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“Deal Killer”: Developers Grow Wary, Pause Projects, as Interest Rates Rise

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Developers of rental housing are sounding the alarm that rental projects are collapsing as interest rates rapidly rise. They’re asking for senior levels of government to step up financial support, like they did decades ago, when housing was considered a government responsibility.

They say that the combination of interest rates and inflated construction costs are making projects so risky that projects will not get built and rents will go even higher as landlords seek to recover costs.

They say that low interest government loans and other incentives are crucial to delivering housing in order to keep up with the record-setting immigration numbers and government promises of thousands of new housing units. But they say they need certainty around interest rates if loan programs are to prove useful. And that is just one move among many that needs to be made at this critical juncture — when housing costs are rising and a recession looms. Basically, government needs to do more — a lot more.

“Government funding is really the key, and further deepening that commitment. If any of these politicians are going to make good on the threat of delivering 100,000 units or whatever they are promising, we need a significant increase to government funding and a much more widely accessible set of financing programs,” says Mike Mackay, president of Strand, a Vancouver-based real estate finance, development, and investment company.

“I think we will see a good number of rental projects that don’t proceed on the basis of not just the increase in equity that’s required, and the lack of loan size that corresponds to that, but also because of the viability of a lot of these projects coming into question.”

Federal financing programs that offer low interest rates at favourable terms to developers are more crucial than ever, says Mackay.

“To put it in perspective, if we were going to a conventional bank, we would probably be in a position today where we would need to put 25 to 30% more equity into a deal than we did in January. That’s a deal-killer right there.”

For those with big enough portfolios, they can apply for one of several financing programs, such as the Rental Construction Financing Initiative (RCFi) or the new MLI Select, both of which are low-interest rate loan programs to incentivize rental construction. The RCFi has proven especially popular with developers the last few years because of the loan size and a possible 50-year amortization in exchange for the delivery of rental units with middle-income affordability. The Canada Mortgage and Housing Corporation oversees the program, which lasts until 2028, and has a budget of $25.75 billion for insured loans, without premium payments, based on a 10-year term at a fixed rate. The appeal of the program had been the low equity requirement. That changed with several Bank of Canada interest rate hikes, now at 3.75%, an initiative to aggressively address inflation.

Developer Zack Ross, president of Cape Group, says that while awaiting permits for his development, he’s being required to come up with three to four times more equity than originally planned because of the hikes. He’s put the project on hold as a result. Adding to the pressure are construction costs that until recently had been increasing at a rate of around 1.5 to 2% a month. He fears further hikes.

“For a project with a $50 million loan at seven to eight per cent, that’s three and a half million to $4 million a year at completion, in interest alone. That’s where they are going. How does that bode for affordability?” asks Ross.

“The rate increases further the dilemma of building these projects, and because they take so long to get approved, we are pushing off a problem that will get exponentially worse.

“We anticipated it. As soon as they started raising rates, you knew they would start going on a roll. That was the problem I had with it. I don’t mind them raising rates, use it as a tool. But the way it’s being done is not allowing anyone to make adjustments to their lives. Inflation is a lagging indicator, and it’s critical that we don’t overshoot interest rates and put us into an even deeper recession. We need to stabilize inflation, flatten the curve, and not cripple individual Canadians financially.”

Of course, the ones who will most feel the effects of increased mortgage payments and diminished borrowing power are the local residents who can no longer afford to purchase a home. Those people are staying in their rental units, putting pressure on a 1.2% vacancy rate, which means renters will also feel the pain. For landlords facing higher costs, government regulations restrict their ability to increase rents on existing tenants. However, when a tenant moves out, the unit rent can be increased, a trend underway in Metro Vancouver, where an average one-bedroom now rents for $2,500, according to Zumper. A year ago, that rent was $2,100.

Mackay said his company has nearly 500 rental apartments in its portfolio in Vancouver, in buildings located in Cedar Cottage, Fraser, Cambie Corridor and Kitsilano. In Strand’s new rental buildings completed since 2019, they’ve increased rents when a tenant has vacated. Units fill within two weeks of vacancy.

“We’ve seen increases ranging from 10 to 20% in some units, and that’s just based on what a comparable rental apartment would be renting for. We really don’t see a sign of there being a point where that is going to cease,” says Mackay. “There might be a tempering in the coming months into the next year, as perhaps there is more of a recessionary environment… But there is the supply crunch, and we’ve got people moving here for high-paying jobs. So I see an inflationary environment on the horizon from a rent standpoint.”

The only solution is government intervention, says Mackay. His company has benefitted from the CMHC’s new MLI Select, a mortgage loan insurance program for the construction or renovation of multi-unit projects, based on a point system for affordability and energy efficiency. Points determine amortization periods and loan-to-value ratios. Borrowers must have a minimum net worth of at least 25% of the loan amount they’re requesting. He said it’s more straightforward than the RCFi program.

For Strand, the program meant that additional equity was not required for their latest project at completion. That’s far better than the 25 to 30% they’d have needed with a conventional bank loan.

“It’s been critical to getting started on the development of rental housing for us,” he says. “We have a building in Coquitlam we broke ground on, and we wouldn’t be proceeding if not for the prospect of financing through MLI Select.

“But I think we are in a situation though, where we have a crisis of housing supply at all ends of the spectrum, and really what we need to do right now is figure out a way to unlock further funding. The private sector can do a lot of it, but if we don’t have additional funding from senior levels of government it’s not possible to be in the rental business today.”

Government could help by expediting the permitting process, being more upfront about community amenity contributions they require for a rezoning, and at the federal level, giving developers a break on GST, for example. Other incentives for owners of older apartment buildings could include tax breaks, grants or rebates for building improvements so that landlords don’t immediately look to rent increases. If older apartment stock is to become affordable housing, then new rental stock for higher incomes needs to get built. Otherwise, owners of old apartment buildings will redevelop because they are the only ones who aren’t dealing with exorbitant land costs.

“I am never going to be the one to say to someone, ‘you need to move out because I’m knocking this thing down to put up a newer building,’” says Mackay. “I personally don’t think that’s right. At the same time, we also need to more deeply incentivize the rehabilitation of existing housing stock.”

Government could also make an effort at de-stigmatizing trades jobs to encourage youth to go into the trades. Labour shortages have become a key issue as trades are aging out in the next decade, and the next generation isn’t stepping into those jobs.

“Any of these levers can be explored. We needed to do this yesterday,” says Mackay.

“There’s a holistic approach that’s necessary, and it needs to be better integrated across municipal, provincial, and federal government levels if we are going to even maintain the current situation.”

As well, he’d like to see fewer restrictions put on low-interest federal mortgages so that those who don’t have large portfolios could qualify.

“I think that if they wanted to really quickly inject a lot of new housing supply into the market, they would make it easier for rental providers to qualify for these mortgages.”

Ross said that if developers are shouldered with the responsibility of providing affordable housing, the cost just gets transferred to the consumer. In other words, they can only provide affordable housing by charging more for the other units in the building. Private and public interests need to collaborate on the housing file.

“We can spend billions of dollars on certain things, so why can’t we have money for housing?” he asks. “I think the feds and [provincial government] have to get involved. I don’t think there’s a way around that.”

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