How New Legislation Could Kill Condominium Construction
Man, I’m so tired of being right.
I’m also tired of being humble. And modest. And subdued…
If there are two beliefs about the intersection of politics and economics that I hold near-and-dear, they are the following:
1) Taxation is a zero-sum game. I know some of my regular readers have disagreed, but if you implement a novel new program or benefit at a cost of $1, then you need to increase taxes elsewhere for $1 to pay for that expenditure, or, reduce expenditures by $1 somewhere else.
2) All legislation comes with unintended consequences. Even the noblest of intentions will produce shockwaves elsewhere.
Over the years, we’ve seen the federal government implement fiscal and monetary policies aimed at “improving housing affordability” that have had unintended consequences.
Just about every single change from the CMHC has produced some sort of fallout.
When the government mandated a 20% down payment on properties of a $1,000,000 purchase price or higher, that meant that $800,000 properties shot up to the high-$900’s essentially overnight. This was 2017, I believe. And we lived it!
That’s an unintended consequence of the government trying to decrease demand over $1,000,000 and at the same time, decrease exposure for the CMHC.
So was it worth it?
Are any pieces of new legislation or policy implementations by the government worth the fallout thereafter?
We’ve talked a lot about “inclusionary zoning” in Toronto and most have heralded this as a great thing.
But the unintended consequences are apparent for anybody that wants to take off the rose-coloured glasses for long enough.
Let’s say a developer is building a 100-unit condo. Let’s say the developer is selling these condos for $1,000 per square foot.
Now, let’s say that new legislation mandates 30% of these units must be “affordable.” This could be in the form of reduced rent, reduced sale price, or the government “buying” the units from the developer. Regardless, let’s say that this reduces revenue to the developer by, say, 40% for those units.
The developer will now increase the price per square foot of the 70 market-price units to $1,172 per square foot to offset the lost revenue.
That is the unintended consequence of inclusionary zoning.
There’s no avoiding this. Not if you’re rational, realistic, and understand that businesses are in business to make money.
For those not familiar with the change in inclusionary zoning at the municipal level, here’s the City of Toronto press release from November of 2021:
Today, City Council adopted a new Inclusionary Zoning policy framework which will get more affordable housing built across Toronto.
The City of Toronto is the first city in Ontario to implement inclusionary zoning which will require certain new residential developments to include affordable housing units.
Council approved an Inclusionary Zoning Official Plan amendment, a Zoning Bylaw amendment and draft Implementation Guidelines, which will make it mandatory for certain new developments around Protected Major Transit Stations Areas to include affordable rental and ownership housing units beginning in 2022.
Inclusionary Zoning will secure five to 10 per cent of condominium developments (over minimum unit thresholds) as affordable housing, increasing gradually to eight per cent to 22 per cent by 2030. The amount of affordable housing required will vary depending on where in the city the development is located and whether the units are intended for rental or ownership, with the highest requirements in the Downtown area, followed by Midtown and Scarborough Centre.
Toronto’s Inclusionary Zoning framework sets out foundational requirements for affordable housing to be incorporated on a consistent basis in new developments and ensures affordability is maintained for 99 years. The policy will be closely monitored and reviewed after one year to allow for adjustments that may be required including changes to the phase-in and/or set aside rate, alterations to the minimum development size threshold and any other changes needed to ensure market stability and production of affordable housing units.
Additional market analysis will be conducted in areas of the city currently undergoing a planning study, such as Little Jamaica and the Sheppard Subway Corridor, to identify opportunities to expand Inclusionary Zoning to other areas, with an update report by mid-2022.
In the City’s policy, rent and ownership prices will be centred on new income-based definitions of affordable housing, targeting households with an annual income of between $32,486 and $91,611.
This policy tool was developed based on detailed financial impact analysis and input received from extensive public consultations, which took place throughout the last two and a half years. The resulting balanced, forward-looking and equitable framework will help the City achieve the HousingTO Action Plan target of approving 40,000 affordable rental homes and 4,000 new affordable ownership homes by 2030.
Whether or not it’s up to the private sector to build affordable housing is a debate for another day.
But you can’t deny that “forcing” for-profit corporations to build affordable housing, is going to have the unintended consequence of increasing prices of market-price housing.
This week, I saw how this works, first-hand.
I’ve written before at length about my “side-hustle” of working on land assemblies for developers. Over the last two years, these have proven pointless. There is far too much opposition from NIMBY city councilors, who tout the need for more housing and affordable housing, but won’t let it happen in their ward.
Toronto doesn’t have many empty parking lots left on which to build condos, and the idea of “assembling a bunch of old houses” to create a condo site has become tougher and tougher. So I had this idea: what if you could buy out an entire condo and build a much larger condo on that site?
I had the inside track on a 32-unit condominium that’s situated on a massive piece of land in a prime location.
This site could have been had for $80 Million.
On this site, I believe you could have built 36-storeys and with a gross floor area of 500,000 square feet.
For $80 Million, it’s an absolute no-brainer.
And what’s more is that the reason land assemblies often fail (I mean, before city councilors started blocking development…) is that there are always a few holdouts, but in this case, we had a commitment from the entire building.
I pitched this to one developer with whom I work, and they said “no.”
I was shocked.
Because of inclusionary zoning.
“I won’t look at anything until after September,” I was told.
It seems that September is an important date for applications to be submitted to the City of Toronto for which inclusionary zoning, in future projects on those sites, will not be forced.
“I need to see how all of this shakes out,” I was told. “There’s no point in buying land today, at today’s valuations, when changes down the line could completely cripple those valuations.”
In essence, an entity that derives revenue from building condos is no longer looking to purchase sites. At least, not for the time being.
I pitched this to a colleague whose familial connection puts him in tight with another major condominium developer.
“Bring this back to me in six months,” he said.
He went on to explain what is happening “behind the scenes” with respect to the fallout from inclusionary zoning.
“Everybody’s making applications,” he told me, “Whether they want to build or not.”
“I know guys who have commercial, industrial, even office properties that they had no intention of ever developing; some guys’ have this in their family for fifty years,” he said, “And now they have to submit an application before September to avoid whatever inclusionary zoning requirements are coming down the pipe.”
If one developer passed on this condo site because of inclusionary zoning, that’s notable. But if two developers give the same reason, then there’s merit to the thought.
Inclusionary zoning does have benefits, and surely that’s not something we can debate.
But what is up for debate is the NET result after we add affordable housing via inclusionary zoning, but also consider the increase in cost for market-price properties and the delay and potential paralysis of the purchase and sale of development sites.
Another piece of legislation that’s going to have unintended consequences is the government’s targetting of property speculation. Again, this legislation is probably a good thing, since there are speculators out there not being taxed as they should be. But the unintended consequences could actually hurt the condo market, according to noted Toronto real estate lawyer, Bob Aaron.
“Budget ’22 May Rattle The Resale Of Pre-Built Condos”
Property speculation is targeted in the recent federal budget and has the potential to cause upheaval, writes Bob Aaron
By: Bob Aaron
The Toronto STAR
April 30th 2022
The 2022 federal budget has the potential to create a huge upheaval in the market for pre-construction condominiums.
The government plans to reduce what it calls speculative trading in the Canadian housing market. Its target is the resale of purchase contracts signed before the home or condo has been built or occupied.
Currently, when a person makes a new home assignment sale, Harmonized Sales Tax may or may not apply — depending on the reason for purchasing the home. For example, HST does not apply if the buyer initially intended to live in the home.
This creates an opportunity for speculators to be dishonest about their original intentions, and uncertainty for everyone involved in an assignment sale as to whether HST applies.
The existing rules also result in the uneven application of HST to the final price of new units.
To address these issues, Budget 2022 will make all assignment sales of newly constructed or substantially renovated residential housing taxable for HST purposes, effective May 7, 2022.
HST applies to the price from the builder to the first buyer, and an additional 13 per cent tax will be imposed on the entire price paid by the second buyer to the original buyer.
Effectively, every assignment sale closing on or after May 7 will be subject to tax of up to 26 per cent.
The tax will be paid by the original buyer from the builder who “flipped” the agreement to an end user.
In order for the first buyer to just break even, the home or condo has to increase in value by the 13 per cent HST, five per cent real estate commission, and any charge by the builder to consent to the assignment.
This means that for all new or existing assignment sales closing on or after May 7, the first 18 per cent of the new price will go to HST and real estate commission, even if the seller winds up in the red.
Will this kill the market for assignment sales?
John Pasalis is the broker of record at Realosophy Realty Inc. and a frequent industry spokesperson. He emailed me to say, “If the federal government is able to police this and condo investors have to start giving up 13 per cent of their capital gain to the federal government in the form of HST… this is not good for investors who intend to flip their condos.”
Jose Manalo is a broker with Sutton Group Realty Systems, in Mississauga. He spends much of his time on assignment sales.
I asked him about the impact of the budget on assignment sales. He responded: “Will it curb the resale prices in the future? I would say no! The 13 per cent HST plus the five per cent in commission will just be added into the investor’s selling price. Some investors will grovel for a bit in the start, but later it will just be a normal added cost.”
My own take is that the assignment market could well come to a screeching halt next week, but once it adjusts to the new taxes, it could revive after some time passes.
Bob Aaron is a Toronto real estate lawyer and a contributing columnist for the Toronto Star. He can be reached at [email protected] or on Twitter: @bobaaron2
Almost all of you are saying in unison, “This is great.”
And you’re right. It’s nice to see that people making untaxed dollars that should be taxed are now likely going to be forced to pay up. After all, you pay taxes on your investments, so why should pre-construction paper-flippers be any different?
The problem with this is the unintended consequences that exist.
Add 13% in HST to the sale of this “paper” and, in theory, the sale prices of all these pieces of paper will be increased by 13%.
As I noted with respect to the inclusionary zoning, if the municipal government cuts into the developer’s profit margins, the developer will simply increase the price of real estate to recoup those losses. By the same logic, somebody looking to flip a pre-construction condo will undoubtedly look at this 13% as an expenditure that needs to be added to the expected profit upon a sale.
The difference in these situations is: the developer has a far greater chance of success than the individual.
A developer has a far greater audience and there’s far more demand for pre-construction condos from the source than there is for assignments of existing pre-construction contracts. The developer can raise prices and still sell out a building. The paper-flipper has to now find a “greater fool” who will pay a premium, profit, and HST.
Then again, these issues are intertwined.
If paper-flippers stop buying because they don’t want to see 13% of their profit eaten up by taxes, then the developer has less demand at the pre-construction launch. Less demand, and higher prices necessitated by inclusionary zoning, could lead to faltering sales.
This seems to be the essence of Bob Aaron’s article above.
Personally, I think a 13% tax on paper-flipping will have an effect. It’s impossible for it not to. How much of an effect remains to be seen, but I also think that investors who set out to flip paper are maybe 10-15% of the pre-construction buyers, whereas the balance seek to close on the condo upon completion and re-sell.
I’m not the only one talking about unintended consequences, it seems.
There’s a lot of talk about various plans for housing “backfiring.”
“Canada’s Plan To Ease Runaway Housing Prices Could Backfire On Trudeau: Experts”
From the article:
“I think we definitely need new supply to meet increasing household growth as a result of immigration. I believe that the 3.5 million is a complete exaggeration,” said Steve Pomeroy, a housing policy consultant and professor at Carleton University in Ottawa.
There are very real risks to trying to force the pace of construction higher too quickly, he added.
“The consequence, if we do try to increase it, is we will run into a whole bunch of issues in the supply chain – labor, land and materials – and will actually push house prices even higher,” Pomeroy said.
So it’s not just the humble blogger that thinks every “plan” that the three levels of government launches will have fallout and unintended consequences, eh?
Time will tell…