How the recent housing policy changes affect
Toronto’s residential real estate market
Recent changes have been made to
In different countries around the world, regulation differs widely - from very relaxed to very strict - and there are some people who believe that moderate government regulation helps smooth out market shocks.
In this article, I would like to discuss three key government measures adopted in Toronto:
- tax on foreign buyers (15%);
- vacant homes tax (rate under discussion);
- rent increase cap (2.5% p.a.).
We will take a look at how these measures could influence the residential market, with the purpose of this article being to evaluate the effects of such measures, and not to give an overall forecast of market dynamics.
Tax on foreign buyers and vacant homes tax
A tax diverts at least some foreign buyers away from markets (or stimulates them to find ways in which to circumvent the measure), meaning a reduction in demand and a depression of prices. Some people argue that the measure is inefficient since the share of foreign buyers is not so significant. However, there is no clear statistics on this. I suppose that if a measure is affecting the market in right direction
This can be said for the vacant homes tax: it leads to some owners placing their properties on the rental market, increasing rental supply and making renting more affordable. The only question is the size of the impact such a measure provokes.
Rent increase cap
This measure is most the controversial. Not only may the reasons for introducing it include a political context (as voters obviously prefer lower rents), but
When trying to understand this
As stated above, the key argument some experts allude to regarding this measure is that it may in fact increase rental prices where developers abruptly cease pursuing rental projects. However, while in theory this statement is true, in practice there is not enough evidence to support the assertion that developers are ready to abandon many projects (and even if they do, it does not affect the market
We should note that a financial model with a stable rent roll increase that outpaces inflation is an optimistic one, however, a cap on rent increases is likely to lower
- if a decrease in demand from rental project developers leads to a change in the “best use” of the land - meaning there is more economic value in developing another asset class (from rental residential,
to the second-bestuse) - then indeed, the landowner will refuse to lower the price and will sell the land to the developers of the second best use (e.g. condo or commercial), with the residential developer abandoning the project;
- but, if even at a reduced price, residential properties set for the rental market still remain the most profitable use for such land, the landowner will have to “bite the bullet” and accept a lower price if they want to close the deal. As such, the landowner suffers, while
the developers’attitude to new projects remains unchanged.
Therefore, this measure may have a negative impact where it leads to a massive change in the best use for properties (i.e. from residential to another asset class). Given that there is no severe deficit of any other asset class (retail, office, industrial) in Toronto, and also due to the fact that changes are not always possible, a complete change of use for land is unlikely.
What is more likely, however, is that such developers may consider switching their rental residential projects to condos. Some people may argue that, as caps on rental increases force many developers to switch their projects from rental to condo, the supply of residential properties for rent lowers, thus increasing rental prices. However, even if this does take place, it is only over
- since the supply has increased, but demand has remained at the same level, condo prices go down, making developing them less profitable and so developers have less of a reason to switch the development from rental in the first place. As a result, the condo supply decreases and the supply of rental properties increases back to its initial level, meaning rental prices return to their initial level;
- even if we imagine that all of the additional supply of condos is met by increased private investor demand from those looking
to buy-to-letand the prices don’t godown, these condos will head for the rental market. Therefore, we will have an increase in the supply of rental properties (with only difference being that they are now owned by many individual owners, instead of a single property developer), so rental prices return to their initial level.
Some people may argue that previous rises in residential property prices made major redevelopment projects economically viable (e.g. the Toronto waterfront), whilst any decrease in prices may make them unviable. However, most of those projects began at least
Some are also of the opinion that capping rent increases at a level that may be lower than inflation makes investing in such projects unviable, and certain buyers (such as pension funds) only invest in properties where the rent will subsequently experience an increase in real terms. However, there are two prerequisites for making this investment unviable: an inability to increase the rent to cover capital expenditure or repairs and renovations; and an inability to increase rent when leasing to new tenants. Both conditions are not applicable
Regulation to control abnormal and excessive price increases
Denis Borisenko, Partner, Head of Capital Markets at Tranio.com