Purpose-built rental gains economic viability

Midtown Toronto luxury project balances development risks and returns
Friday, December 12, 2014
By Barbara Carss

A developer’s instincts for untapped demand underpin plans for new purpose-built rental housing in midtown Toronto. The proposed luxury building near the intersection of Yonge Street and Eglinton Avenue will retain elements of the circa-1936 post office building now on the site, and be positioned to capture a market segment that has been renting units in condominium towers.

“Purpose-built rental seems to be coming back,” Michael Tucci, director of acquisitions and development with the Rockport Group, told seminar attendees at the recent annual PM Expo in Toronto. “Condo stock is not being managed the same way as a rental building. When it’s managed by a professional company, it’s a different experience (for tenants) and they are going to pay for it.”

Tucci shared the insight as part of a broader discussion of the risks and returns of the development process, along with co-presenter, Kristy Shortall, project manager, planning and environmental design, with the consulting firm, MMM Group. In that bigger picture, he’s not among those who fear a glut of condo units in an unsustainable market.

“In 2011, the number of condo units that was sold was an all-time record. Records were shattered, and in 2012, the development community pulled back,” Tucci recounted. “We’re very, very, very prudent. It is very, very calculated, and it is done in accordance with good economic practice.”

From a financing perspective, the two types of residential tenure are markedly different. Condominium projects don’t get built until a major share of the units are sold, at which time condo lenders advance the rest of the funds. Purpose-built rental is more speculative and developers can’t count on any cash infusion from residents until the project is completed and occupied.

“We’ll construct the building, and then we start to lease it,” Tucci said. “It takes an incredible amount of equity.”

Other factors, particularly related to obtaining planning and environmental approvals, are similar regardless of tenure.

“Eleven times out of 10, the property needs to be rezoned. That’s how often it happens,” Tucci quipped. “It is almost never ready to go.”

With rezoning, comes a statutory requirement for public consultation — a reality that both Tucci and Shortall advise it’s best to embrace proactively. Local councillors can be allies or adversaries, and communication, or lack thereof, is often key to shaping that relationship.

“At Yonge and Eglinton, we had seven meetings with the community before we even made an application,” Tucci reported. “I think it’s important to get them (councillors) involved early. If you don’t, you’re in big, big trouble. Eventually, they become your champions because you have demonstrated to them that you have thought about the project, you have thought about the community.”

Local councillors are also the power brokers when it comes to so-called Section 37 benefits — thus named for the section of Ontario’s Planning Act that enables local governments to increase the allowable building height and/or density on a site in exchange for the developer’s contribution to the nebulously termed “community benefits”. This is something of an unknown for developers in their budgeting, as Shortall noted there are no established benchmarks or consistent measures for valuing Section 37 payouts, either within a single municipality or to compare between municipalities.

“There are some consultants right now who are tracking trends, but it’s still a guess and it depends on who the councillor is,” she observed.

“It really boils down to what the Councillor wants,” Tucci concurred.

Known costs are no less onerous. In Toronto, for example, development charges now equate to $17,293 per two-bedroom (or larger) unit and $11,903 per one-bedroom or bachelor unit, although developers meeting Tier 2 of the city’s Green Standard can qualify for rebates of up to $1,867 per one-bedroom and bachelor unit or a maximum of $2,737 for larger apartment units. Still higher fees outside the city’s borders hold little appeal for Tucci.

“We know there is development occurring in the 905, but I don’t know how those developers are making money,” he said. “The land would have to come down (in price) for that to work, and it’s just not there.”

Multi-residential towers are generally a good fit with overarching provincial planning goals for accommodating growth in existing urban areas, but developers can encounter environmental cleanup costs, particularly in former industrial areas or along the major commercial strips and nodes that many cities the Greater Toronto and Hamilton Area have now tagged for intensification.

“There is a history of gas stations and dry cleaners on all these streets,” Tucci said.

Meanwhile, the history of Rockport’s Yonge and Eglinton development site is more storied — having originally accommodated Montgomery’s Tavern, from which William Lyon Mackenzie instigated the 1837 Upper Canada rebellion. The neighbourhood’s current status matches the more affluent demographic the developer aims to attract to a high-end rental building, but he acknowledges that the building itself will have to have the features and amenities to live up to that promise.

“I know it is going to cost more to build it,” Tucci affirmed.

On the flipside, building with a purely rental title should translate into property tax savings. Toronto is one of the Ontario municipalities that has implemented the optional property tax class for newly constructed multi-residential rental and currently taxes qualifying buildings at the same rate as residential properties. (Older rental stock in Toronto continues to be taxed a more than three times the residential rate.) Presuming a lower assessed value for purpose-built rental, there is no economic advantage from a tax perspective in registering the building as a condominium.

“There is a significant tax saving on a purpose-built rental than if I put a condo on it,” Tucci said.

Barbara Carss is editor-in-chief of Canadian Property Management.