Transition Zone

With vacancies exceptionally low and demand rising, cities like Toronto and Vancouver are having to adapt to a new wave of rental interest. What used to be a hotbed for the for-sale condo market has become an immense opportunity for investors seeking to cater to immigrants, young people and those still wary of buying a home.

“You’re looking today at about 30 percent of households looking to rent in the greater Toronto area, and we’ve seen pretty strong population growth, especially from immigration over the last decade,” says Jason Mercer, senior manager of market analysis at the Toronto Real Estate Board (TREB).

“As a result,” adds Mercer, “we’ve been seeing vacancy rates in and around the one percent range for the city of Toronto, and over the last year or so, we’ve been seeing the number of lease transactions outstripping growth in listings.”

Indeed, the most recent quarterly report from TREB shows listings for bachelor units in Toronto falling 9.8 percent over the past year, this while rents rose 4.6 percent. Additionally, overall average rents rose 5.7 percent between the third quarters of 2011 and 2012, with three-bedroom apartments posting the largest gains by far at 12.7 percent.

Mercer notes that one of the key factors underlying the tight market conditions is that Toronto, along with Vancouver and other metros, has not seen a lot of purpose-built construction over the past decade. This has led to many investors snatching up the city’s sizeable condo inventory and turning them around into high-end rentals, creating a climate of higher rents overall.

“If you look at investor-held condo rents and what the average rents are for one or two bedrooms versus the same for purpose-built rentals, there’s quite a gap—with obviously the condo rents being at the higher end,” says Mercer. “It is more of a niche sort of segment of the marketplace.”

Mercer, however, adds that such is “certainly the segment people would be pointed at if they’re looking for the higher-end finishes and amenities” close to the downtown core and employment opportunities.

Henry Morton, president of Campus Suites—which owns and operates a number of units in the Toronto MSA, has seen the same trends over the past couple of years and, even as there is a growing concern of an abundance of higher-end units in the metro, believes such apartments will always maintain their value.

“Rental rates and concessions both seemed to have firmed up over the last couple of quarters,” says Morton. “Some managers feel that if you can get generally higher rents, then occupancy should follow… which is a very good model. Others are more conservative and just like to always be full, a less appropriate measure in my mind.”

Additionally, Morton notes that growing enrollment in the metro’s major universities will likely create a new segment of renters—ones who will likely rent for the next eight to 10 years, both in and out of college—and that “the debate will be the economics of pushing rents and product to never-before-seen levels and whether markets can still sustain them.”

Campus Suites recently took advantage of Canada’s growing student population by initiating an RFP process for a sizeable student housing development at York University—one of the largest schools in the country. After being picked as the preferred proponent, the development company plans a bold, contemporary community with access to various area amenities.

“It is a project that can have up to 2,200 beds and will be transformative for the future of the school,” says Morton. “Combine this development with the Pam American games, the new Engineering school, the new subway [and] the growth of the business school and you have a once-in-a-lifetime opportunity up there to make something special.”

Over on the western side of the 3.8 million-square-mile country, the picture for multifamily is remarkably similar. Vancouver—the largest and most populous city west of Ontario—harbors an apartment market that mirrors many elements of Toronto’s. Specifically, the scarcity of purpose-built rentals has created an impetus for condo conversion—leading higher rents and exceptionally low vacancies.

“The vacancy rate for Vancouver hasn’t really changed too much over the last few quarters,” says Rob Greer, principal at the Vancouver office of Avison Young. “We probably have one of the lowest vacancy rates in Canada. In Vancouver specifically, we’re sort of hovering between 1 and 1 and a half percent vacancy, so it’s really, really tight.”

However, Greer notes one key shift that has taken place in the market over the last year or so. Vancouver’s local government recently began giving developers incentives to build a new wave of purpose-built rentals—the existing inventory of which dates back decades.

“This is the biggest story in our market, by far,” says Greer. “All of our purpose-built rental stock was built between let’s say 1968 and 1975. So we haven’t seen new purpose-built rental stock in our market in a long, long time, and we’re just finally starting to see it.”

Greer lists some of the key government incentives being a relaxation of parking restrictions and space allocated to such, debt guarantees to lenders, and low interest rates. And with such favorable conditions, he and other insiders believe the metro could become even more of a hotbed for investor activity in the years to come.

Currently, the traditional metrics used by investors to rate opportunities in multifamily do not necessarily apply in Vancouver, as a rather uniform purpose-built inventory makes it hard to classify properties as A, B or C assets. Location, Greer notes, is key.

“We really don’t have a lot of A rental buildings just because we haven’t had a lot of new construction in a long time,” says Greer. “So it doesn’t matter if it’s an A or a B building, or even a C building. If it’s in the right location—it’s always very expensive, and vacancy rates are always very, very low.”

Additionally, in terms of the kind of returns owners and investors might see in Vancouver, there isn’t really much of a distinction between older and newer properties.

“Cap rates for a building that was built in the ‘60s and late ’70s in an A location are still as low as 3 percent in our market, if you can believe it,” says Greer. “Well, you could also buy a brand new purpose-built rental building for in and around the same cap rate. There should be a bigger spread between a brand new building and an older building. The reality is there just isn’t because we’re just so starved for product here.”

Population growth and employment remains relatively steady in Vancouver and the western metros. While population growth in Vancouver has typically fallen between three to five percent over the last few years, Greer notes that much of this is due to an influx of new immigrants—many of them not able or willing to enter the metro’s single-family market.

“There’s only so many high-paying jobs for a new immigrant to come in and actually afford to buy a new home; that entry point is very expensive,” notes Greer. “On the flip side, that really helps our rental market. New immigrants tend to rent for many years before they even consider buying a place.”