Financing & Economics of Affordable Housing Development iii
University of Toronto
The development of multi-unit residential housing is a complex, costly, capital-intensive, andrisky business, particularly for the major players: real estate developers, owners of rental build-ings, and financers of development projects and long-term mortgages. All expect their financialreturns to be commensurate with the risks they assume, and all need to cover their investmentof time, money, and expertise.The purpose of this paper is to help a broader audience unfamiliar with real estate finance tounderstand the economics of the major for-profit players, or “how they make money.” Betterunderstanding of the for-profit real estate business and the issues faced by for-profit players inrental development should help generate ideas for incentives (or ways to overcome disincen-tives) to stimulate greater private-sector involvement in creating affordable multi-unit rentalhousing.The paper uses simplified financial models to explain and compare the economics of for-profitcondo development, for-profit apartment development, and affordable rental development. Themodels show that a for-profit developer would need to charge luxury rents of more than doublean affordable rent level to reach a minimum acceptable profit margin. Charging lower rentsmeans insufficient income to cover interest costs – that is, bankruptcy. This is why it is not eco-nomically attractive for the private sector to participate in the creation of multi-unit rental hous-ing, particularly in large urban centres like Toronto.Toronto’s high land prices and construction costs, difficulty obtaining financing on favourableterms, and lack of incentives to create rental apartments make rental development riskier andless profitable than condominium development. This is true even for luxury apartments de-manding high rents, and even more so for affordable rental development, which is not econom-ically feasible without significant government subsidies.Even when subsidies are available, private-sector involvement in creating affordable rental ishampered by uncertainty about government commitments to programs that support the creationof affordable rental housing (such programs have sometimes been cancelled with little notice);government requirements that result in higher construction and operating costs for affordablerental buildings; and other irritants that make it difficult and time-consuming to obtain buildingpermits, zoning approval, and construction and mortgage loan insurance.What would it take to increase private-sector participation in creating or helping to preserve af-fordable rental housing? The people interviewed for this paper had many ideas that would im-prove the economics by reducing costs and risks and streamlining approval processes. Reduc-ing land costs, potentially by freeing up surplus government land, was considered mostimportant in combination with government grants or tax incentives. There were also ideas forreducing construction costs by lowering soft costs (such as those for environmental assess-ments or development charges) and by changing building codes to allow less expensive woodframe construction for low-rise rental buildings. Every development is different and many wouldlike to see a “menu” of incentives that could be applied as appropriate for the situation.