Vancouver developers crowd into the rental market

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It was only a couple of years ago that Vancouver’s presale condo market was so hot that you could flip a unit before it was even built, avoiding the closing costs and scooping up a tidy profit in the process. Now the condo market has cooled, however, and some of those presale owners who expected to make money are cutting their losses.

And the market slowdown means developers have been looking increasingly towards rental projects, with some even deciding to convert condo proposals to rental, especially as municipalities create enticements to build rental. The demand for rental housing in the region is high. Bryan Yu, deputy chief economist for Central 1 Credit Union, says that although housing demand will soften in the next couple of years due to COVID-19, it will pick up again once the market recovers and immigration numbers increase. About 80 per cent of the region’s population growth is driven by immigration, and those numbers will slow to a trickle into 2021, he says.

“I don’t think we can over build [rental], even if we see lower demand in the short term,” Mr. Yu said. “Once this period ends, you will have a backlog of people wanting to come into the country.”

Big institutional investors, such as pension funds and real estate investment trusts, have also been active. These new landlords have faith in Metro Vancouver’s rental market and are looking for lucrative investment opportunities. Some are even developing rental projects themselves, which means there’s competition for those properties.

Cam McNeill, executive director of MLA Canada, said the trend began in 2018, when the condo market started to slump. (His company helps developers decide what to build, including unit mix and amenities, and the type of tenants to target.)

“There was an interest in rental projects because the economics for rental were improving,” Mr. McNeill says. “There was a supply constraint. We were seeing rental rates rise. So we had the cost of bringing these projects to life coming down and the revenue side was coming up, and the tables were turning. The cities were able to give extra goodies to developers to entice them to build rental, and that alignment of planets started to motivate the developers.

“It is now becoming crowded – developers are competing over rental sites in an acquisition mindset.”

Vancouver realtor Ian Watt says the presale condo market is officially dead, at least compared to what it was. He recently received an e-mail from another realtor about two units at the four-tower development Lumina, in Burnaby’s Brentwood neighbourhood, close to the SkyTrain. The listing agent is looking to sell two contract assignments in the Starling tower at a discount of $50,000 each. Unit 1504 had been reduced from $788,900 to $738,900, and unit 2504 on the 25th floor had gone from $838,900 to $788,900. The tower is scheduled to complete this summer.

“All we’re seeing right now are end user buyers and maybe investors buying a small studio or one-bedroom, which is the way it should be,” Mr. Watt says. “The presales are so far above market value now that nobody in the local market will buy them.”

The discounted presale units in the e-mail are likely owned by someone who paid too much, he says.

“They bought thinking they would flip out, and they know they can’t complete on this. If they do, it would cost them at least $50,000 in GST and closing costs, and all those other things, why not take a loss now and get rid of it?”

Mr. McNeill says the hot market of a few years ago turned investors into speculators. Many of those flippers had originally intended to hang onto the properties, he says, but because the market was so strong, they ended up flipping, often encouraged by their realtors.

He’s seeing some desperate sellers in the current market, including people who’ve lost their jobs due to the pandemic. But he believes it’s more of a lull than a dead end for Vancouver’s condo market. Once the market recovers, Mr. McNeill says, big institutional investors will continue to build rental projects and a lot of developers will return to condos. In fact, at the beginning of the year, pre-COVID, all signs were pointing to a condo market revival based on pent-up demand and population growth.

“I believe the condo market will come back probably in the medium term, but absolutely in the long term, " Mr. McNeill says. “We were frankly starting to see that in the beginning of 2020, pre-COVID. We really had seen the [condo] market starting to surge back, and then COVID-19 was a double blow in the real estate cycle.”

Mr. McNeill says many developers simply can’t realize enough profit off long-term rental to make it the preferred choice for them: “The pendulum swung in the favour of the rental at the same time as the huge capital influx of that institutional money – and those investors are okay with 3.5-per-cent yields, while a developer is simply not going to bear the risk with that kind of yield. They are searching for much larger yields and rental doesn’t provide that.”

There are developers, such as Vancouver’s Cressey Development, who’ve built both rental and condos. They are able to respond to the market with increased development of rental properties that they hold onto for the long term. Cressey’s vice-president of asset management, Tom Johnston, has previously said rentals are a safe recession-proof investment. Cressey opened rental building Conrad at 1771 E. 18th Avenue in June, making use of government incentives.

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Geoff Nagle is director of development, Western Canada, for Morguard Corporation. Ontario-based Morguard has managed the Coquitlam Centre mall for decades on behalf of the pension funds that own it. The purchase was made with the expectation that SkyTrain would come through the area. Now that it has, Morguard is planning to build out the acreage with office, retail and rental residential towers as part of Coquitlam’s emerging urban core. The first proposed phase includes nine towers over podiums on a new street grid and the market will dictate how much rental gets built, and when.

There is no interest in building condominium projects because they don’t need the immediate returns, Mr. Nagle says. Residential properties have become a major part of Morguard’s investments in the last decade, with more than 20,000 units in North America, he says.

“The ownership group or pension funds are collecting long-term rent to meet their pension obligations. They don’t need more immediate term capital. They need long-term flow,” Mr. Nagle said.

“We’ll build as much as the market has demand for, we will bring it on in stages. If in the next decade there’s demand for three towers of pure rental residential, we will be happy to accommodate that. If there is demand for nine towers, so much the better.”

Mr. Nagle concurs that as the condo market has waned, competition for rental residential sites has become more heated: “As the condominium market slows, a lot of guys who were intending to build condo and purchased a site are now looking to be merchant builders. They will be looking to build rental residential and selling that to an institutional holder. So there will be more product generated, which is good from the perspective of market balance.

“But for every one conversion [to rental] that actually occurs, there are 15 guys looking for it.”

Not all developers can convert from condo to rental. Mr. McNeill says it’s a prohibitive process if the project has already been designed. And for developers who paid too much for a property, converting to a rental won’t make sense financially, Mr. Nagle says. In that case, he says, values will have to adjust.

“If you were halfway through a luxury condo building in 2018 and it’s now not selling very well – that’s an uncomfortable moment,” he says.

Although it can be a struggle to make the numbers work with rental, and the returns can take a couple of decades, it’s steady cash flow for investors, he says. And institutional investors will maintain the properties because they don’t want their assets to lose value, which is good for renters.

However, he is not a fan of government policies for rent or vacancy controls, which puts caps on rents, and makes development of rental residential less appealing: “Certainly the risk factors in rental residential are low, because we have a shortage of supply and stable demand. We’ve had historically low vacancy rates. But you have to layer in political risk: ‘Okay, who’s going to tell me I can’t ever sell this building or raise the rents or whatever other things that come along with rental residential?

“The fastest route to the destruction of rental stock or the unavailability of rental is rent control.”