, accounting for more than half of all multifamily starts. “That’s in stark contrast to even going back five or 10 years ago when the purpose-built sector was more like 20 or 30 per cent of a much smaller apartment supply pipeline,” Norman said.
However, recent new construction — averaging out to roughly 41,000 unit starts per year over the past five years — hasn’t translated into an equivalent gain in the rental universe because demolitions have occurred along with, or as a precursor to, new development. Norman pegs the net addition of new units at closer to 20,000 per year and characterized this as the sector renewing itself. In the process, it’s already re-tilting the balance with rental condominium supply.
“The investment-grade asset that provides a variety of amenities and modern features is a very dominant product in the market,” he maintained. “If it’s competing against 30-year-old buildings; if it’s competing against 25-year-old condo buildings that are owned by individual investors; if it’s competing against carve-outs in single-family homes, there’s a lot of room for that investment-grade market to continue to take a larger share.”
Based on conventional turnover patterns, millennials should be exiting the rental market. “They’re now all in prime homebuying years. Certainly, in the decade ahead, that will be the predominant influence that millennials will have,” Norman said.
Yet, there are some unprecedented impediments to the traditional generational trajectory. Recent research from CBRE Canada calculates that residents of the Greater Toronto Area need an annual income of nearly $240,000 to affordably purchase a single-detached home at the region’s current average price or earnings of $146,000 for a condominium. The threshold for required annual income is even steeper in Greater Vancouver at $340,000 for a single-detached home or $160,000 for a condo.
“An increasing number of Canadians are being priced out of home ownership and their only option is to rent it,” Paul Morassutti, chair of CBRE Canada, observed in a recent address in conjunction with the release of the firm’s 2023 Market Outlook report. “Because of this, rents have surged.”
There is broad consensus that more affordable ownership and rental housing is imperative to support and nurture a productive population that underpins a strong and innovative economy. In turn, there is general acknowledgement that it will take some time to resolve a supply-demand imbalance that developed over decades. For investors looking for long-term sustainable returns, there is limited opportunity to acquire existing multifamily assets, but also assurance for prospective developers that there won’t be a glut of product any time soon.
“Demand is not down. It’s the lack of supply in the marketplace that’s affecting apartment transaction activity,” Raymond Wong, vice president of Altus Group’s data solutions and research division, advised during his firm’s online presentation.
“It is certainly encouraging that every level of government is finally responding and there are definitely good initiatives underway, but the chances of meeting the proposed target of 1.5 million new homes in Ontario over the next decade stands somewhere between slim and none. We have to do more and, yet, there are really no easy solutions,” Morassutti mused. “If you own apartment buildings, it means continued upward pressure on rents.”
Barbara Carss is editor-in-chief of Canadian Property Management.
