Incenting Purpose Built Rental Housing – A Primer on the Economics of Development CMHC Housing Policy Division April 20th 2016 Steve Pomeroy Focus Consulting Inc. & Carleton University Centre for Urban Research and Education (CURE), Ottawa Focus Consulting inc. CURE (C) 2015

Outline Long term trend in rental supply Why rental development not viable Key terms used Elements of a pro forma and illustrative examples How different incentives might improve viability/affordability Focus Consulting Inc. 2016

Rental Housing Production - Canada Focus Consulting Inc. 2016

Rental Trends - Ontario Rental on average 6% of all starts since 2000 Focus Consulting Inc. 2016 Focus Consulting inc. CURE (C) 2015

Assessing the economics of rental development: Developing and using a pro forma analysis Focus Consulting Inc. 2015

Rental Pro Forma – Key Terms LTV = Loan to Value Ratio Cap rate = capitalization rate (to estimate lending value) DCR = Debt Coverage Ratio NOI = Net Operating Income RoE = Return on Equity CMHC MIF Premium = mortgage insurance Focus Consulting Inc. 2016

Main elements of pro forma Operating Budget (revenue & expenses: establishes potential cash flow and NOI available to service debt Capital Budget - establishes total capital requirements (covered by mortgage and equity/grant) Underwriting terms – establishes maximum loan capacity (lender and CMHC as insurer) Focus Consulting Inc. 2016

Operating Budget Expenses Monthly rent Rental revenue Sundry Revenue (laundry, parking) subtotal revenue Less 3% vacancy (a) Gross Revenues Maint and Operations (incl management) Utilities Property Taxes (b) Total Operating (a)-(b) = Net Operating Income Focus Consulting Inc. 2016

Capital Budget – Land and Hard Costs Construction Budget* Renovation Conversion hard costs Stoves and Refrigerators Laundry Equipment Furnishings and equipment Other Surface parking Landscaping Equipment (apt elevator) Land Acquisition Land purchase Engineering servicing costs Legal fees Title Transfer Fees Soil geotech Parkland Levy Pre const interest carrying costs * Current hard costs $/sq ft range Basic wood-frame $100-$135 between Medium quality concrete mid-highrise $170-$220 Focus Consulting Inc. 2016

Capital budget – Soft costs Taxes during construction Insurance during Construction Utilities during const. Interest During Construction Legal Fees (excl land) Architect/Engineering Consultants Development Consulting Additional Public Fees and Charges Site Plan Application Building Permit Municipal Dev'l charges Mortgage application fees (excl MIF premium) PST/GST (HST) CMHC Insurance Premiums* * While a cost, these are amortized so not reflected in capital budget Focus Consulting Inc. 2016

Lending and Underwriting Criteria Strongly influenced by CMHC insurance criteria Sets method for establishing maximum loan (based on a max LTV or 85% and DCR of at least 1.2 if 10 yr term (1.3 if only 5 yr term) DCR more important than LTV Some reduction-flexibilities if target affordable rents waive premium, lower DCR to 1.0, incr LTV to 95% Focus Consulting Inc. 2016

How elements come together Capital Budget (Total costs to be covered) Operating Budget (NOI) Minimum Equity/Grant Required CMHC Underwriting rules Maximum Financing Capacity Viable Not Viable Focus Consulting Inc. 2016

Illustrative Pro forma (per unit) Typical new market (rents - $1600/mo) Operating Budget Revenues Rental Income 19,350 Gross after 3% vacancy 18,770 Operating Costs Maintenance and Operations 5,000 Property Taxes 1,000 Total Operating Costs 6,000 Net Operating Income 12,770 Capital Budget Land 28,000 Construction costs 160,000 Soft costs 32,000 Subtotal 220,000 HST (Net at 5.2%) 11,440 Total Costs 231,440 (excludes CMHC premium) Assumes mix 1 & 2 Bed; rents @ 150% of AMR (of $1,075/month); Taxes at new multi-residential rate Focus Consulting Inc. 2016

Illustrative Pro forma (per unit) Determining potential to carry debt and thus required equity or grant – based on NOI Total Cost 231,440 NOI 12,770 Lending value @ 6.5% Cap rate 196,724 Maximum Financing Based on lowest of: a) 85% of Lending Value 166,986 b) 85% of Cost c) Achieving Minimum 1.2 DCR (3.5% mort) 177,613 Max financing (mortgage loan) Required Equity/Grant * 64,454 * Amount of required equity impacts RoE Focus Consulting Inc. 2016

Combining elements Focus Consulting Inc. 2016

Eg 2: Rents at 100% AMR (use with rent supplements) Exhibit 2 Rent at 100% AMR ($ per unit)   Development Costs Land 28,000 Ave rent/month $1,075 Construction 160,000 Soft costs 32,000 Total Cost 220,000 HST 11,440 Project Costs 231,440 Financing Equity 146,270 <-- Less leverage = more equity/grant  Mortgage Financing 85,170 Less leverage = smaller loan CMHC Insurance Premium 3,833 (added and amortized) Total Mortgage 89,003 Revenues, Costs and Cash Flow (Rents and operating inflated at 2%) Year 1 Year 5 Year 10 Revenues 12,513 13,963 15,417 Maintenance & Operations 5,000 5,412 5,975 Property Taxes 1,000 1,082 1,195 Total Operating Costs 6,000 6,495 7,171 NOI 6,513 7,469 8,246 Mortgage Payments 5,332 Cash Flow 1,181 2,136 2,914 Cash-on-Cash Return 0.8% 1.5% 2.0% Unattractive rate of return on equity  Focus Consulting Inc. 2016

Pro forma for affordable (80% AMR) Exhibit 3 Affordable Rent 80% AMR ($ per unit)   Development Costs Ave rent/month = 834 Land 28,000 Construction 160,000 Soft costs 32,000 Total Cost 220,000 HST 11,440 Project Costs 231,440 Financing Equity 178,996 <-- Large grant/equity required Mortgage Financing 52,444 <-- Significant reduced loan capacity CMHC Insurance Premium No CMHC premium, higher LTV 95% Total Mortgage Revenues, Costs and Cash Flow Year 1 Year 5 Year 10 Revenues 10,010 11,171 12,333 Maintenance & Operations 5,000 5,412 5,975 Property Taxes 1,000 1,082 1,195 Total Operating Costs 6,000 6,495 7,171 NOI 4,010 4,676 5,163 Mortgage Payments 3,142 Cash Flow 868 1,534 2,021 Cash-on-Cash Return 0.5% 0.9% 1.1% Focus Consulting Inc. 2016

Options to enhance affordability Reduce costs: Waive Municipal fees and charges CMHC premium waiver for affordable rents Zero rate HST (not done in Fed Budget) Contribute Public land (reduce or eliminate land cost) More basic construction (wood, surface parking) Increase Revenue Mixed income with full market to cross subsidize affordable (vs. 100% affordable) Utilize rent supp/allowances, and retain market rent Focus Consulting Inc. 2016

Options to enhance affordability LTV constrains max financing to $85,000 vs. DCR @1.1 (= $120,000) Focus Consulting Inc. 2016

Focus Consulting Inc. 2015

Exploring implications What is policy objective? Stimulate supply (private market); or Address affordable rental need Focus Consulting Inc. 2016

Incenting market supply Options to improve net income Reduce or eliminate property taxes Energy efficiency(tenant vs. owner) Optimize rent at max possible Options to lower costs Basic construction (WF vs. masonry) Waive some public fees and charges Exempt rental from HST Land at below market cost Focus Consulting Inc. 2016

Incenting market supply Options to provide low rate financing No impact on cost Increases leverage of a fixed NOI Translates into larger loan (re DCR) and lower equity Thus enhances RoE Focus Consulting Inc. 2016

Addressing affordable rental need Can we build affordable housing? Reduce size/quality Limits to options on cost side Provide rent subsidy/housing allowances Avoids distorting viability of development Build at real cost, optimize financing/grant mix Specifically target low incomes Avoid project based oversight, admin cost Focus Consulting Inc. 2016

Questions and Discussion Focus Consulting Inc. 2016

Thank you! Additional background reports available at www.focus-consult.com