After a lack of new construction for many years, market conditions have set the stage for a fresh wave of apartment development, according to Canada’s largest non-bank mortgage lender.
“We’re in a position, for the first time in a very long time, where you can say that it actually makes sense to build new apartment buildings,” says Andrew Drexler, assistant vice-president, commercial financing at First National Financial. “That is because returns are starting to look more attractive when you compare them with buying older apartment buildings.”
There was a time when investors could expect a nine per cent return on an apartment building. But the low-interest-rate environment has driven up the cost of these buildings. And as buildings age, expenditures increase, further driving down return. CBRE Research has reported that 79 per cent of Canada’s existing rental stock is more than 35 years old, meaning that big repairs — and big expenditures — are on the horizon.
“What’s happening now is we’re down to a 3 or 4 per cent return on existing buildings,” Drexler says.
He says investors should be looking not only at net operating income, but also at net cash flows, which are better in new buildings because they don’t need new roofs, balconies, windows or other major repairs. A new building also comes with 25 years of depreciation, which is a big tax benefit. And new, more energy-efficient buildings help keep costs down, which further enhances returns.
Jon Bester, CFO of Shiplake Properties in Toronto, confirms this trend.Another factor, driven in part by new condo development, is that today’s urbanites have become more sophisticated in terms of what they want in an apartment rental.
Shiplake Properties is a third-generation family-owned business with deep roots in the rental business. Its newest project, Balliol Park, is a 521-unit, two-tower apartment building in the Davisville area of Toronto, available for occupancy in June. One bedrooms rent for an average of $1,600 a month, two-bedrooms for an average of $2,250.
With all the must-have bells and whistles — rooftop pool, indoor lap pool, movie screening room and two gyms — the development has attracted significant interest since the leasing office opened in February.
While new construction can be a daunting task, which requires deep pockets, the right market conditions, excellent relationships and significant building/leasing expertise, renovating older buildings can be a good alternative. “You have to know how much of a premium renters are willing to pay before you borrow money to put in new kitchens or knock down walls,” Drexler says.
His advice to landlords is to renovate several units at a time upon turnover. That way, they can keep their subcontractors busy and can gain valuable insight into how much of a rent increase the market will bear as the renovations progress.
Over the years, Shiplake Properties has had positive results upgrading its existing buildings in Toronto, Bester says. It continues to see good returns, for instance, on renovations of a 575-unit apartment building built in the 1970s just south of Yonge and Eglinton. “We complete about a dozen renovations annually in this building. Renovations include new kitchens and new countertops and we have been able to get rent increases that make the investment worthwhile”
When deciding whether to build or renovate, the first question to ask is whether you can enhance your return by bringing in new rental stock.
“It’s all about understanding the market that you’re in,” Drexler says. “Adding new rental stock is feasible now, but it’s got to be the right borrower with the right experience in the right market.”
Andrew Drexler is an Assistant VP, Commercial Financing at First National Financial. Get to know Andrew here.
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