Apartment Investment Seen As Solid With Plenty Of Growth

There are a number of factors driving the positive outlook for apartment investment in Canada. As an investment vehicle, multifamily commercial real estate has always had many plusses associated with it, and as a subset of this sector, apartment investment has happily benefitted from them.

But when the end of the COVID-19 pandemic was officially declared, a whole new set of variables melded together to bolster multifamily and apartment investor fortunes, including:

Inflation, Interest Hikes and Mortgage Rates Combining to Heighten Demand

Inflation – coupled with Bank of Canada interest rate hikes put in place to fight it – sent mortgage rates soaring. Already elevated housing prices combined with higher overall costs and increased mortgage rates to make renters more reluctant to transition to homeownership. Predictably, the national apartment rental turnover rate fell, declining from 15.5% in 2021 to 13.6% in 2022, according to the Canadian Mortgage and Housing Corporation’s (CHMC) most recent Rental Report. The lower turnover rate, in turn, pushed the national vacancy rate down from 3.1% to 1.9% – Canada’s lowest vacancy rate since 2001.

Even though Canada’s supply of purpose-built rental units increased by about 55,000 apartments between October 2021 and October 2022 (+2.6% and the strongest buildout since 2013), the increase in supply was no match for the increased demand that followed.

Rent growth reached a new high due to lower vacancy rates and an overall tighter rental market. Again, according to the CHMC, average rent growth for purpose-built 2-bedroom apartments common to the October 2021 and October 2022 surveys (known as same-sample rent growth) rose from 3% to 5.6% over the previous 12-month period, notching a new annual high well above the 1990-to-2022 average of 2.8%. Furthermore, when a purpose-built, 2-bedroom unit was turned over to a new tenant, the average rent increase was a staggering 18.3%, well above the 2.9% rent growth for units without turnover.

Because landlords are generally free to increase asking rents to current market levels once a tenant vacates a unit – or renovate and raise the unit quality and rent that way – even if interest rates abate and occupancy levels decrease, the possibility of increased rent from new tenants adds a silver lining to vacancies that would normally spell trouble for apartment investment. And because a lack of new apartment and housing supply in Canada will keep demand for apartments at high levels for at least the next several years, less marketing will be required to replace tenants as well.

Immigration Goals Boosting Demand

As part of the federal government’s plan to increase immigration, at least 1.5 million newcomers will arrive in Canada between 2023 and 2025. Because newcomers tend to look to the rental market to meet their housing needs, as immigration numbers increase, the demand for rental units increases in tandem.

While population growth in many countries stagnates, Canada is set to become the fastest-growing country in the G7. In fact, if Canada’s immigration were to continue on the same record-breaking trajectory as today, Canada’s population would double within the next 30 years.

The upside for apartment investment is that demand for purpose-built apartment rentals will remain strong for years to come.

Although not part of formal Canadian immigration goals, international students will also play a part in keeping demand for apartment rentals high, with their increased numbers creating new opportunities in the purpose-built student housing sector as well.

Government Incentivizing of New Rental Construction

And while a sky-high demand for rentals would be a welcomed gift for apartment investors, it would only exacerbate the already high tensions in communities across Canada faced with an ongoing lack of affordable housing.

As part of a plan of urgent action to drive down the cost of housing across the country – including for renters – Canada’s federal government recently introduced legislation to enhance the Goods and Services Tax (GST) Rental Rebate on new rental housing. The new law will incentivize the construction of more new purpose-built rentals, including apartment buildings, student housing, and senior residences explicitly built for long-term rental accommodation.

Projects designed to convert existing non-residential real estate, such as office buildings, into apartment complexes will be eligible for the Enhanced GST Rental Rebate if they meet all the conditions of the legislation.

The enhancement increases the GST Rental Rebate from 36% to 100% and removes the existing GST Rental Rebate phase-out thresholds for new rental housing projects. As a result, for a two-bedroom rental unit valued at $500,000, the enhanced GST Rental Rebate would deliver $25,000 in tax relief.

The federal government is also calling on provinces that currently apply provincial sales taxes or the provincial portion of the Harmonized Sales Tax (HST) to rental housing to match the federal government’s rebate as a way to supercharge new apartment rental construction.

The Enhanced GST Rental Rebate applies to projects that begin construction on or after September 14, 2023, and on or before December 31, 2030, and complete construction by December 31, 2035.

The Enhanced GST Rental Rebate will not apply to substantial renovations of existing residential complexes, as it’s intended to stimulate new supply, not remove it from the market.

According to a recent report from British Columbia’s Urban Development Institute, GST charges are one of the most significant barriers to delivering new rental housing, and the federal tax is the single largest tax or fee in a rental project development budget.

This latest effort pairs well with the federal government’s Housing Accelerator Fund, a $4-billion program introduced in the last federal budget, which earmarks funds for municipalities to support new housing creation. Incentives are meant to cut down on “red tape” and are tied to zoning changes that allow for more mixed and middle housing options to be built, including apartments and student housing.

So What’s the Net Net for Apartment Investments?

With increased demand and higher rent revenue being driven by a tighter rental market, immigration goals set to bring an influx of at least 1.5 million newcomers into Canada by 2025, and Canada’s federal government taking serious legislative steps to accelerate the construction of new apartment rentals – the prognosis for apartment investment in Canada is solid, with the potential for substantial growth.