The economics of developing purpose-built rental housing

CMHC commissioned a research project to assess the general economics of developing purpose-built rental apartment buildings in six of Canada’s major markets. These were Vancouver, Calgary, Winnipeg, Toronto, Montréal and Halifax. The project was undertaken to provide insight on current factors that can influence investors’ and developers’ decisions to fund purpose-built rental housing.

To that end, the analysis used a pro forma spreadsheet tool. This tool was used to summarize the financial performance of new rental housing projects, based on development costs, financing details, revenues and expenses. A total of 12 pro forma models were developed. The models represented a variety of new rental apartment buildings in each of the six markets, based on a combination of variables:

• project type and location (for basic, medium and high-end options)
• rents (achievable market rents versus required economic rent to make the project financially viable)
• land costs (market versus zero).

All scenarios assumed CMHC mortgage loan insurance was provided and that projects had an 85% loan-to-value ratio. Assumptions for vacancy rates and real income growth were developed to be specific to each market.

The analysis shed light on rental project construction and operation costs, and potential returns on equity, given diverse market conditions across Canada. Cash-on-cash returns were determined for the rental apartment buildings modelled. These returns were calculated as follows: annual revenues, less operating costs and mortgage payments, divided by the initial cash investment, expressed as a percentage. The returns so calculated were typically negative — even when land cost was assumed to be zero. As well, the economic rents were found to be generally above achievable market rents for the apartment building types modelled.

While the returns estimated for building typologies modelled were low, this does not imply that no such development will take place in the current market environment. In fact, purpose-built rental unit development has been exhibiting some increases in recent years, although it is still well below demand levels in key markets.

The analysis undertaken was illustrative of a “typical” situation that a developer may face, given prevailing market conditions. As has been the case in the past, individual developers may find rental investment attractive under specific circumstances. However, the analysis does illustrate that, in general, the economics of new rental unit development are still challenged, except in special circumstances.

Read a summary of the study (PDF)