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.




Liar Loans are common in Toronto residential real estate

But as long as the music is playing, you’ve got to get up and dance

Canada or at least Vancouver and Toronto area is facing a housing affordability crisis. I have written about it many times earlier

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

Worry about Canadian real estate but don’t lose sleep over it — CMHC

Predicting Minsky moment for Canadian housing

so I will not reproduce the charts again. However, whenever discussing it with banks or regulators, their response can be summarized as:

Unlike US banks in 2008 and earlier, Canadian bank’s are well capitalised and lending standards are stronger so Canadian real estate debt is not like US pre-2008

Since they have a much better overview of the industry than myself, I took their word for it. The only kink I saw was a personal anecdote which I wrote in Unintended, or intended, that is the question but one anecdote does not a statistic make

I asked a real estate broker what will be the consequences of the new mortgage rules. His reply, “Don’t you worry about it at all. You tell me which house you want to buy, I will arrange for you to qualify under the new rules.”

As I was looking for a rental place, I didn’t probe further as how will he make me qualify. I should have satisfied my curiosity.

Then I came across tweets of @mattintoronto and he had some interesting tit bits to share

Again it is anecdotal but every time I used an Uber in Milton, driver tried to sell me a condo where he is either acting as a broker or is the owner. Same goes for driving instructors as heard from many of my friends.

But what I found scary in the above tweet was the [fake] Notice of Assessment that were being used to qualify. It reminded me of the whole LIAR loans and Countrywide saga that played a significant role in the US subprime crisis.

I presumed that what Matt was highlighting was something new but bit of googling revealed that it is pretty prevalent in Canada

This was published last year by @tamsinrm but seems no one cares

How mortgage fraud is thriving in Canada’s hot housing market

Those in the industry agree that much of what constitutes mortgage fraud in Canada is what’s known as “soft fraud” or “fraud for shelter” and usually involves people who are genuinely looking to buy a home and pay their mortgage, but can’t quite qualify for a conventional loan.

In some cases borrowers are simply trying to buy a home that is out of their reach financially. In others, the borrowers could qualify if they had a bigger down payment and paid a higher interest rate, but instead alter pay stubs and bank statements in order to qualify for the cheapest possible mortgage. Still, more involve people like Mr. Dhaliwal, who forge documents in order to save a deal that is up against a tight deadline.

Soft fraud? I didn’t know there are two types of frauds. Anyway, one shouldn’t ask the realtors or the bankers what do they think because they come up with this

Broker Mr. Cashin blames overly stringent federal rules governing insured mortgages, such as shorter amortization periods and higher mortgage insurance premiums, for making it harder for average Canadians to get a mortgage, especially in expensive markets like Toronto or Vancouver.

Such policies are aimed at ensuring the housing market didn’t experience a catastrophic U.S.-style meltdown. Mr. Cashin argues that they have had the opposite effect, pushing otherwise creditworthy borrowers who would have qualified for a conventional mortgage in the past into riskier areas of the market, including to industry professionals willing to commit fraud to get a deal done at all costs.

“They’re creating an environment for people to cheat because they want those low rates,” he says. “A lot of times it’s because they need it. House prices are going up. Everything is going up except people’s wages, but policy is keeping the cheap money away from the people who need it the most.”

Others say the driving force behind mortgage fraud is to help clients who have the means to afford the mortgage, but who work for cash or otherwise aren’t declaring all their income. That might make them tax cheats, but it doesn’t necessarily put them at higher risk of defaulting on a mortgage.

“If I feel a client can afford it, I’ll help them and guide them,” says one Toronto mortgage broker who spoke on condition of anonymity because he admits he helps clients fake job letters, income documents and employer phone references.

“Yes it’s fraud. But we are looking out for the bank. We are looking out for the economy in that we’re not giving the mortgages we know are going to screw up,” he says. “I will stop clients and deals that I know are headed for trouble because it’s not healthy for anybody.”

Home Trust CEO Gerald Soloway told an analyst conference call earlier this year that the mortgages it had flagged for fraud were actually performing better than the company-wide average.

So yeah, liar loans in Toronto are pretty common, wide spread and business as usual. The new element that was highlighted by Matt in his tweets was Borrowers getting additional loans from alternative lenders secured by secondary mortgage which the first mortgage holder doesn’t know about.

If my loan is secured by a 2nd mortgage, I would want a piece of action either in the form of higher interest rate or shorter loan term. It would be interesting to find out these things about the 2nd mortgage but if it has a higher rate or shorter term, it promotes flipping and not ownership.

Yeah…well…ok…hmm… no one cares except for a few twitterati. In the now infamous but immortal words of Chuck Prince (CEO Citibank)

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.”

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.