Man, I’m so tired of being right.
It’s tedious.
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.
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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.
Why?
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.
Same, Same.
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.
Here’s his
“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 2022The 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 bob@aaron.ca or on Twitter: @bobaaron2
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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…
A Grant
at 8:25 am
“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.” … 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.”
Setting aside for the moment that any “inclusionary zoning” will typically include a municipal variance to allow additional stories to help offset the loses associated with building affordable units, I’m having trouble getting my head around the potential increase to the “market rate”.
Isn’t price set by “the market”? Are we saying that a developer would have been willing to leave $172 sq/ft on the table if only “the big bad government” hadn’t forced them to build affordable housing? Similarly, if various taxes/fees/developer charges are reduced (or eliminated altogether), are we saying that developers would then reduce the price of their units by a corresponding amount?
Or can we safely assume that developers/sellers will always charge as much as “the market” will bear?
Kyle
at 9:52 am
The price is set by the market, but the market is set by supply and demand. IZ will reduce the economic viability for developers to move forward on some projects, which will reduce supply. This is what David is clearly saying when he says it will “Kill Condominium Construction”. Over time, with the reduced supply prices will eventually rise on market units to cover the costs of IZ.
A Grant
at 4:14 pm
So what’s the end game then? If I were to read in between the lines, the goal ought to be to increase supply to such an extent, without any consideration for affordable housing, so as there will be a glut of condo stock which in turn will depress prices to affordable levels?
Not likely (nor wanted) for a myriad of reasons.
Perhaps my overall issue with David’s piece is that inclusionary zoning is rejected simply because of the potential impacts on the costs associated with condos sold at “market value”, which in turn might impact the willingness of some developers to initiate new projects.
Fine. Point taken.
But rather than dismissing the practice out of hand, perhaps look at how these impacts can be tempered by other government policies. Such as the municipal variances I mentioned above.
daniel b
at 11:06 am
toronto’s policy specifically excludes any offsets to compensate for the affordable units.
Appraiser
at 8:58 am
Regarding assignment sales. It brings to mind an old saying about closing the barn door after the cows have already escaped. The market peaked 2 months ago.
Also I don’t believe Mr. Market would agree with the notion that “flippers” could simply add the HST to the eventual sale price in order to circumvent any financial impact of the tax, unless the market is scorching hot.
Other than perhaps quenching some perceived if somewhat manufactured moral outrage, the effect of this particular legislation will be negligible.
Steve
at 9:46 am
“Whether or not it’s up to the private sector to build affordable housing is a debate for another day.”
Well the government doing it themselves has gone so well in the past…
Marina
at 10:05 am
It has in other countries. And I think the private sector builds it, it’s just paid for by the government through normal channels, rather than coercing it through legislation.
Graham
at 11:14 am
For sure. I know in London, Ontario (obviously a different market than the GTA), the City of London partnered with EllisDon to build an affordable housing project — with some funding coming from the province and the feds.
Keith
at 11:11 am
Until the mid nineties, the federal government was financing and building 25,000 units of non market means based housing per year. The program was axed under the Chretien government, and the private sector has not been able to provide affordable housing.
I don’t see a private sector solution, between the price of land, the cost of building, the incredible increase in investor demand of all kinds, and the limits to the supply of construction labor. When I was growing up, there weren’t middle class mom and pop investors in real estate and the stock market. People had a work place pension, and GIC’s paid 6 to 19 percent. Who needed the risk and hassle?|
You can upzone land all you like, it increases the price per buildable square foot, and I doubt the development community would increase building of supply to the point that prices fell in any meaningful way. The private sector is not the route to affordable housing in very many large western cities – I can only think of Dallas Texas as the only one.
In the absence of a resumption of a massive non market public housing strategy, the alternative is to legislate affordability. This is a problem if the massive appetite for real estate falls and refuses to pay. The market has been unaffordable for a long time, and the effects on community and society are turning pretty ugly. Big problems require big solutions, and I don’t see the right leadership on this issue yet.
Appraiser
at 1:52 pm
I agree the government, at all levels must take action. According to the Centre for Urban Research and Land Development, the government owns a great deal of property. https://www.ryerson.ca/centre-urban-research-land-development/research/governmentpubliclandswebmapTEMP/
“Their land assets may be used to provide public benefits through public-private partnerships, partnerships with other governments or agencies, or with non-profit organizations.”
Sirgruper
at 1:27 pm
Assignment Sales are the perfect greater fool investment. Very few people understand the tax implications including many lawyers. Before the budget there was HST on the deposit portion of the assignment and on the profit portion. Did it get paid? Usually not and CRA was poor at taxing the HST and on taxing capital gains/income. CRA is getting better but buyers are not. How many buyers look at the box that says HST included/not included? Its a huge money difference but I’ve seen it missed again and again.
Condo’s are not like Birkin bags. As price hits a certain level, demand will fall. The smart money that I know that have done well investing in condos have stopped and are buying in other cities or countries. The buyer’s now tend to be users or parents buying for their kids. Even the developers are getting nervous but more so with the uncertain cost of construction than anything else.
Condodweller
at 5:18 pm
What I’m curious about is how is the government going to keep these units affordable? Surely, they can’t prevent an owner from selling nor put a limit on the sale price. As I understand, the rental units are a 99 year deal but what about purchasers? Are investors allowed to buy at the cheaper price if they guarantee the affordable rental rates?
Regarding HST simply increasing the price, wouldn’t people who were attracted to this simply stop buying once it’s not worth it anymore thereby freeing up supply and possibly making them more affordable going forward?
Alexander
at 7:37 am
Why would investors buy any if the legislation and policies do not change? My brother-in-law tenants are paying 2000 + for a 4 bdrm detached house in Aurora since 2017, all annual rent increases are pathetic. Allowed rent increase in Ontario for 2022 is 1.2% with real inflation at 8.5% or more. The current rate for similar properties is 3200-3400… As Keith mentioned all small investors are getting into housing and stock out of desperation and we should thank our government CPI calculations methods + outstanding returns on savings accounts NOT.
Bryan
at 1:19 pm
Because the value of that house in Aurora went up about 30% from March 2018 to March 2021 (the random graph I found only uses March for York Region). On a ~$1.2M 4 bedroom house that is about $360,000. Rent prices matter, but an extra thousand a month even over 4 years ($48k) pales in comparison to property value gains.
I think Condodweller has a really interesting question about how they intend to keep units affordable and what that does to investment. My understanding is that these “affordable” units will in fact have sale price limits (though there is a lot of misinformation floating around and I could be misinformed). So now imagine that $1.2M(2017 price) house in Aurora was limited to 3% price increases each year as well. That would put it at $1.35M, or about a $150,000 gain. With costs for repairs, capital gains, selling fees and the like, that now looks like a bad investment to me. Even worse, what prices weren’t controlled for 70% of the houses on that street? I would bet that the same amount of people would want to invest as do today (what with all the bad CPI and savings account returns)…. so would that not cause prices of those “non affordable” houses to go up even further as the same number of people compete for fewer places?
Alexander
at 4:16 am
I do not believe housing prices will go up indefinitely and now with QT and high CPI is certainly time to scratch your head and guess where we are heading with our housing market. What is going to happen if we will be back at 70-80’s mortgage rates in short to medium term and subsidized ( by government decree ) by landowners rents without exciting housing value gains?
Bryan
at 10:43 am
Long and rambling reply incoming…. be forewarned!
In modern history (since 1970), Toronto has had 2 periods where housing prices decreased. There was a long, gentle decline from 1974 to 1985 and a sharper decline from 1989 to 1996. Up until 96, I would say Toronto had a sort of “boom and bust” housing cycle. Generally gentle booms and busts but about every 5-10 years things would switch. Rising prices would fall a bit or vice versa. In the last 35 years though? All upwards. The dot com boom did not cause a drop, nor did the 08′ financial crisis or the COVID pandemic. I guess the question of “will prices fall like they did back then?” requires one to look at what was different back then. Like you say, interest rates were brutal…and those interest rates were caused by runaway inflation.
Let’s start with the first decline. In 1974, inflation in Canada hit about 12% due to the international oil embargo, and the Iran/Iraq war. Canada responded by raising interest rates from 6% to 12% and raising them all the way up to 21%(!) just prior to the 81-82 recession (that this caused). In the 11 years of prices falling, the GTA grew from 2.6M people to 3.2M people… or about 50k people per year. The second decline was seemingly much more intentional. Inflation went back up to 5%(from a steady 4%) in 1990 and the BoC introduced a radical change with inflation targeting and raised rates back up to 15% to bring down inflation rapidly. They then kept it in the 2-10% range for 30 years to maintain CPI. prices fell from 89 to 96 and during this time, the GTA grew from 3.7M to 4.2M…. or about 75k people a year.
So what we have here is a formula for price drops in Toronto. The BoC increasing interest rates rapidly over a very short time (to the 15-20% range) either in response to runaway inflation it failed to contain (80s) or as a new preventative policy to pre-emptively correct runaway inflation (early 90s)… all while the population does not grow enough for housing demand to keep up with the tighter borrowing environment. Is that where we are headed today? We certainly have the inflation issue (5.7%)…. but do we really expect that interest rates are going to go to 15-20% in the next 5 years? I sure don’t. Up until October, the BoC had actually been making QE purchases throughout the pandemic. They have eliminated those with only maturing bonds being replaced, and now they are just not replacing maturing bonds (QT). I think this lever will almost bring inflation back in line itself…. taking away the need to really lean on interest rates (which have a far bigger impact in real estate land). Realistically, we could maybe get up into the 5-6% range we were in from the late 90s to 2008 which will certainly soften price growth. That said, we now have population growth of 100k people per year to soften the blow… so while I think the real estate party (endless double digit YoY growth) may be temporarily suspended, prices will continue to slowly climb…. perhaps limiting the profitability of real estate speculation. That is, unless development slows as the article suggests. Those 100k people/year need to live somewhere….. interesting times ahead.
Mxyzptlk
at 3:12 pm
Excellent analysis, Bryan.
Further to your “prices will continue to slowly climb” scenario, from 1997 to 2015 the average resale price in the GTA never hit double figures, although 9% was exceeded three times. The average annual appreciation over that time was 6.18%
Since then, double-figure increases have occurred four times, although it must be remembered that prices dropped 4.21% in 2018 and only recovered by 3.97% the following year. As a result, prices have increased by an annual average of 9.88% between 2015 and 2021.
All this to say that although average home prices in the GTA have risen more in recent years than in the two decades previous, the difference is not, in my opinion, all that great (about 3.7 percentage points) particularly considering that overall inflation between 1997 and 2021 has been muted, to say the least.
Condodweller
at 3:45 pm
@Bryan Good analysis for those who have a longer attention span than that of a…let’s say the younger tweeter generation.
I can confirm everything you said though my experience doesn’t quite go back as far as the 70s. In addition, it’s important to note a few other factors at play today and the recent past.
1. The saying “they’re not making more land” is true. We have no space to build new housing in the city. (other than getting creative with zoning etc. )
2. Generational wealth supporting current buyers.
3. A multi-decade bull market (savvy investors were able to generate significant wealth to afford higher house prices that can’t be obtained by even two professional salaries.
4. High-paying high-tech jobs, even earning US-level salaries working remotely in Canada.
5. Bitcoin, yes it’s highly questionable and speculative but it has produced millionaires who can afford current house prices.
6. Immigrants are showing up with significant wealth and those who don’t already have it, tend to be hard workers/savers who can afford it in a few years.
Higher interest rates will put a damper on prices but it may not be sufficient to stop the increases. I’m curious where inflation will go and how long it will persist.
Toad
at 7:12 am
As someone already said, if the developer could sell it for $172/sqft more, they’d be doing that already. So the $1000/sqft example is already the most the market will bear. So it’s a bit of a logic flaw in the article. And no, developers will not just stop building (even though they’re currently pausing to see what shakes out).
But what the real “unintended consequence” will be is what David hinted at. Developers are pausing because that $80M condo will almost surely come down in price. And it’ll come down in price enough so that the $1000/sqft price on newly built units will still be economically viable for the delevoper since again, that’s what the market will bear in this fictious example.
So, the people selling their land/older houses will lose out because developers will offer less for land assemblies. But then end buyers will pay the same.
Which is better? We shall see, I guess.