Saturday, January 21, 2012

Rock-bottom vacancy rates creates a lucrative market for condo investors

Looking to rent an apartment in Ottawa? Maybe you should move into a condo — a rental one, that is.

The continuing dearth of apartment building construction here combined with the rabbit-like proliferation of condos means a new kind of landlord has emerged: the individual investor who buys one, two or more condo units and rents them out. The idea is not so much to get rich on the rent — it sometimes barely covers the mortgage, tax and other expenses — but to use the rental income to cover those costs while acquiring a potentially valuable asset in the process.

Some say investor landlords could spell trouble for tenants, while others caution that becoming a landlord isn’t as easy as it appears. We’ll get to those issues in a minute.

Just 101 rental apartments, also known as purpose-built apartments, were started in Ottawa in 2011, according to Canada Mortgage and Housing Corp. That followed several years of minimal construction. At present there’s just one apartment building application before the City of Ottawa’s planning department.

Ottawa’s “last big year for (apartment) construction was 2002,” says Sandra PĂ©rez Torres, CMHC’s senior market analyst for Ottawa. “Even if builders started (planning) apartments now, we wouldn’t see anything for at least a couple of years.” She pins the paucity of construction on skyrocketing land and development costs.

In a city where one-third of residents were renters, according to the 2006 census, that means a vacancy rate of just 1.4 per cent as of October 2011, according to CMHC’s latest Rental Market Report. That rate is down from 1.6 per cent the previous year and means only five Canadian cities had a tighter vacancy rate than Ottawa.

Even so, average vacancy rates fell across 34 other Canadian cities as well last year, to 2.2 per cent in October compared to 2.6 per cent a year earlier.

In Ottawa, says the agency, increases in the cost of buying a home, modest job and income gains and continued inflow of new residents to the city have strengthened rental demand. It predicts vacancy rates will fall to 1.2 per cent in 2012, the tightest it’s been since 2001.

Little incentive
“It’s just too expensive to build (apartments),” says Terry Nichols, vice-president of finance at Urbandale Construction. Like others, he blames development and land costs. “You have to ask, ‘Where can I get the best return?’ ” The company has more than 1,500 rental units in Ottawa, though most are 30 to 40 years old — in keeping with the rest of the city’s aging apartment stock — and therefore subject to provincial rent control regulations that govern rentals including condos in buildings constructed or first occupied before Nov. 1, 1991. Controls, not popular with property owners, kept annual increases to an average of 1.89 per cent from 2004 to 2011, although this year that jumps to 3.1 per cent.

Nichols says Urbandale has looked into building more apartments and even has a couple of properties in mind, but can’t justify it at present.

Condo construction, while slowing down last year along with Ottawa’s overall decline in house building, has boomed relative to rental apartment construction and is playing an increasing role in filling the apartment shortfall.

Of the 1,473 apartment starts last year, 1,372 were condo units. Some area developers report that as much 30 to 40 per cent of condo buyers are investors, although CMHC says it’s closer to 19 per cent. CMHC, meanwhile, says the number of investor-owned condo units has surged to 5,000 from 3,400 in the past six years. That’s just under eight per cent of Ottawa’s total rental apartment units.

Investor Monique Lalonde and her husband, Paul, rent out several condo units in Ottawa. A full-time accountant, she says it’s not a “high cash-flow thing” and that they are more focused on the appreciating value of their units than on whether the rental income is hugely profitable. In partnership with a couple of other family members, for example, they are renting out a 563-square-foot unit in Ashcroft’s new 101 Richmond Road building in Westboro.

“We’re making maybe $50 or $75 a month right now. Even if we just break even, it’s OK because our equity has already increased by about $40,000,” says Lalonde.

Traditional landlords can’t operate like that, says Roger Greenberg, chief executive officer of Minto. The company is Ottawa’s largest residential landlord, with just under 10,000 units in its portfolio. It, too, is holding off on building more apartment blocks. “A purpose-built landlord can’t afford to not make a profit for years,” he says.

It’s a situation echoed or magnified in other major centres across the country, according to CMHC. In Vancouver, for example, more than half of renters live in “secondary” dwellings, including investor-owned condo units, townhomes and others, and a little over 25 per cent of condo units are rented out.
In Toronto, where the vacancy rate is the same as Ottawa’s, 22 per cent of condos are rented out.
Not that no new apartment units are going up.
Montreal-based Groupe Lepine has constructed more than 900 rental units in Ottawa since 1997. They include the swanky, just-opened Kanata Lakes Apartments. The 146-unit site includes a club house, indoor salt water swimming pool and fully equipped gym. It’s one of four buildings planned for the area, which will eventually house 740 rental units.
Patience pays
“It’s what we do,” says company president Francis Lepine when asked why he’s building apartments when others aren’t. Unlike the fast turnaround in the condo market, where deposits and down payments mean ready cash, in the apartment business “you have to be patient.”
Rents at Kanata Lakes start at $1,285 for a 650-square-foot unit including utilities except hydro. A two-bedroom unit goes for $2,200, about double the average price of a similar-sized unit elsewhere in Ottawa, according to CMHC.
Lepine explains that builders can’t afford to put up low-end apartment projects and expect to make a profit, saying government-based charges from taxes to development fees amount to 20 per cent of total construction costs.
That worries City of Ottawa planner Stan Wilder. “We need a lot more affordable units,” he says. “I’m worried all rental (properties) will be higher-end products.”

A recent City of Ottawa staff report says more than 10,000 households are on the waiting list for subsidized housing. The report also states that family stays in emergency shelters have increased to an average of 72 nights in 2010 from 46 in 2007.

Phoenix Homes, meanwhile, is also planning an apartment building in Chinatown, although the company is battling with the city on height restrictions. Known mostly as a land developer and builder of singles, townhomes and condos, the company is looking at apartments to diversify its portfolio with a product that yields continuing long-term cash flow as opposed to the faster, one-time profits of other construction projects, says vice-president Rahul Kochar.

Interestingly, Brian Card, president of the real estate research firm CRG Consulting, says existing rental properties, which are relatively inexpensive to buy compared to building new, are among the hottest acquisition items for both developers and pension fund managers. A tight rental market practically guarantees that the units won’t sit empty, even if some upgrading is required upon acquisition.

With all this happening, what’s the scoop on becoming a tenant in a condo unit as opposed to renting a purpose-built apartment?

Well, it won’t cost you a lot more for a condo, according to CMHC. In 2011, a two-bedroom condo in Ottawa rented for an average of $1,235, compared to an apartment at $1,086.

For the extra money, you’ll likely get a new condo unit with all the trimmings, including an open-concept design, up-to-the-minute kitchen and amenities like a fitness room and maybe a rooftop terrace with a barbecue. Many of Ottawa’s condos are being built in the popular downtown, Westboro and Little Italy areas with good access to public transit, restaurants, bike paths and more.

Older apartment units can have trouble competing with all that. In fact, CMHC even reports a decline in the rental of townhomes, semi-detached and singles in favour of condos.
Not a threat
Still, says Greenberg, condo rentals aren’t a threat to traditional landlords. “They’re needed in the marketplace as cities like Toronto and Ottawa grow. If landlords like Minto aren’t building, where are these people going to live?”

But he cautions that investor landlords need to remember that there are tenants from hell who will fall behind in their rent, damage the unit or pull a midnight skip.

Tenants, he says, should do their homework before renting a condo. How much experience does your landlord have with the rental world? Does he or she live in Ottawa, and how accessible is the landlord if you have problems?

“Sign a lease,” he urges. It’s for your mutual protection.

Paramount Properties, an Ottawa apartment rental company, suggests prospective tenants also inquire about condominium regulations and other matters before signing on (see paramountapts.com/articles/condo-vs-apt-ottawa.aspx).

And if you think the condo investor model is just a contemporary spin on the traditional small-holding landlord who knew you by your first name, Wilder cautions, “In the old days, the mum-and-pop landlord watched their little building like a hawk. An investor might leave the whole thing up to a property management company.”

Condo tenants, however, are protected like any other tenant under Ontario’s Residential Tenancies Act and in case of disputes have access to the Landlord and Tenant Board.

The above holds true whether the tenant has signed a lease or just has a verbal agreement with the landlord.

In addition, Ontario Ministry of Municipal Affairs and Housing representative May Nazar says in an email, “under the RTA, landlords who enter into verbal rental agreements with tenants are required to provide tenants with written notice of the landlord’s legal name and address within 21 days from the start of the tenancy.”

While condo landlords may have the best interests of their tenants at heart, a changing marketplace could have a negative impact on both parties.

Card says that condos make a “nice little investment” that should pay off in the long run, but that a likely slowdown in resale value this year means the skyrocketing growth in equity that owners have enjoyed to date will moderate. That could leave landlords who planned to sell at a fat profit and use the money to finance other commitments with less cash than they anticipated. That, or even a jump in interest rates, could force investors to sell properties, leaving tenants unexpectedly looking for new digs at the end of their lease or facing hefty rent increases if the building is not subject to rent control.

Industry insiders like Greater Ottawa Home Builders’ Association executive director John Herbert have also worried about the potential for overbuilding in the condo market and a resulting price correction. His concern was underscored by chief executives from the Royal Bank of Canada and the Bank of Montreal at a recent banking conference. Although their concerns focused on the Vancouver and Toronto markets, Ottawa’s love affair with condos could put us in a similar situation where condo landlords suddenly have a lot less cash — or credit — than they thought.

Large landlords can also get snared in financial sand traps, but they tend to have much deeper pockets and a more sophisticated knowledge of the rental business than small landlords.

No one has a crystal ball, of course, and the market could go up, down or sideways. But however it plays out in the long run, we should expect to see even more, not fewer, condos for rent in Ottawa in the coming years.
By Patrick LangstonJanuary 20, 2012 10:50 AM
© Copyright (c) The Ottawa Citizen

1 comment:

  1. This is a good common sense Blog. Very helpful to one who is just finding the resources about this part. It will certainly help educate me.

    ReplyDelete