Seriously, is it just me - a realtor of 25 years who has navigated Buyers and Sellers through the trials and tribulations of a crash and boom - or are all three levels of government each trying to wrestle our real estate economy with agendas they believe will ultimately help the market lately?
Although our Federal, Provincial and Municipal Governments have historically been active in shaping the Canadian housing market, recently there's been a crush of policy and regulation in an effort to align taxation with profit, mitigate indebtedness and affordability, while balancing supply with demand. Now I don't want to take the position our governments are meddling with what should be a free market, as I promote the belief that in Canada, 'housing should be a right, rather than a privilege'. However, as with any ideology that moves from theory to practice, there can be complications, shortfalls or even unintended consequences. Given these more recently introduced government policies are impacting the Toronto real estate market - and my real estate clients - in their own distinct ways, I thought a post summarizing these measures would be of merit in these uncertain times.
Here's my overview!
THE FEDERAL GOVERNMENT
Mortgage Stress Test
There's no question overleveraged Canadians are incredibly vulnerable in the event of a market correction and/or an interest rate hike(s). As Toronto real estate prices fall back and interest rates creep up in tandem, highly-leveraged homeowners potentially push their indebtedness into a financial corner.
While the impetus for the new mortgage stress test that comes into effect in January 2018 is for the country as a whole, there is impact particularly for Toronto (and Vancouver) homebuyers. Given that prices have been so high, it was common for lenders to qualify borrowers at the lowest rate possible in order to ensure they could access enough funds to buy property in our hot market. Now all borrowers - regardless of the size of their down payment - will need their lender to stress test their debt load, qualifying for a mortgage at either the five-year posted rate or their contracted rate + two points. Here's my post on the matter: What You Need To Know About Canada’s New Mortgage Rule Changes.
For homebuyers who have faced a number of challenges just trying to secure a home in the last few years, this can appear to be yet another hurdle they need to clear. However, it’s actually a safeguard to build wiggle room in household budgets in the event of interest rate increases; it also helps to protect the ratio between debt and equity on your home. On both counts, it reduces financial vulnerability. It's hard to argue this is a detriment to our real estate economy as a whole. A collapsing 'house of cards' would not bode well for our GDP.
Principal Residence Exemption
Earlier this year, the Federal Government made changes to the Principal Residence Exemption (PRE). Sellers are required to report the sale of any property so it can be appropriately taxed (remember, a property deemed an investment will be taxed as investment income). However, if the dwelling is your principal residence, you are (generally speaking) tax exempt.
The intent here is to focus on speculative investors who are holding multiple properties that don't report their investment income accurately, or who move frequently as flippers. There had been a number of loopholes, which speculative investors were able to leverage - until now. By controlling this exemption and the reporting structure, this investment gets less attractive to speculative investors because the return-on-investment erodes, which should reduce interest by investors thereby creating more supply for purchase by end users.
Click here to read my past post on the PRE: “Changes To Canada’s Principal Residence Tax Exemption”.
Canada Revenue Agency Targets Shadow Flippers
In addition to increasing PRE reporting, recently the CRA has ramped up its efforts to identify shadow flippers in the condominium market. Shadow flipping is when a condo is bought from a developer pre-construction and then sold to another buyer in quick succession before it is registered. Typically, profits from flipping real estate are generally considered to be fully taxable as business income, but because of the existence of several loopholes, along with a lack of technology and tracking, this fraudulent practice has proliferated.
The CRA is currently investigating almost 3,000 pre-construction purchases in Toronto, widening the lens on these investors. It appears that their suspicions are correct. In audits of completed during the last fiscal year (ending March 31 2016), the CRA recovered $18 million in income tax and $32 million of GST/HST in Ontario alone. Additionally, across the country, they issued $10 million of penalties, with the highest weighing in at almost $2.5 million. It certainly makes the case for compliance, especially from an investment standpoint. Although for investors looking to make a quick buck through shadow flipping, this certainly takes a bite out of their return on investment.
There is multi-benefit here to legitimate homeowners in Toronto through this crackdown. Enforcing compliance will deter shady investment because the returns are less attractive. This should help increase the supply of stock to the market, which in theory should help with affordability.
Here are some stories on CRA’s recent crackdown on shadow flipping: “CRA Analyzing Pre-Construction Condo Flipping Cases In Toronto For Tax Avoidance”, “How The CRA Is Cracking Down On Non-Compliance In Canada's Hottest Housing Markets “and “CRA Probes Presale Condo Flips In Toronto As Part Of Real Estate Crackdown."
This system is not without its critics; the most common complaint is a lack of tracking of compliance, which makes it difficult to determine exactly how much revenue the CRA generates from this particular effort. Click here to read: “CRA Crackdown On Real Estate Taxes Fails To Track Collection Results”.
THE PROVINCIAL GOVERNMENT
Fair Housing Plan & Rent Control
Last Spring, in an effort to cool the Toronto property market and help with eroding affordability levels, the Provincial Government introduced the Fair Housing Plan. This was an attempt to address our pandemic housing shortage, restrict the questionable ethics of multiple offers, combat low vacancy rates, and the eight year affordable housing wait lists. The plan focused mostly on implementing a tax for foreign buyers (which I'll address soon in a future blog), stopping realtors from representing both the Buyer and Seller in a transaction and introducing rent controls on all housing types.
To date, this plan spooked the market sufficiently to cool the freehold housing market (generally over $1mil) back towards balanced territory, although the condominium market (generally under $1mil) has continued to spike (which I'll address in my coming Real Estate Forecast). However, prices still continue to be very high, with affordability an ongoing issue in the City of Toronto, as low supply and high demand are still putting pressure on prices.
One issue that has emerged in the months since the Fair Housing Plan has to do with rent controls. Although the rent controls have been put in place to help protect renters by preventing unfair rent increases, the belief is that these rent controls are actually creating another set of problems. Many developers who were building rental purpose housing are either abandoning projects or converting their proposed projects to condominiums.
With a tight vacancy rate, rentals are at a premium and little has been done to ease supply concerns over the last many years; in fact, relatively speaking, very few rental units have been built. Developers - who construct these projects which are financed or purchased outright by Pension Plans and other conglomerates seeking long term bricks and mortar investments - did feel that, because of existing rental age (maintenance becoming too expensive), low interest rates and the significant demand, that the timing was naturally right for a cycle of new development to begin. However, for-profit developers are rethinking how sustainable these new projects are as rentals, when the condominium market offers a quicker return. The Fair Housing Act helps manage affordability from the point of view of the renter, but it doesn’t help to address (or assist) landlords with tight operational margins. In our top dollar market, the returns are pretty slim for any property purchase, which I explored recently in Dear Urbaneer - Does It Still Make Financial Sense To Invest In Downtown Toronto Real Estate?.
According to a recent report from Urbanation, there have been upwards of 1,000 rental purpose units converted to condominiums. It’s about return on investment ultimately; control on rent increase erodes the property investor’s investment, compelling them to sell their existing properties - or potentially not to purchase at all, directing funds towards other type of investment.
Here is a good article outlining some of the perils of rent controls: "Haider-Moranis Bulletin: Why Rent Control Is A False Cure For Housing Shortages”.
The suggestion here is that rent control, while well intentioned, does not address the supply issue that plagues the market. In fact it exacerbates it. This article refers to a study that indicates that there will be over 6000 units short in supply every year until the supply finally reaches demand: “Ontario Needs To Give Developers A Better Reason To Build Rentals” suggests alternative approach to helping with affordability by kick-starting building to help with supply crunch (think tax breaks for developer or tying rent control to the inflation rate, in addition to the Province offering up land.
Here are some more great articles that offer different insights on this particular dilemma and the issues of supply: “Toronto, Vancouver Housing Shortages Will Keep Prices Soaring”, “Toronto, Vancouver Heading Towards Higher Home Prices Despite New Rules,”, “1,000 Planned Rental Units Cancelled Following New Ontario Rent Control Rules: Report” and “New Ontario Rent Controls Will Mean Fewer Apartments, More Condos, Developers Warn.”
The underlying sentiment is that some of the measures around the Fair Housing Plan assist with affordability in the immediate moment, but they fall short of helping keeping housing affordable in the long term.
The lack of rental housing isn't limited to Toronto. I've been reading with interest how Vancouver is trying to address their rental housing shortage, with proposals exploring the merit of zoning sites specifically for rental property. It's an interesting idea. Here's 2 Globe and Mail articles worth reading called The Push For Rental-Only Zoning In Vancouver and Have Vancouver’s Policies Hindered Rental Housing More Than Helped?.
THE MUNICIPAL GOVERNMENT
For consumers looking for short-term rentals in the City of Toronto, the arrival of Airbnb provides choice and frequently more-affordable-than-hotel accommodation. It also gives homeowners the chance to generate income from their homes, which can be a real plus given the hefty mortgages that the bulk of homeowners are shouldering, simply to afford owning a home in Toronto.
However given the market conditions and other factors, there have been a series of problems created by the growth of Airbnb in Toronto. It was becoming more common for tenants to get evicted from their homes so that the landlords could rent the dwelling on Airbnb. Why? Because there's less risk and more profit for landlords to sign on with Airbnb than enter into a conventional rental agreement when Ontario tenants are protected under the Residential Tenancies Act. This really comprehensive article called This Is What Causes Housing Shortages documents how the Residential Tenancies Act In Ontario heavily favours tenants over landlords, and why it's driving homeowners to embrace the Airbnb program.
The downside? It’s hard to foster community in a sea of short-term rentals in residential districts, with Airbnb clients coming and going (and sometimes not being “good” neighbours to permanent residents). And - by many accounts - the lack of regulation propelled the Airbnb market as condo rentals were being snapped up by companies turning multiple units into unregulated hotels, with a litany of problems. I wrote about this in my 'tales from the real estate trenches' post called Airbnb And The Economy Of Shared Housing.
In order to address these problems, the City of Toronto moved to close the loopholes around Airbnb rentals by proposing new regulations, which the Licensing and Standards Committee released in a report. The report recommends that “that anyone doing a short-term rental in their home must register with the City and any companies that facilitate short-term rental activity, like Airbnb, must be licensed”.
Basically, the gist of this is that anyone wishing to rent short-term rental space out in their home would be required to register with the city and pay a nominal fee. Companies like Airbnb that act as a third part to facilitate these rentals would be required to pay an initial license application fee of $5000, with a licensing fee of $1/per night/per booking. There would also be rules around how many nights people are allowed to rent out space in their homes (up to 180 nights a year, no more than 28 days in a row).
Do These Regulations Address The Problems At Hand?
While homeowners are required to register with the City and to declare these homes as personal residences, it's not going to be easy to regulate. More importantly, I'm not sure the ghost hotels, absentee landlords and rental firms are even going to attempt to comply. After all, the City is hardly likely to set up another layer of bureaucracy to police this. So while I respect this endeavour is to get more properties on the market for long term tenants to rent, it doesn't appear to be well thought out.
Meanwhile Fairbnb, advocating on behalf of homeowners and the hotel/B&B industry, is pushing to have the “principal residence” identification authenticated for Airbnb hosts across the board. It is also lobbying for condo boards to have the option to exclude entire towers from short-term rental licensing at their discretion. There was the first instance of a condominium board agreeing to Airbnb rentals in its complex, when Airbnb and Neptune Condominiums set up a contract that allows their condo board to keep tighter control around short-term rentals, including requiring guests to have government ID on file with Airbnb, having the option to evict guests if numerous complaints are made and collecting of insurance and hosting fees.
Here are some stories that delve a little deeper into the Airbnb debate: “Toronto Could Soon Make It Harder To Use Airbnb”, “City Wrestles With Airbnb Rules”, “Chris Selley: Toronto's AirBNB Regulations Are A Confused, Half-Hearted Distraction”, “Don’t Believe The Pitch From Airbnb”.
Removal of Basement Suites
Recently, City Council has moved to eliminate basement suites from Airbnb rentals, which may prompt some owners to rent their Airbnb suites to long term tenants, thereby helping with affordable housing. But it creates another problem: the elimination of sufficient rental income, as Airbnb can generate about twice as much revenue than a long term tenant, and the wear and tear is not significantly more and possibly even less. I have several clients who rely on this short-term rental income from their lower level units to help with their mortgage and housing costs, which is no small expense in a City like Toronto, where the cost of living is so high, and taking out a huge mortgage is common.
One other fascinating insight from the real estate trenches: I would say only 5% of basement suites are actually legal and comply with the City's zoning, building code and fire code. For years the City of Toronto has turned a blind eye to this truth, mostly because if they enforced compliance then most basement tenants would be evicted either so the work could be completed (digging a basement down to have 7' ceilings and fire rating it is no easy feat), or because the homeowner would instead choose to deconvert their basement suite into personal living space to avoid the hefty expense. Either way, to enforce compliance would create a housing crisis. In this respect I find it ironic the City now feels they have the right to regulate who occupies these illegal suites, which are potential fire hazards. Most Airbnb guests don't use the kitchen facilities, which actually make them a safer - albeit temporary - form of accommodation.
Personally, I'm not convinced the City of Toronto should be in the landlord business. The problem would better be solved by helping homeowners create legal ancillary suites in their homes (and laneway housing) through grants. This has the benefit of also helping homeowners cover their mortgages. The grants could be partially recovered through modest increases in property taxes, but in conjunction with this the city has to let go of insane development charges (here's my post called The Pitfalls Of Permit Fees And Toronto Real Estate) and easing of building code restrictions which just propagates unsafe and illegal basement apartments.
Here are some articles that outline these new regulations and some of the problems that are now facing homeowners : “New Airbnb Rules Will Ban Toronto Owners From Offering Ip Basement Apartments” and “Basement Apartment Owners Unhappy With City Ban On Airbnb-Like Rentals” and “Toronto Passes Strict Airbnb Rules Aimed At Preserving Long-Term Rental Supply”
Would a Vacancy Tax Help?
There is talk of introducing a vacancy tax like that levied in Vancouver to discourage investors from holding empty properties as a way to park their capital and benefit from a surge in housing prices. Again, this places pressure on an already tight supply in Toronto and removes housing from those who seek affordable shelter, not just investment opportunity.
It stands to reason that if there are so many vacant units (although admittedly, there isn’t much hard data on how many units are vacant- and is hard to determine which are truly vacant). One of the issues around the Vancouver tax is that, while it is expected that a vacancy tax would indeed help push supply into the market, it doesn’t really address high prices.
The question remains then should Toronto follow suit with a vacancy tax? Certainly an increase of units into the rental market would help ease supply issues, but will it ultimately help with affordability?
... Thanks, John Tory.
I talked about the pros and cons in this post: “With 65,000 Vacant Units, Will A Vacancy Tax Be Helpful To Toronto Real Estate?”. In this post, I agreed with the fact that a vacancy tax would help with supply, and curb speculation. However, there are longer term implications to consider, namely restrictions around rentals of condominiums, difficulty in identifying accurately “what is vacant” and the challenges of rolling out such a tax without negatively impacting innocent homeowners.
Here are some more stories that offer additional insight: “Vancouver Property Owners 'Panic' To Rent As Vacancy Tax Implemented” and “Empty Homes Tax”.
What all of this underscores is exactly how vital a role housing plays not only in the financial health of our city, province and country, but in the socio-economic health as well, which is why governing bodies have stepped up to intervene. However, are all of these regulations enough and do they hit the mark for their intended purpose? Housing is the only commodity I know of where the government believes they have the right to regulate private ownership. While lending restrictions help reduce homeowner debt, they do limit purchasing power. Rent controls, Airbnb restrictions and Vacancy tax all impact an individual’s opportunity to capitalize on their investment. And while I do believe we should all have shelter, I'm not sure the collective actions outlined in this post will ultimately help with affordability in the long term while helping legitimate homeowners grow their housing investments.
In order to navigate a complex real estate market, you need to not only accurately chart a path, you need to have a comprehensive view of market influences. With decades of in-the-trenches experience and a multi-disciplinary education in housing, I - and my team - welcome the chance to offer our guidance in helping you understand our current market influences.
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