The Toronto real estate scene appears to be grossly misinformed when it comes to rent controls. Since Ontario announced the Fair Housing Plan, real estate agents, developers, and even politicians have said the province is attacking landlords. You’ve probably heard someone on the news, or even a friend, discuss how the “unfair” the new Rental Fairness Act is. They’re under the impression that the new controls will force landlords to rent at a future loss. Turns out the Province isn’t that mean, and the fear mongering is bulls**t. Rent controls are designed to preserve cap rates, while preventing predatory increases against tenants.
First, WTF Is A Cap Rate?
There’s one term you’ll need to know in order for the rest of this to make sense – cap rate. Cap rates, for those that don’t already know, is the percentage of net operating income (NOI) that a landlord makes, compared to the cost of the rental. Oh yeah, if you’re not an accountant, the NOI is the amount of annual rent the landlord charges, less expenses. Basically, a cap rate is the percentage of profit you’ll make annually, compared to the price you paid for the rental unit.
Still unclear? Let’s work through a quick example. Let’s say you buy a condo for a $1,000,000, and decide to charge a tenant $8,000 per month for rent. That works out to $96,000 annually. Let’s say taxes, maintenance, and insurance remove 10% of that value. In this magical world, there’s no other costs. Your NOI would be $86,400, and your cap rate would work out to 8.64%. Look at you, you know how to calculate cap rates! Remember this term, because we’ll come back to it later.
Ontario Fair Housing Plan, and Expand Rent Control
The new Ontario Fair Housing Plan extends rent controls to almost all rental units. This means if you bought a condo, and decided to rent it out, you’re probably bound by rent control guidelines. The maximum amount the rent can be raised is limited to the Consumer Price Index (CPI) for that province. For example, this year your rent can only be raised by 1.8% in Ontario, as outlined in the Rent Increase Guidelines.
Real estate agents, developers, and even politicians think this forces landlords into an unprofitable situation. The most commonly cited example I hear is “what if condo maintenance fees, or property taxes rise quickly? Landlords shouldn’t be forced to take a loss.” From a casual market observer, that’s a valid question. From someone in the industry, it’s either ignorance or propaganda. The province does not force landlords to take a loss, they can apply for an “Above Guideline Increase.”
Above Guideline Increases
The Landlord Tenant Tribunal, the peeps in charge of enforcing guideline increases, confirmed to me, that landlords may qualify for an above guideline increase. If the landlord faces a sudden rise of expenses, they can apply to have the province accommodate the new costs, even above the guideline. They just need to prove that the costs are necessary, “extraordinary,” and not frivolous. Structural issue? That might qualify. Want to make a cosmetic change and charge the tenant? Probably not. Point is, they can make valid rent increases. They just can’t raise rent whenever they want.
Source: CMHC, Government of Ontario, Better Dwelling.
Rent Control Tackles Quickly Rising Prices
Rent controls don’t impact cap rates, they control rising home prices. If you can apply for an above guideline increase, you’ll likely maintain your cap rate. The only people that are impacted, are new investment property buyers. These people can’t just offer 18% more than the previous buyer, and pass on the new cap rate to the existing tenant. Like many people had begun doing in 2016.
The real reason the industry is against rent controls, is it cools condo prices. Buying an existing rental property means you are now buying the cap rate, as is, for the most part. This limits the price increase on the unit, because who buys a property with a s**ty cap rate? This in turn impacts comps, which throttles the whole system of price increases.
Fun Fact: These types of buyers that buy a rental property at inflated prices are called “predatory landlords” by The City of New York. The reason being, if you pay a high price compared to rental income, you likely intend on raising rent by a lot. The city now publishes a list of people that do this automatically, to help determine who’s displaying a pattern of bad behaviour.
Killing the ability to raise rents by as much as a landlord would like, kills rapid price increases. This is especially true for secondary units in the condo apartment segment. If you entered your career as a landlord with a decent cap rate, you should expect it to hold up fairly well. If you enter it with a terrible cap rate, expect that to last the lifetime of that property. There’s a reason you don’t see a lot of professional landlords buying after rapid price increases. It’s not because of those darn Liberals ruined the market.
Those about to argue that rent should be controlled by the free market, are right in my opinion. We should have a free market. A free market includes the elimination of taxpayer guaranteed mortgage backed securities, and banks controlling their own risk. No taxpayer liquidity injections that exceed the market cap of the bank, when they screw up. Until then, government controls are going to be needed.
Update 4:21PM EST: The manager of the Ontario Ministry of Housing has reached out, and would like me to clarify: A condo landlord can apply for an AGI, to show that the fee increase was the direct result of an allowable increase. Keywords being “direct” and “allowable.” I’m guessing if the fee increase is the result of something trivial like a condo rebrand, they’re not going to let you pass that on to the tenant.
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