Federal plan to tackle the market housing shortage
(1) Attack the municipal approval bottleneck, (2) Reduce taxes and charges
For quite a while I’ve been puzzled about what the federal government was planning to do on market housing (as opposed to non-market housing). Last week’s announcements made things much clearer:
On Wednesday, Justin Trudeau and Sean Fraser announced the first Housing Accelerator Fund agreement with London.
On Thursday, Fraser sent an open letter to Calgary mayor Jyoti Gondek saying that any Housing Accelerator funding would require Calgary to approve its missing-middle plan.
Also on Thursday, Trudeau, Chrystia Freeland, and Fraser announced that GST on new rental housing will be removed.
Before the cabinet shuffle, it was basically Poilievre pointing out the obvious (the full pro-housing / YIMBY message): we don't have enough market housing, prices and rents are going through the roof, municipal gatekeepers are a big problem. The response from the Liberals was to point lamely to the 2017 National Housing Strategy, which put $15B in new money into non-market housing for lower-income households.
After the cabinet shuffle, it was obvious that Trudeau and the Liberals were going to do something on housing, pivoting to it and taking on Poilievre directly on his strongest issue, instead of evading - putting Sean Fraser on the file, getting briefed directly by Mike Moffatt and Tim Richter, Trudeau speaking in Hamilton. Their polling numbers went way down, breaking the long-standing Liberal/Conservative deadlock. My guess is this is basically the dynamic that David Shor describes: cross-pressured voters who agree with you on some things (e.g. climate) and disagree with you on others (e.g. housing) are not going to support you when the spotlight is on housing.
The Liberal playbook is now clear: steal Poilievre's ideas and outbid him. (Which, as a Liberal, I'm perfectly fine with.) Use a combination of persuasion, carrots, and sticks to push the municipalities to get out of the way. Put real money behind it, like removing the GST.
Poilievre released his plan yesterday. Mike Moffatt's assessment is that it's surprisingly weak: Poilievre's rhetoric is strong, but his plan is more "nibbling around the edges."
It's a bit strange because the way the Conservatives talk about the housing crisis is quite strong, but their policy prescriptions are incredibly weak tea.
Shannon Proudfoot described the Liberals as basically having two choices: saying that they've been working diligently on this file all along, or saying that they've gotten religion and now things will happen. It's obviously the latter!
Use the Housing Accelerator Fund to get municipalities to unlock housing: London
On Wednesday, Trudeau and Fraser announced the first Housing Accelerator Fund agreement with London, Ontario. This is for $74M, with London making regulatory changes which are expected to result in 2,000 additional homes just over the next three years.
With $74M of direct funding, the federal government could build perhaps 150 homes at $500,000 each. So opening up the approval bottleneck and getting 2,000 additional homes (more than 10X) over three years - maybe 6,000 homes (40X) over 10 years - is far more cost-effective.
Use the Housing Accelerator Fund: Calgary
Last week, Calgary city council was scheduled to decide whether to go ahead with the missing-middle plan previously recommended by a city task force. There was some ambivalence: in June, council had voted 8-7 to reject the recommendations, before (very unusually) reversing itself the next day. Previous post.
On Thursday, Calgary mayor Jyoti Gondek published an open letter from Sean Fraser, saying that unless Calgary city council approved its missing-middle plan, Calgary would not receive Housing Accelerator funding. Fraser’s wording is quite direct:
I understand that key elements of this housing action plan will either be approved or rejected at this week’s Council meeting. In light of this, I wish to inform you that Calgary’s Housing Accelerator Fund application will not be approved unless you follow through to create the new missing middle zoning designations of H-GO and R-CG, as you laid out in your application. Otherwise said, in order to receive a positive decision from me on your application - you must end exclusionary zoning in your city.
This is intergovernmental relations as diplomacy (“persuasion, compromise, pressure”), with Sean Fraser using the Housing Accelerator Fund as a negotiating element (“to receive a positive decision from me”), rather than a technocratic approval to be made by someone within CMHC.
Calgary did indeed approve the plan on Saturday, 12-3. A subsequent tweet from Sean Fraser:
Reduce taxes and charges: remove the GST on new rental housing
Last Thursday, Trudeau, Freeland, and Fraser announced that the federal government will remove GST from new rental housing. A project that builds new rental housing will no longer need to cut a large cheque for GST.
A Finance backgrounder provides the details: it applies to any new rental projects that begin construction between now and 2030, and that are completed before 2035. (Previously, a rental project would have to pay the 5% GST on the full market value on completion; a condo project would not, since the buyers would pay the GST. There was a rebate for 36% of the GST payment, but it didn’t apply to apartments with a market value above $450,000.)
How’s this going to help? Short answer: It’ll get hundreds of thousands more rentals built. People living in them won’t be competing with everyone else and driving up rents, so this will help to put downward pressure on rents.
To build a rental building, you need capital to pay for land, workers, and materials, so when capital is scarcer and interest rates are higher, it's more difficult. Governments can counteract these headwinds by:
reducing taxes and other charges on new housing, so that more projects will go ahead;
making approvals faster and more certain, since delays cost money.
This tax change only affects purpose-built rental buildings, not condos which are individually owned and rented out. Mike Moffatt’s back-of-the-envelope estimate is that this one change will result in roughly 200,000 to 300,000 more rental units being built between now and 2030; TD estimates about 230,000 more.
On the flip side, the estimated cost of this change (back in 2016) was about $125M per year. If the federal government were to put $125M into building housing directly, it could build perhaps 250 homes per year (at $500K each), or 2,500 over 10 years. So this is roughly 100X as cost-effective.
One reason that this one change makes such a big difference is that purpose-built rentals are a low-risk, low-return business.
Why purpose-built rental is a low-return business
There's basically two kinds of rental:
(1) Purpose-built rental buildings, owned by long-term institutional investors like pension funds and REITs. This is a low-risk, low-return kind of business: in Vancouver you're not going to have high vacancy rates, and conversely you know that your rental income is going to be pretty stable without a lot of upside (it's not like investing in a tech company like Google or Nvidia). Typically they'll finance the building with a mix of equity (putting in their own money) and debt (a long-term loan), because their interest payments are tax-deductible. The operating income (rental income minus operating expenses) has to cover the debt.
From a renter's point of view, the key advantage of renting in an institutionally-owned purpose-built rental is security: when you're renting a basement suite or a condo, the owner can always reclaim the space for personal use.
A couple examples explained by Redditors: Buying an old rental building. Building a new rental building.
(2) Individually owned rentals, like condos. This is a very different business. Typically the investor would put down a 20% down payment and borrow the rest. In Vancouver, I think it's actually difficult to get "positive cash flow": because investors expect prices to go up over time, they're willing to bid up prices so much that the rent doesn't cover their expenses. Their strategy is what Wall Street Bets would call "hodl": to hang on as long as possible, putting money in every month and watching prices go up, and then make money when they sell.
This is much more speculative and risky (especially compared to something like the Canadian Couch Potato). You're making a leveraged bet that prices will go up.
From the point of view of renters, renting a condo is much less secure, but my understanding is that it may be cheaper to rent a new condo than to rent in a new purpose-built rental building.
Besides individually owned rental properties like condos, there's also secondary suites, like basement suites, within an owner-occupied house. Here the logic is "mortgage helper": the income from the rental helps to cover the mortgage. So that provides an incentive for a buyer to purchase a larger house than they need themselves, and to plan to rent out part of it, at least until they've paid off their mortgage in 25 years or so.
Impact of the GST change
An example from Brent Sawchyn:
In an interview with STOREYS, Sawchyn, of PC Urban, uses one of his own projects to illustrate how much money we're really talking about.
The project is 1605 Gordon Drive in Kelowna, which is set to have 198 rental units and is expected to complete construction by Q3 2025. The value of the project is $103,043,195, meaning the 5% GST would amount to over $5M.
One thing I’ve learned from talking to non-profit developers is that the business case for non-market housing is very similar to the case for market housing. This change benefits non-market housing as well.
An example from Housing Now Toronto, describing the impact of removing both the federal and provincial shares of the HST:
Commentary:
“It will move the needle”: the industry reacts to feds’ removal of GST on new rentals. Howard Chai, Storeys. Plus a followup article: Important details emerge in feds' removal of GST on new rentals.
Builders call Ottawa’s tax break ‘major needle mover’ on construction of rental units. Same metaphor! Rachelle Younglai, Globe and Mail.
Video: How cutting the GST can help fix the housing crisis. Interview with Jennifer Keesmaat on CBC.
Why didn’t this happen before now? The RCFI as a substitute
According to Steve Pomeroy, the Liberal promise in 2015 to remove the GST on new rental housing ran into a lot of opposition from senior civil servants in the Finance department.
As a general principle, Finance officials believe that program outcomes should be pursued through targeted programs and a parliamentary appropriation process, not by revising (or as they might say, distorting, the tax code). Finance is reluctant to change tax rules unless there is a clear case of unfair treatment and unintended effects (and evidently low rental construction was not perceived as such).
The Rental Construction Finance Initiative, which provides low-cost, long-term loans to build rental housing, was introduced as an alternative. It’s been expanded from $2.5B initially to more than $25B now. The Senakw project is a high-profile example, but there’s been many small apartment buildings which have been financed by RCFI.
The RCFI interest rate is basically the rate at which the federal government can borrow money (the current benchmark 10-year bond yield is 3.69%), plus another 0.3 to 0.5%. The sharp rise in interest rates makes economic viability more difficult.
Because the RCFI is basically lending out money and then getting repaid with interest, it can be expanded without adding to the deficit. But a key weakness, compared to just removing the GST, is that it’s slow and somewhat complicated. You need to submit an application to CMHC, the application is scored based on various conditions, and it can take a long time (assuming you get a yes).
CMHC completes a prescreening (review for eligibility and completion) and prioritization of the strongest applications. Each application is either selected for underwriting, rejected, or kept on hold.
It can take up to 60 days following your submission to receive a conditional commitment letter if your application is selected for underwriting.Once selected, your application will be sent to CMLS (our external service provider) for underwriting.
Applications are subject to approval based on multiple factors that include but not limited to the underwriting assessment of the borrower, the property and the market.
Once all the required documentation has been provided to CMLS, it can take up to 265 days to complete the underwriting and for the applicant to receive a Letter of Intent.
These timelines are goals, but it can take much longer (like, 2X as long).
Two housing shortages: market and non-market housing
As Jenny Schuetz and Steve Lafleur describe it, there's really two housing crises. One is a shortage of non-market housing for lower-income households. The other is a shortage of market housing, which affects younger people all the way up the income scale.
Before Covid, the federal government was focused primarily on non-market housing, specifically via the $15B of funding in the 2017 National Housing Strategy. But now the big problem is the shortage of market housing. It’s like a Covid aftershock.
When Covid hit, suddenly we had a giant surge of people working from home, increasing total demand for residential space, and spreading it out over the country. (We can see this happening in other countries as well.)
Plus we suddenly had dining out, shopping, and travel come to a dead stop. This had two effects: people who could work from home had a lot more savings, and people who were out of work needed emergency funds (CERB and other programs).
Even during the pandemic, this was a giant boost to demand, aggravated by supply shortages (e.g. lockdowns in China, the war in Ukraine), resulting in an overheating economy. To cool down the economy, the Bank of Canada raised interest rates at a rapid clip.
Higher interest rates pushed down home prices, but they're still "sticky downward" - they only come down slowly. So in the meantime, higher interest rates have put home ownership out of reach for a lot of people, increasing rental demand.
Now we have both the Liberals and the Conservatives focused on the market housing shortage, and the need for municipal governments (“gatekeepers”) to allow more housing. As Jason Markusoff puts it:
Liberal housing minister demands end to NIMBY-friendly zoning rules in order for Calgary to get federal funding.
Poilievre has promised to do this exact same thing, so there's now cross-partisan consensus on cracking whip on municipal land-use policy to expedite housing.
Or as Timothy Huyer puts it, describing a clip of Trudeau making the London Housing Accelerator Fund announcement: “It isn’t easy to tell the difference between this tweet and a CPC one.”
Provincial sales tax
At the provincial level, Ontario and Newfoundland have already committed to waiving provincial sales tax on new rental housing. Grant Thornton:
The federal government has also called on all provinces to remove their provincial sales taxes (PST) in line with the federal relief. The Ontario and Newfoundland and Labrador governments have followed up with their intentions to remove the provincial portion of the HST on purpose-built rental housing. In addition, the British Columbia government committed to removing the PST from certain construction costs for purpose-built rentals.
Rachelle Younglai:
Ontario, the country’s most populated province, has already vowed to cut the provincial sales tax from new rental construction, which further reduces costs for builders.
Quebec and Nova Scotia have said they were reviewing the federal decision. British Columbia does not charge provincial sales tax on the sale of purpose-built rental buildings and Alberta does not have a provincial sales tax.
What happens next
At the federal level, it’s pretty clear: the federal government will negotiate more agreements with municipal governments to get out of the way and allow more housing, in exchange for infrastructure funding, using Poilievre-style sticks as well as carrots. Poilievre will criticize from the sidelines (which is his job, of course); perhaps the Liberals will steal more of his ideas.
With the Housing Accelerator Fund (say 100,000 additional homes) and the GST change (say 250,000 additional homes), we’re starting to see some substantial changes. But I would hope and expect that the federal government will go further, picking up more ideas from the National Housing Accord. CMHC’s 10-year target is 3.5 million additional homes, on top of the business-as-usual rate, so more policy changes will be needed.
I still expect the federal government to introduce some kind of reform to international student visas. As Alex Usher explains, just introducing a federal cap opens up all sorts of new problems - making it first-come / first-served would be bad, but having the federal government screen out either students or post-secondary institutions would also be bad. Maybe the federal government will negotiate a cap or quota with each province - perhaps just Ontario, BC, and Nova Scotia - and let the provinces make the decisions.
I expect the Eby government in BC to bring in its province-wide changes in the fall. It looks like the Ford government in Ontario still doesn’t have much appetite for the changes recommended by the Ontario housing task force.