Self Supply Tax and Rebate for residential rental construction

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We reach out to banks regularly to finance construction of rental building. Due to the high turnover as well as fast growth at the banks, there is a new analyst doing the grunt work financial and credit analysis of our construction proforma number. Whereas all other cost figures are pretty straight forward to understand, I have found analysts to be flummoxed by the self-supply HST number. Initially they reach out to their seniors in the banks who explain it to them as best as they could. Then the analysts reach out to me to confirm their understanding and I tell them that they have understood it wrong. So here I try to explain the concept of self-supply HST when it comes to construction of rental building.

What is Self Supply HST ?

From the Canada Revenue Agency website,

If a builder constructs or substantially renovates a residential complex that is:

  • a single-unit residential complex,
  • a residential condominium unit, or
  • a multiple-unit residential complex,

and subsequently supplies

  • the single-unit residential complex,
  • the residential condominium unit, or
  • a residential unit in the multiple-unit residential complex

by way of lease, licence or similar arrangement for use by an individual as a place of residence, the builder is deemed to have sold and repurchased (i.e., self-supplied) the residential complex at its fair market value generally

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when the unit is first rented. In the case of a multiple-unit residential complex, such as an apartment building, the builder is treated as having sold and repurchased the whole of the residential complex, i.e., the whole apartment building, at its fair market value generally when the first unit is first rented.

Why Self Supply HST ?

From the same website

The self-supply rules … apply only to “builders” and their purpose is to remove the potential tax advantage a builder would have in constructing or substantially renovating a residential complex and then offering the residential complex for rent or appropriating it for the builder’s personal use. A person who is not a builder who wanted to do the same would have to purchase the new or substantially renovated residential complex in a completed state from a builder and would have to pay GST/HST on the purchase. In the absence of the self-supply rules, the builder who constructs or substantially renovates a residential complex would generally experience a competitive advantage through tax savings on the non-taxable value that is added to the residential complex, such as the value of employed labour, financing costs and profit which would otherwise be realized through the sale price established by a builder who sells the residential complex.

Let’s take a simplified example

Say a builder constructs a residential rental complex at a cost of $100 Million and its market value is $200 Million. The builder would have paid $13 Million (at the rate of 13% comprising of 8% of Ontario provincial tax and 5% federal tax) as tax on the costs. Now if a REIT buys this from the builder, the REIT will have to pay $26 Million as tax.

From tax perspective, building a residential complex gives substantial tax advantages compared to buying a ready built residential complex. The purpose of self supply rules is to eliminate this tax advantage.

Note that the self-supply rules that apply to a supply of a residential complex are triggered only if the supply is by way of lease, licence or similar arrangement. The self-supply rules are not triggered if the supply of the residential complex is made under an agreement of purchase and sale.

In simple words, self supply tax is only triggered if the builder is renting out the newly constructed/renovated units.

When to Pay Self Supply HST ?

In the case of a newly constructed or substantially renovated multiple-unit residential complex or addition to a multiple-unit residential complex, the builder must generally self-assess GST/HST on the fair market value of the whole of the substantially completed multiple-unit residential complex or addition when possession of the first unit is given under a lease, licence or similar arrangement as a place of residence of an individual.

So in our proforma modeling, using the aforementioned example, $26 Million self supply tax is paid on the day building is completed and first unit is rented out.

What is the Fair Market Value ?

the fair market value represents the highest price, expressed in terms of money or money’s worth, obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm’s length, neither party being under any compulsion to transact.

So how does one estimate the fair market value of the building yet to be constructed in the proforma. One way is to ask an appraiser to provide us with a fair market value or the building “as completed” or “as stabilized” and use that to arrive at the HST value.

Alternatively, this is how I estimate the fair market value

  • In the rental proforma, calculate the stabilized NOI which is the annual NOI for Year 2.
  • Discount it by 2% rate (for inflation, turn over and rent increases during the year) to bring the NOI value one year.
  • Divide it by prevailing cap rate of 4.5% to arrive at the Fair Market Value.
  • HST is calculated by multiplying Fair Market Value by 13%.
  • The FMV is usually divide by Net Saleable Area (NSA) or Net Rentable Area (NRA) of residential units to arrive at FMV of each unit which is required to calculate NRRP rebate (as explained in following section).

New Residential Rental Property (NRRP) Rebate

At the same time, we also apply for the rebate under NRRP rebate program. One can consult with their tax advisor or visit the CRA website GST/HST new residential rental property rebate to find out more about how the rebate is calculated. To summarize,

Builders in Ontario are charged 13% HST on their self supply, which consists of a 5% federal tax and 8% provincial tax. The NRRP rebate in Ontario essentially kicks back 75% of the Ontario portion of the HST, which maxes out at unit value of $400,000. This results in a maximum rebate at a provincial level of $24,000 ($400,000 x 0.08 x 0.75) per unit. Federal rebate pays back 36% of the Federal portion of the rebate for units with a maximum rebate of $6,300. However, if the unit is valued at more than $450,000 no rebate is available. Based on the type of units constructed it can be substantial amount up to 50% of the self supply HST amount. For example, in our above example where $26 Million cheque was written to CRA, depending on the type of units build, the rebate could be as substantial as $11 Million. Thus the net HST to the builder would have been $15 Million ($26MM self supply – $11MM NRRP rebate).

As to timing of receiving the rebate, it varies. Builders usually apply for the rebate as soon as they file the payment. I generally model that the rebate is received at the end of lease up period. In reality, it could be later or earlier.

Proforma Modeling Consideration

From construction financing as well as cash flow perspective, it is imperative that the timing difference between payment of HST and receipt of rebate is understood. I have seen many a loan documents as well as proformas wherein the builder has modeled the net HST amount. This leads to a cash flow squeeze right around the time when the building is complete, all the credit limits are fully utilized because the bank approved a $15MM amount for the net HST amount whereas the builder ended up writing a cheque to $26MM to CRA and it will be some time before the rebate cheque is received from CRA.




Lender of last resort (BoC) vs Subprime Lender of last resort (BC)

British Columbia breathing new life into the American dream

The subtitle is alluding to For Canadian GTA and GVA residents, the American Dream is dead

It is 10pm in the night and just came back in the house after clearing the snow off the drive way. I should go straight to bed but the events of today have taken away my sleep. What a day!

In the morning, Bank of Canada releases the Financial System Review — December 2016. If you have been following the Canadian housing and debt metrics, there was nothing surprising in the report. The report highlight three vulnerabilities that BoC sees in the financial system

ƒ1- The elevated level of Canadian household indebtedness

ƒ 2- Imbalances in the Canadian housing market, and ƒ

3- Fragile fixed-income market liquidity.

We will focus on the first two aspect of the report which are inter-related.

Policy Steps

First, the report mentions the policies implement or steps taken to reduce the risks

Higher qualifying rate for debt-service calculations: Under mortgage insurance rules, a borrower’s ability to make payments must now be assessed using the greater of the contract interest rate or the benchmark posted rate for five-year fixed-rate mortgages. This requirement was already in place for high-ratio insured mortgages that have variable rates or fixed rates with terms less than five years. It now extends to all insured mortgages. For newly affected borrowers, this change currently represents an increase in the qualifying rate of about 2 percentage points. The higher qualifying rate acts as a type of through-the-cycle stress test to ensure that borrowers can still afford their mortgage payments even if interest rates are higher when they renew or if their household income is reduced. ƒ

Restrictions on the eligibility of low-ratio mortgages for mortgage insurance: The criteria for portfolio insurance and other discretionary mortgage insurance have been tightened to bring them in line with the rules for insurance on high-ratio mortgages. This type of insurance is used by lenders to reduce credit risk in a mortgage portfolio and to access funding through the National Housing Act Mortgage-Backed Securities or Canada Mortgage Bond programs. Under the new restrictions, insurance will no longer be available for mortgages with an amortization period longer than 25 years or those obtained in refinancing transactions.

ƒ Property transfer tax for foreign buyers (Vancouver): On 25 July, the BC government announced a 15 per cent transfer tax on residential properties in the Greater Vancouver Regional District for purchasers who are neither permanent residents nor citizens of Canada. The tax came into effect on 2 August. ƒ

Empty homes tax (Vancouver): The City of Vancouver has introduced a tax on empty homes, set at 1 per cent of a home’s appraised value each year, to take effect in 2017. ƒ

Housing affordability measures: Governments have announced new plans to make housing more affordable, especially for first-time buyers and lower-income households. Among these measures, the Government of Canada announced in Budget 2016 additional funding for affordable housing. It has also completed a consultation process on the National Housing Strategy. In Ontario, the provincial government announced an increase in the land transfer tax rebate for first-time buyers. As well, the BC government announced a $500 million investment in affordable housing.

Impact of these policies

Chart 4 shows the impact of the higher qualifying rate on borrowers if the measures had been in place during the 12 months ending in September 2016. All else being equal, about 31 per cent of high-ratio mortgages issued nationally during that period would not have qualified. The higher qualifying rate used in debt-service calculations will immediately improve the quality of new mortgages and gradually make the overall stock of debt more sustainable than it would have been without the changes. Table 2 shows the impact that the higher qualifying rate would have had in different cities. Across the country, housing expenses and payments on consumer debt would have caused a significant proportion of borrowers to exceed either the TDS or GDS qualifying criteria (top row). The new qualifying rate used in debt-service calculations would have had its largest effects in the cities where house prices are the highest relative to incomes, such as Vancouver, Toronto and Calgary. This result can best be seen by looking at the GDS criterion alone, which assesses affordability only against housing expenses (second row of Table 2). In cities such as Montréal, Ottawa–Gatineau and Halifax, where house prices are not as high, the consumer debt measured in the TDS criterion plays a relatively larger role.

Consumer debt is usually much smaller than a mortgage, but since it can have considerably shorter amortization periods or higher interest rates, it can still have an important effect on debt-service ratios. To qualify under the new rules, some of these borrowers could have chosen a less-expensive home, reduced non-mortgage debt or made a bigger down payment (possibly funded by a co-lending arrangement). To meet the new criteria through less mortgage borrowing alone, the average mortgage would need to be reduced by roughly 10 per cent. Almost all (95 per cent) of affected mortgages would have qualified with a 20 per cent reduction in borrowing.

Beyond the higher qualifying rates used in calculating debt-service ratios, the tightened rules for obtaining portfolio insurance and other low-ratio mortgage insurance will also affect the accumulation of household debt. For example, more than 40 per cent of recently issued portfolio-insured mortgages had amortization periods longer than 25 years, and a large portion involved refinancing transactions, neither of which are eligible under the new rules. Without access to mortgage insurance, refinancing and long amortization transactions have already become slightly more expensive or less available.

Borrowers affected by any of the new rules may seek out less-regulated, higher-cost lenders, such as mortgage investment corporations and private mortgage lenders. Since these lenders are not subject to OSFI regulations and, unlike mortgage finance companies, do not use mortgage insurance, they are not constrained by the new rules. Careful attention from authorities will be needed to monitor any increase in vulnerabilities resulting from greater use of alternative lending channels.

So in a space of three paragraphs, BoC has twice mentioned that borrowers will approach high cost unregulated lenders. Here it seems that BoC is pretending unregulated mortgage lending will be a new phenomenon but as I cited earlier in Liar Loans are common in Toronto residential real estate, unregulated mortgage sector as well as down right fraud is thriving in the real estate sector.

Vulnerability 1: Elevated Level of Canadian Household Indebtedness

Increasing household debt and strong house price growth have continued to reinforce each other, with the national ratio of debt to disposable income approaching 170 per cent

Among high-ratio mortgages, the proportion of borrowers with a loan-to-income (LTI) ratio over 450 per cent rose through the third quarter of 2016.

This trend is partly fuelled by rising house prices, particularly in Toronto and Vancouver. For example, almost half of the high-ratio mortgages originated in Toronto in the third quarter of 2016 had LTI ratios exceeding 450 per cent, up from 41 per cent one year earlier.

This trend is partly fuelled by rising house prices, particularly in Toronto and Vancouver. For example, almost half of the high-ratio mortgages originated in Toronto in the third quarter of 2016 had LTI ratios exceeding 450 per cent, up from 41 per cent one year earlier. Moreover, high LTI mortgages are spreading throughout the Toronto area (Chart 3).


It seems Toronto followed by Vancouver is home to most indebted residents.

Since the above is by BoC, it makes the statement in a neutral manner. But if you want to be awoken from your slumber by sensational reporting, Bloomberg has you covered:

Canada’s Gravity-Defying Household Debt Swells to C$2 Trillion

“Household indebtedness continues to defy gravity and remains the Achilles heel of the Canadian economy,” said Charles St-Arnaud, senior economist at Nomura Securities International in London, who has worked in Canada’s finance department and central bank. “Continued increase in yields and job losses remain the biggest risks.

Vulnerability 2: Imbalances in the Canadian Housing Market

Strong fundamentals underpin housing markets in the Greater Vancouver Area (GVA) and Greater Toronto Area (GTA), but self-reinforcing price expectations may also be supporting price increases.

Though BoC doesn’t mention it as it becomes a political question, but rising house prices will start affecting Canadian society which I covered earlier in Can rising real estate prices lead to rise of alt-right in Canada?and Canadian dream is alive for the wealthy class.

BoC conclusion

But as CMHC hinted earlier Worry about Canadian real estate but don’t lose sleep over it, BoC also summarizes the report that there is nothing to worry about

The overall level of risk to Canada’s financial system remains largely unchanged from six months ago, the Bank of Canada said today in the Financial System Review (FSR). The Bank continues to highlight two key vulnerabilities related to Canadian households: high levels of indebtedness and housing market imbalances. A third ongoing vulnerability is the potential for fragility in fixed-income market liquidity.

Nonetheless, the Canadian financial system remains resilient as the nation’s economy improves and financial reforms in Canada and worldwide progress.

So you see, there was nothing new here and I could have waited till the weekend to summarize the report.

WTF moment in Vancouver

But in the afternoon, well it was afternoon here in Toronto, Premier of British Columbia makes a housing policy announcement that left everyone (except for developers and brokers) befuddled.

Premier Christy Clark announced Thursday that a new provincially backed loan program would match the amount a first-time buyer has saved for a down payment — up to $37,500, or five per cent of the home’s purchase price.

Clark painted the move as an attempt to help middle-class British Columbians overcome the hurdle of saving for expensive down payments. Not everyone has a parent they can borrow money from to get into the housing market, and some need government’s help, she said.

Thankfully no one, except for realtors, was fooled by this step. Rather most were aghast as it just adds to fuel to the crisis. If people cannot afford to buy a house at current low mortgage rates, giving them interest free loans for five years is akin to offering teaser rates to subprime borrowers before the 2008 crisis. In effect, BC government is acting as a subprime lender here.

First, some responses on social media that capture the WTFness of this:

Adding to the WTFness of it all, Christy Clark RTs own praise by none other than a mortgage lender.

Joshua Gottlieb, National Bureau of Economic Research faculty research fellow, UBC

“It’s a pretty bad idea. It is counter-productive and if you give people more purchasing power, they will be able to bid up the prices of the homes that they’re looking at, and that price increase will eat up any benefit from the subsidy. The same people who were going to compete for a home at $500,000 are still going to be competing for that same unit, but at a higher price. They’re just going to compete away the benefit. The only people who gain are existing homeowners or developers who benefit from these higher prices.

“This is not going to improve affordability anywhere in the market and if anything will make it worse, for sure in the lower end and possibly creeping up above that $750,000 [cut-off price]. Different parts of the government’s policies really don’t fit together. They claim to want to promote affordability but they want higher prices. Well, higher prices are the opposite of affordability, so it just doesn’t fit together at all.

“There is no way there was any serious analysis done on this. You can see that even from the press conference this morning which claimed that it won’t increase prices. Well, it’s not going to increase supply and it’s supposed to increase demand, so how is it not going to increase prices? There’s something missing in this analysis. There’s no way there was any serious economic analysis.

“It’s pretty rare that there are so many economists who agree on this. It’s just shockingly illogical.”

From Macleans:

B.C.’s free loans to homebuyers won’t buy much in Vancouver

Not everyone qualifies for this homebuyer subsidy, mind you — only people struggling to get by on household incomes of less than $150,000 a year can use it. And don’t go thinking you can buy a mansion, either: the maximum purchase price under Clark’s plan is $750,000.

Which, if you’re looking for a house and not a condo near downtown, leaves you with limited options.

How limited? Well, according to, there are only four houses available for under $750,000. They don’t come with land. And you’ll have to build two of them.

From Metro Vancouver

B.C.’s interest-free loan to homebuyers offers much risk, few rewards: economists

Pumping money into the demand side of Metro Vancouver’s already supply-constrained real estate market will push prices higher, especially for condos, said the economists.

The program could encourage more speculation in Vancouver’s market, which is already helping to drive prices far beyond the range that local incomes can support.

Somerville described a situation whereby a homebuyer gets the government loan, then sells the property at the five year mark — before the payments kick in.

“If I sell and the price has gone up by more than the loan payments from the provincial government, they’ve given me a great loan I don’t have to make payments on,” Somerville said.

People are already stretched from attempting to get into the market as prices rose at nosebleed levels throughout 2015 and 2016. Davidoff wondered “who’s left?”

“I think we’re probably scraping the bottom of the barrel in 2017,” he said.

As I said earlier, brokers are pretty happy


We all know that low interest rates are playing havoc with the housing market. By making cost of borrowing low it acts as a self reinforcing mechanism by allowing borrowers to take on ever increasing amount of debts to buy expensive houses which results in houses becoming more expensive. Now borrowers who couldn’t afford a house at such low interest rates will be able to get loan at zero interest rate for 5 years. After 5 years, the interest rate on the loan will not be the current market rate but the market rate prevalent at that time. What guarantee is there that the borrower will be able to pay market interest rates at that point? The assumption here is that income of the borrower would have increased in 5 years time enabling him to afford the mortgage at market rates. But I haven’t seen any hints at the horizon that incomes of Canadians are increasing. Rather as I quoted in Will Canadian workers go the way of horses?

From CIBC research report

Is the quality of employment in Canada in decline? We think so. By looking at the distribution of part-time vs. full-time jobs; self-employment vs. paid-employment; and the compensation of full-time paid employment jobs in more than 100 industry groups, we observe a slow but steady deterioration.

As illustrated in Chart 5, the declining share of young Canadians in the labour market can bias our direct measure upward. At the same time, the rising share of older Canadians that are less engaged in the labour market can bias the measure downward. Chart 9 overcomes that problem by focusing on the age group between 25 to 54. The story is the same: The share of lower-paying jobs has been on the rise.

Keeping all things the same, Christy Clark’s proposal is a recipe for disaster which will end badly for the province and probably the country.

Canadian dream is alive for the wealthy class

Canadians take on more debt but their indebtedness decreases

Q: How to find a day care that doesn’t cost as much as your mortgage?

A: Get a bigger mortgage

New stats were released by StatsCan today. Depending on you how you want to look at it but people have been finding both positive and negative aspects in it.

On absolute basis, household debt increased.

Total household credit market debt (consumer credit, and mortgage and non-mortgage loans) reached $2,004 billion at the end of the third quarter. Consumer credit was $590 billion, while mortgage debt stood at $1,312 billion. The share of mortgage liabilities to total credit market debt edged up from 65.1% in the second quarter to 65.5%.

Household credit market debt to adjusted disposable income (excluding pension entitlements) edged up from 166.4% in the second quarter to 166.9%. In other words, there was $1.67 in credit market debt for every dollar of disposable income.

Ratio of credit market debt to disposable income

The increase is mainly result of increase in mortgage liabilities. On the flip side, the value of the value of assets held be households has been increasing at a higher rate. As such, when comparing indebtedness to total assets, the ratio has actually gone down.

Household sector net worth at market value rose 2.5% in the third quarter to $10,133 billion. On a per capita basis, household net worth was $278,200. The leading contributor to the rising net worth was a 3.2% increase in financial assets as the value of investment fund shares, particularly mutual fund units, life insurance and pension assets, benefited from stronger domestic and foreign securities markets. Non-financial assets grew 1.2%, mainly real estate assets.

Leverage as measured by the ratio of household debt to assets edged down from 16.9% in the second quarter to 16.7%.

Household sector leverage indicator: Debt to total assets

So putting all of it together

Needless to mention, that aforementioned is an aggregate measure and would be hiding certain segments of Canadians who will be stressed out by high leverage but on overall level, it is business as usual if it is not worse.

So if you didn’t worry when earlier data came out and I wrote Worry about Canadian real estate but don’t lose sleep over it — CMHC then I don’t think there is anything to worry about here.

True in US Fed has increased rate but that increased rate is token 0.25% and BoC is not expected to follow suit. So Canada has a lot of buffer before we start worrying about increasing interest rates leading to a bursting of real estate bubble which I already discussed in Predicting Minsky moment for Canadian housing is moot exercise.

And Canadians are pretty judicious about paying their bills. So much so that US investors can’t have enough of Canadian debt

Credit-card debt of prudent Canadians finds eager U.S. buyers

What makes the debt attractive to U.S. investors is that Canadian consumers are more likely to pay off their bills in full every month than their American counterparts. In the third quarter, the average monthly payment rate for Canadians was 47 percent, versus 29 percent for Americans, according to Fitch Ratings. A similar payment gap has been in evidence for since 2012, even as the rates climbed in both nations from crisis lows.

To be sure, credit-card backed securities, being unsecured by collateral, are only worthwhile as long as the customers keep the checks coming, and even cautious Canadians have taken on historically high levels of debt, exceeding the country’s gross domestic product for the first time. Bank of Canada Governor Stephen Poloz has warned that high levels of debt could magnify any economic shocks, and Finance Minister Bill Morneau has introduced a number of mortgage rule changes designed to cool the nation’s red-hot housing market.

Yet even as Canadians take on bigger mortgages, there’s no evidence that it’s affecting their ability to pay down their credit-card bills. That creditworthiness will keep their debt in demand by American investors, and the U.S.’s lower borrowing costs will keep Canadian banks heading south to sell it.

But I want to discuss something else here: How the rising real estate prices will play havoc with Canada’s social fabric? I kind of hinted at it here Can rising real estate prices lead to rise of alt-right in Canada? but recently I came across a few articles that I thought are worth sharing.

Soaring House Prices Could Mean A New Kind Of Aristocracy: Economists

“The bar is being raised further and further,” he said in an interview. “At these prices [the housing market] is only open to people who have generational wealth.”

He says there is a risk that home prices will continue to rise until it’s not even possible for most people to save up for a down payment. If trends don’t change soon, that could be the case in Toronto and Vancouver. It now takes twice as much time to save up for a down payment in those cities, compared to their average since 2000.

“Parents will only be able to help if they themselves are wealthy homeowners, so you could have a landed wealth-owning class perpetuating through the generations. At that point being born into the right family matters a lot,” Rashbrooke said in an email to The Huffington Post Canada.

Soaring house prices have led to a “massive misallocation of resources,” Eaqub said. As more and more money is concentrated in the residential real estate market, it leaves less money flowing around for other kinds of investment.

In Canada in recent years, housing investment soared while business investment plunged off a cliff after oil prices fell…. mortgage lending went from being less than eight per cent of bank assets in the early 1970s, to more than 40 per cent today.

This is exactly what I pointed out in For Canadian GTA and GVA residents, the American Dream is dead.

Solution usually pitched by experts is to make renting attractive or at least remove stigma from renting. I grew up in a rented apartment so I don’t mind living in a rented space with my family. But Canadians have one of the highest home ownership rates in the world and hence look down upon renting. What we need is an decent quality rental product but land prices are so high, it only makes sense for builders to build high end rental products and we are back to square one.

Builders flock to high-end rental development

In the past two or three years, executives for Minto, the Ottawa-based apartment developer, have spotted an opening in a market that had seemed all but moribund for years, even decades.

Those opportunities, as it turns out, were hiding in plain view, in the form of the sprawling open spaces at the bases of some of Toronto’s 1960s-vintage apartment towers.

Martin Tovey, a Minto vice-president, points to an infill project in Don Mills that’s on the verge of securing council approval –200 stacked townhouses, to be situated on the largely unused grounds of a three-building apartment tower complex at York Mills and Leslie. Minto purchased the properties a few years ago.

The spacious, newly-built units — each over 1,100 sq.-ft — will come in two- and three-bedroom versions. They’re close to schools, parks, transit and shopping.

And this twist: they’re rentals that will lease for about $2,000 a month.

This gentrification of neighbourhood can also impact schooling as it is affecting in Washington, DC.

How exclusionary zoning limits poor families’ access to good schools

….wealthy neighborhoods around the US ban rentals, multifamily housing, and smaller homes through regulations like zoning. This excludes lower-income families by outlawing housing they could afford.

Because school attendance zones tend to follow neighborhood boundaries, exclusive neighborhoods have spawned increasingly economically segregated schools.

The average low-income student lives near a school that scores at the 42nd percentile on state exams, while the average middle-to-high-income student lives near a school scores almost 20 percentage points higher.

Part of the reason: housing costs are almost two-and-a-half times higher near high-scoring schools. Home values are $205,000 higher in the better-scoring areas, the typical home has 1.5 more rooms, and the share of rentals is 30 percentage points lower.

The Price of Australia’s Real Estate Boom

Australia is entering the third decade of a real estate boom that has altered the national psyche. Over the past 30 years, housing prices have risen 7.25 percent a year, leaving the country with some of the most expensive real estate in the world. In the third quarter of this year, real estate prices in major cities rose 11.2 percent on an annualized basis, dashing some experts’ predictions that they were starting to taper.

The rising property values of the last 30 years extinguished economic diversity in Balmain, which is now filled with Sydney’s elite: lawyers, doctors and bankers who built or bought spectacular houses with views over one of the world’s great harbors. The old power station may be converted into offices for Google.

Australia’s broad welfare system and high taxes ensure that those who don’t own homes have decent medical care and access to state-run schools and colleges. Few homeless people are visible on the streets. Following and predicting interest rates have become the national pastime.

Among the 48 percent of Australians who don’t own homes, women over 50 years old are the most vulnerable. When the researchers Susan Thompson and Peter Phibbs interviewed renters for a study a few years ago, they found the cost of property was contributing to malnutrition.

Elderly women, who are more likely to rent because lower wages meant they couldn’t save as much as men throughout their lives, were paying their landlords first and utilities second and buying food last. “They were eating slices of white bread with all they could find on the last few days before pension day,” Mr. Phibbs said to me this month. “That’s depressing in a rich society.”

For Canadian GTA and GVA residents, the American Dream is dead

It is Generation Squeeze alright

Expensive Detached Homes

The title is from the closing sentence of article Your Kids Will Never Own A Single-Detached Home by Ben Myers, SVP of Fortress Developments. I would have presumed that since he works for a condo developer, he wants to use the article to nudge you to buy a condo. However, despite its scare mongering title, it actually comes across as very insightful:

I consider myself lucky to have purchased a condominium apartment 10 years ago in Toronto, catching the upward price wave before it became a tsunami. Like many of my peers looking to start a family, I bought an entry-level condo townhouse after three years of small-space loft living.

On paper, my home has appreciated by $200,000 since I bought it seven years ago. I should be ecstatic, I should be jumping for joy at my financial windfall. However, strangely, I have not done any joyful jumping whatsoever; like many people in my situation I am stuck on the property ladder.

Despite the substantial increase in the value of my townhouse, single-detached homes in my neighbourhood have increased by $500,000 during the same period!

My kids want a back yard (and so does my dog), but I don’t want to double or triple my mortgage for a piece of grass and a couple extra feet between me and my neighbours.

Over leveraged Home owners

Below is from PWC’s Emerging Trend in Real Estate 2017 report #ETRE17

The prices are so out of reach for average household that despite making a hefty 25% down payment and a 25 year amortization, you still cannot afford to own a home at average price as most of your income will go towards making mortgage payments.

Ben is being conservative and cautious here as he is not doubling or tripling his mortgage. But are other GTA and GVA residents as conservative? Below is from DBRS report that I have reproduced in my earlier posts too

One indicator of the stress on home buyers from rising house prices is the high level and continued increases in the proportion of all insured mortgages that have loan-to-income ratios (LTIs) above 450%. The proportion of these high LTIs has been rising across all metro areas in Canada, particularly in the GTA and GVA (see Exhibit 3)

GTA and GVA residents are going deeper and deeper into debt to get on the property ladder to buy that coveted single family detached home.

Expensive Condos

So if you can’t buy a single family detached house, you can buy a condo in a high rise. But condos aren’t cheap either and getting more expensive by the day

According to President of Bild,

“The recent increase in high-rise prices can be attributed to the rise in average suite size, combined with a growing price per square foot,” Tuckey said. “This year we have seen the introduction of larger suites aimed at purchasers who have been priced out of the low-rise market.”

It is not only that condos are getting expensive to buy, occupying the newer construction with amenities such as gym, sauna, roof top terraces acts as a double whammy because of the recurring maintenance charges which may make sense for a young professional or a couple but for someone starting a family or becomes un-affordable. After buying a condo, paying up to $500 per month in maintenance changes is not my idea of affordable.

Questionable Marketing

Then there are condo builders trying to come up with creative solutions to get the people on property ladder. Though Ben disagrees with me on this but I find the following dangerous. If the person can’t even afford the 5% down payment of a condo, why get him enticed. When the time comes he may not even qualify for a mortgage or a slight change in interest rate may cause his to default on his payment.

New development in Victoria offers creative down payment structure

Tomaszewski wants to make home ownership possible for people who are finding it hard to reach that down payment threshold.

“I remember what it was like,” said Tomaszewski. “I had a good job and a family and I wanted to buy my first house, but there was no way I could get together a down payment for the longest time. I want to help people in that situation.”

His solution is a competitive pre-sale purchase incentive that will allow buyers to enter the market with no down payment.

Potential buyers will be able to secure a unit with no money down by making interest free monthly payments now which will add up to five per cent of the value of their selected unit. When the project is completed at about Christmas of 2018, buyers will be able to apply those funds to the purchase price and enter into a regular mortgage situation on their unit.

The report goes on to state that

It’s an opportunity that caught the attention of Jeremy Evans. He’s been looking for a place of his own for just over a year and, despite being employed and saving some money by presently living with his parents, the challenge of raising the lump sum down payment required for a home purchase has been daunting.

And finally

The four storey building will have a central courtyard, complete with its own orchard. Each unit will also be assigned a rooftop garden space where wildflowers, herbs or vegetables will be grown by virtue of a specialized water system for irrigation.

To complete the picture, Tomaszewski has included a rooftop sauna and an apiary to house bees to help pollinate the orchard and gardens.

You have got to be effing kidding me. The guy can’t afford the 5% down payment and he is going to be able to afford the maintenance expenses of a sauna, an apiary and specialized water system for irrigation.

But most of my rage is reserved for this one (which I have already shared in my earlier post) with thanks to @stephaniefusco on twitter

Scare mongering people into securing the kid’s real estate dreams? I can’t even afford a condo for myself much less think about buying a condo for my kid. I wonder who is going to pay the maintenance charges for that condo till my 7 year old grows old enough to realize this dream. I also wondered what “secret strategies” were revealed in that seminar presented by a condo builder, a mortgage advisor, a real estate lawyer and…. wait for it….. a pre-construction condo adviser (is that even a thing?)

Squeezing the Middle Class

OECD came out with its economic survey today stating that increased house prices in Canada are squeezing the middle class

Low interest rates have encouraged further increases in household credit, with household debt continuing to edge up from already high levels. Canadian house prices have risen sharply, especially in Vancouver and Toronto, and housing investment is unusually high as a share of GDP, posing vulnerabilities and squeezing middle-class families in these high-priced markets. In response to these developments, the authorities have deployed some targeted macro-prudential measures, but further regionally focused measures should be considered.

Politicians talking the talk, but not walking it

And though the politicians do talk about affordability, their interest really isn’t in it. Swayed by the likes of Richard Florida of the infamous Rise of Creative Class and their own self interest, their actions don’t walk their talk. As summarized in a Harvard paper

Law and policy at multiple levels of government play a sizable role in all matters of housing affordability. The tax code, for one, is fundamental to enabling and constraining housing initiatives. Most cities rely heavily, if not exclusively, on revenues from property taxes, but many do not have the power to set property tax rates. That power typically rests with the state. Local politicians seeking to increase revenue streams to fund social services have but one practical means at their disposal: Increase property values to drive up tax revenues (Goldsmith & Blakely 2010, Nelles 2013). As Frug & Barron (2008) have argued convincingly, under these legal constraints gentrification becomes necessary for local politicians of any persuasion. Social scientists often present gentrification as something that happens to this or that transitioning neighborhood and explain it by referencing economic and sociological dynamics. But a more expansive approach would analyze how tax policies incentivize, even force, local politicians to court gentrification on a much larger scale.

So far, have yet to see any tax policy etc from Canadian government that is effective or even goes some way towards bringing affordable housing to Canadians.

Not a real estate bubble

I won’t go as far as to call it a real estate bubble because I have seen people calling it a bubble for last 6 to 7 years and frankly speaking it can be very exhausting calling for the bubble to burst at every news item showing rising house prices or increased indebtedness. As the OECD chart above shows, that increase in indebtedness is tapering off. However, I do agree that it is a affordability crisis.

Stagnant Income

But there are two elements of affordability. One is the house price. Other is your income. Even if the house price is increasing, if income of Canadians is increasing at a higher rate, there is still a chance that one day it’ll become affordable. Unfortunately, there isn’t any positive news on that front either. CIBC released a research report today (I recommend reading the full report for the caveats, assumptions and methodology but below I summarize a few points)

Is the quality of employment in Canada in decline? We think so. By looking at the distribution of part-time vs. full-time jobs; self-employment vs. paid-employment; and the compensation of full-time paid employment jobs in more than 100 industry groups, we observe a slow but steady deterioration.

As illustrated in Chart 5, the declining share of young Canadians in the labour market can bias our direct measure upward. At the same time, the rising share of older Canadians that are less engaged in the labour market can bias the measure downward. Chart 9 overcomes that problem by focusing on the age group between 25 to 54. The story is the same: The share of lower-paying jobs has been on the rise.

Generation Squeeze

House prices are increasing and low wage paying jobs are on the increase. Hence, the current and the next generation in the words of OECD, is getting squeezed. I really like the term Generation Squeeze and this is how the advocacy group describes the situation

As younger Canadians finish school, begin careers, look for homes and start families, we are squeezed by stagnant incomes, high costs, less time and mounting debts (including a deteriorating environment) — even though our economy produces more wealth than ever before. While governments use this wealth to adapt policy for others, including our aging population, they continue down a path that leaves less and less for younger generations.


Yep. We are Generation Squeeze alright.

Investors are a godsend for prospective GTA condo residents

Speculators act as catalyst for increasing the supply of condos

Urbanation recently reported that in condo projects, domestic investors can make up 50% of the buyers of the end units. However, in certain projects, share of domestic investors can be as high as 90% of the project. This number caused quite a sensation in the press as well as on this blog as well. Many of us look down upon such rampant speculation, yet Finance 101 taught us that speculation serves an important function. It provides liquidity in the market, supports prices and greases the wheels of commerce.

Financial institutions require certain percentage of pre-sales to for extending construction financing to developers. This is where speculators (nee investors) come in. By acquiring these condos as investments they help the developer achieve the pre-sales milestone, get construction financing from financial institutions, break ground and complete the project.

It is because of these investors that large number of condo projects are under construction in GTA

Focusing on the high rise, above graph clearly shows that despite high active condominium projects, the high rise remaining inventory is at the lowest level when compared to the recent past. Moreover, in terms of vacancies, CMHC is reporting all time low of sub 2% as vacancy rate which means that there is just enough rental unit supply in the market as there is demand.


Speculation ensured availability of sufficient inventory for the families to rent. If the speculators weren’t there, GTA might actually be facing a shortage of housing and not just shortage of affordable housing. So pat on the backs to speculators for enabling Torontonians to have shelter over their head. And above numbers / graph back this argument.


Playing devil’s advocate, I come up with the following. Below is mainly based on hypothetical and anecdotal situations and should be treated as such.

  1. Despite low inventory of condos, the prices in resale market aren’t increasing as fast as investors would like. This is anecdotal. A few of the condo investors I talked to said that detached housing is a better investment as its price increases quickly enabling them to flip the property. This has not been the case in condos so most of the owners are forced to put the property on rent. Significant portion of that rental income goes toward paying the maintenance expenses.
  2. Media keeps telling us that Millenials like the “live, work, play” aspect of condos such as rooftop terraces, sauna and swimming pool in the building, and they also look very appealing in the condo brochures. However, when the Millenial’s family starts to grow with the arrival of kids, these amenities are used less and less. Yet the service charges keep on coming. Unlike gym membership which you can chose to not renew, you are stuck with the maintenance charges of these amenities. So Millenials start contemplating a move to detached housing in a good school district. Thus demands for condo living is transitory as compared to demand for low rise single family housing.
  3. First major maintenance cycle will be around the corner for the new condos that millennials moved in to so they will be finding out shortly if the maintenance reserve that the condo board maintained is sufficient or will it result in sudden increase in maintenance expenses right around the time when millennials’ expenses are increasing due to the growing family size. Any upward shocks in maintenance charges may disillusion millennials from condo living.
  4. Dark windows: It received lot of press in Vancouver press and cited as evidence of foreign speculation. It hasn’t been mentioned in Toronto but what if we have the same problem. This would mean there is lot of inventory which is not coming to the market and neither available on the rental market. In the absence of hard numbers, driving down Gardiner or QEW and counting the large number of black windows isn’t a very logical way to reach any conclusion. But it is food for thought.
  5. The problem with speculation is that the apartments get constructed as per the needs of investors and not owner / occupiers. According to CEO of BILD, the price of condos is increasing because the size of condos is increasing. But is there a need for larger condos? We don’t know because it is not the end user who is buying.
  6. CMHC reports a vacancy rate of 1.8% for Toronto and TREB also quotes CMHC. Even ignoring the empty condos/dark windows theory are we sure that CMHC is really surveying the correct units. Below is from the TREB quarterly rental report

Number of apartments listed for rental was 12,093 out of which only 9,164 were leased. That puts a vacancy rate rate of around 24%. It would be a good exercise to see where is the disconnect between CMHC and TREB numbers what will be the impact once it is reported that there is a 25% vacancy in apartments/condos instead of the 1.8% that is reported.

Final Conclusion

Speculation has brought stability in the market by not allowing the prices to rise as rapidly. However, based on the factors outlined above, I would forecast increased volatility in the condo sector.

Does allowing more urban sprawl lead to affordability?

Spraw externalizes the costs and internalizes benefits

It started with a series of tweets by Cherise Burda, Executive Director of Ryerson University’s City Building Institute (CBI) about a seminar arranged by Ryerson Univesrity’s Centre for Urban Research and Land Development (CUR).

Where as all the above tweets are inter-related, I have already explored the point made in tweet 3 about lack of serviced land or Growth Plan being responsible for housing crisis in GTA in my earlier post “Is Places to Grow Act to be blamed for GTA housing unaffordability?” so will not dwell on it.

The other three hint at benefits of “sprawl” that I would like to explore today. Fortunately for us, LSE and Victoria Transport Policy Institute published a study in 2015 Analysis of Public Policies that Unintentionally Encourage and Subsidize Sprawl that argues against the aforementioned cited benefits:

Social Equity

Social equity refers to the distribution of impacts (benefits and costs), and the degree that this is considered fair and appropriate (DfT 2014; Litman 2002). Sprawl can have various social equity impacts:

– To the degree that sprawl increases external costs, it is horizontally inequitable. As previously discussed, sprawl tends to increase the costs of providing public services, which causes urban residents to cross-subsidize these costs (Blais 2010). Sprawl also increases vehicle travel, and therefore road and parking facility costs, congestion, accident risk and pollution costs imposed on other people. Unless these are efficiently priced with significantly higher development fees, utility rates and taxes in sprawled areas, plus road tolls, parking fees and fuel taxes to internalize all vehicle costs, sprawl tends to be horizontally inequitable.

– Sprawl tends to degrade walking and cycling conditions, and public transit service quality, and increases the distances between destinations, which reduces non-drivers accessibility and increases transport financial costs (CNT 2013). This tends to harm physically, economically and socially disadvantaged groups, leading to social exclusion (physical, social and economic isolation). This is vertically inequitable.

– Sprawl tends to reduce single-family housing costs, but tends to reduce compact housing options and increases household transport costs. This benefits some households (those that prefer larger-lot housing and automobile travel) but harms others (those that prefer adjacent and multi-family housing, and cannot drive)

This indicates that sprawl can reduce social equity by imposing unjustified external costs, and reducing affordable housing and transport options used by disadvantaged populations.

Social Problems

Social problems such as poverty, crime, and mental illness tend to be more concentrated and visible in cities. This occurs because poor people tend to locate in cities in order to access services and economic opportunities (Glaeser, Kahn and Rappaport 2008), while suburbs tend to exclude disadvantaged people by discouraging affordable housing and affordable transport modes (walking, cycling and public transit). As a result, suburban residents tend to be more economically successful and satisfied than urban residents (Mathis 2014; NAR 2013). People sometimes assume that denser development increases social problems and lower density development can reduce them. However, this confuses cause and effect. There is actually no evidence that compact development increases total poverty, crime or mental illness (1000 Friends 1999), on the contrary, research suggests that smart growth policies can reduce total social problems.


Affordability refers to households’ ability to afford basic goods such as housing and transport. Affordability is often defined as households spending less than 30% of income on housing, or less than 45% of income on housing and transport combined (CNT 2013). Sprawl tends to reduce some household costs but increase others, as indicated in Table 7. It allows development of inexpensive urban-fringe land, which reduces land costs per hectare but increases lot size and therefore land per housing unit. Pro-sprawl policies such as minimum lot sizes, building density and height limits, restrictions on multi-family housing and minimum setback requirements tend to reduce development of less expensive housing types, such as adjacent and multi-family housing. Sprawl increases residential parking costs and total transport expenses (Glaeser and Ward 2008; Ewing and Hamidi 2014). As previously described, sprawl increases the costs of providing infrastructure and public services which can increase housing costs and general tax burdens.

Critics claim that by restricting urban expansion, smart growth reduces housing affordability (Cheshire 2009; Demographia 2009; Mildner 2014) but their analysis is incomplete. Restrictions on urban expansion may increase land unit costs (per square meter), but smart growth reduces other costs including land required per housing unit, residential parking requirements, infrastructure and utility costs, and household transport expenses. As a result, smart growth policies can increase affordability overall, particularly for lower-income urban residents who live in multi-family housing and rely on walking, cycling and public transit.

External Benefits of Sprawl?

Sprawl can provide various benefits, including larger residential lot sizes which allow residents to have larger gardens and more privacy, reduced exposure to noise and some air pollutants, lower crime rates and better schools (Burchell, et al, Table ES-17). However, these are mostly internal benefits or economic transfers (one group benefits at another’s expense). For example, the lower crime rates and better schools in sprawled neighborhoods largely results from their ability to exclude poor households that cannot afford cars. This can benefit those community’s residents but concentrates poverty and associated costs (crime, inferior schools and increased burdens on social service agencies) in urban areas. Similarly, sprawl residents’ lower exposure to noise and air pollution is often offset by their increased vehicle travel which increases noise and air pollution imposed on urban neighborhoods. There is little evidence that increased sprawl can provide significant external benefits (benefits to people who live outside the sprawled community). This absence of external benefits is expected since rational people and businesses externalize costs and internalize benefits (Rothengatter 1991; Swiss ARE). If sprawl really did provide external benefits, developers or occupants would find ways to capture those benefits, for example, by demanding subsidies.

To summarize

Sprawl has two primary impacts: it increases per capita land consumption, which displaces other land uses, and it increases the distances between activities, which increases per capita infrastructure requirements and the distances service providers, people and businesses must travel to reach destinations. These primary impacts have various economic costs including reduced agricultural productivity, environmental degradation, increased costs of providing utilities and government services, reduced accessibility and economic opportunity for non-drivers, and increased transport costs including vehicle expenses, travel time, congestion delays, accidents and pollution emissions, as illustrated

…our analysis indicates that by increasing the distances between homes, businesses, services and jobs, sprawl raises the cost of providing infrastructure and public services by 10–40 percent. Using real world data about these costs, we calculate that the most sprawled quintile cities spend on average $750 annually per capita on public infrastructure, 50 percent more than the $500 in the smartest growth quintile cities. Similarly, sprawl typically increases per capita automobile ownership and use by 20–50 percent, and reduces walking, cycling and public transit use by 40–80 percent, compared with smart growth communities. The increased automobile travel increases direct transportation costs to users, such as vehicle and fuel expenditures, and external costs, such as the costs of building and maintaining roads and parking facilities, congestion, accident risk and pollution emissions. Figure below illustrates estimates of these costs.

We estimate that in total, sprawl costs the American economy more than $1 trillion annually, or more than $3,000 per capita, and that Americans living in sprawled communities directly bear $625 billion in extra costs, and impose more than $400 billion in additional external costs. This is economically inefficient and unfair: it wastes valuable resources and imposes costs on people who do not benefit from sprawl.

What was Urbanation thinking?

If you want to look for the culprit of affordability crisis in condo market, Urbanation has just landed a big scoop. No, it is not the “Places to Grow Act”.

First, some context.


Greater Toronto, October 20, 2016 –Prices for all types of new homes in the GTA continue to set records while sales of new high-rise homes are on pace for an unprecedented year, the Building Industry and Land Development Association (BILD) announced today.

So far this year, there have been a record 20,596 high-rise homes sold across the GTA according to Altus Group, BILD’s official source for new home market intelligence. High-rise units have accounted for nearly 60 percent of the GTA’s 34,736 new home sales as of the end of September. For the same period there were 14,140 new low-rise sold.

Average prices for both new high-rise and low-rise homes continued to climb and set new records across the GTA.

BILD President and CEO Bryan Tuckey attributes the GTA’s shortage of housing supply as the primary driver of price increases. “We have a serious housing supply challenge in the GTA due to a significant shortage of shovel ready land and long and uncertain project approval timelines,” he said. “These factors are severely restricting the number of new homes being brought to market and are causing prices to surge month after month.”

Supply of new homes available to purchase in builders’ inventory declined by more than 10,000 homes in the last 12 months. There were 15,421 new homes and condominiums available for purchase in September across the GTA compared to 25,848 at this time last year.


“What has changed dramatically is the decline in options available to buyers….”

High-rise inventory in September was 13,817 homes, down slightly from August and 35 per cent less than at this time last year.

“The recent increase in high-rise prices can be attributed to the rise in average suite size, combined with a growing price per square foot,” Tuckey said. “This year we have seen the introduction of larger suites aimed at purchasers who have been priced out of the low-rise market.”

The average size of a high-rise home in the GTA was 809 square feet in September compared to 767 square feet last year. Meanwhile the price per square foot increased to $601, up $26 from last year.

For quite some time people have been blaming foreign investors for snapping up condo apartments resulting in decrease in supply and increase in prices and unaffordability of the condo units. Urbanation carried out a survey to find out what is the proportion of foreign investors in condo sales.

Foreign Buyers Represent 5% of New Condo Sales in GTA

Urbanation’s survey, which is completed by developers or brokerages representing new condominium apartment projects, found that foreign purchasers represented 5% of all sales that have occurred within projects currently in active development across the Greater Toronto Area. Furthermore, domestic investors represented 52% of sales.

Among projects indicating a presence of foreign buyers, shares of units sold to foreign purchasers ranged between 1% and 25%. Shares of sales to domestic investors ranged between 5% and 90%. The highest shares of sales to foreign purchasers and domestic investors were generally found within centrally-located projects in the Downtown Toronto area.

“The results of this very important survey show a rather limited role of foreign buyers in the GTA new condo market and a very significant overall share of investors. These estimates coincide with the percentages of new condos entering the rental market upon completion, indicating the important role investors play in the GTA housing market” said Shaun Hildebrand, Urbanation’s Senior Vice President.

I do not know about you but I will make the following guesses

  1. It is based on a voluntary survey so my guess is that the brokers and developers would have under reported the numbers
  2. Urbanation wouldn’t have taken a simple average but would have tried to adjust the numbers. 5% seems like a very nice round percentage [I’d have preferred a 4% or 6% but that is just me].

Anyway, considering that 5% are foreign investors and 52% are domestic investors, 57% of supply is being picked up by investors. No wonder that prices are increasing and those who want to buy to live are finding it harder to locate new inventory. If this 57% was available to owner occupiers, there wouldn’t be a shortage of high rise inventory in the market and prices won’t be this high.

Things get more interesting in the second paragraph in the above excerpt. In some projects domestic investors are buying up to 90% of the inventory and foreign investors can go up to 25% of the available units.

This will be a good example of a foreign investor myth busting leading to a “law of unintended consequences.” I think developers and builders will be doing quite a few interviews to play it down in the next few days.