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Rent Supplements Fit Current Market Dynamics New Construction is Costliest Element of Proposed Strategy
May, 2008
By Will Dunning
The City of Toronto is currently engaged in a consultation process on housing strategies for 2008-2018. As part of this, it has established several targets to meet housing needs, with the intention of "focusing the action to be undertaken by governments, the non-profit and private sectors and the public, and to measure results."
Targets are aligned along six strategic themes and annual costs are estimated. The City estimates that this very ambitious set of targets will have a cost of $469 million per year over a 10-year period.
There is some ambiguity in the targets. While targets are set for a total number of households assisted, it is not clear how many households will be receiving assistance at any given time. For example, while there is target to assist 60,000 households to afford rents, this could mean that 60,000 households would be assisted every year or 6,000 households per year, or somewhere in between. For the option to create new rental housing, the objective is to assist 11,000 households over a 10-year period, but it is unclear how many actual units would be created.
At present, about 8,500 rental apartments are vacant within the City of Toronto. The vacancy rate is forecast to remain high and possibly increase further during the next three years. This increase will be due largely to the very high volumes of new condominium and rental apartments that will be completed during the period, which will draw tenants out of the rental market. During 2009 and 2010 there would be 10,000 or more vacant rental apartment units in the city.
Vacancies are widely distributed across the city and there are considerable vacancy rates at all rent levels. In particular, vacancy rates are elevated for units with below average rents.
The City of Toronto has an objective to expand the supply of affordable rental units by about 1,000 units per year. The units would be subsidized through the federal/provincial/municipal Affordable Housing Program and would have rents equal to about 80% of average. The subsidy cost (federal and provincial contributions) would be $70,000 per unit; municipal contributions would take the form of waiving various fees and taxes. While the value of these cost reductions can be calculated, it appears that little if any actual municipal expenditure will occur.
Given the current and anticipated levels of vacancies, there is not a pressing need to expand the rental supply, as many rental opportunities already exist at the level that is proposed for the new program - i.e. 80% of average. Moreover, for available units with rents above that 80% threshold, rent supplements could be used to augment the supply of units at the 80% threshold.
SOME PROJECTED SCENARIOS
This report uses two scenarios to analyze the costs of creating new units via the Affordable Housing Program versus through rent supplements within existing housing.
( In the first scenario, it is assumed that rents contracted under the program are at current average market rents - which then increase at 2% per year - and subsidies are used to reduce the tenants' costs to 80% of the market average rent.
In this scenario, the cost of a rent supplement approach is similar to the cost of achieving the same results through the Affordable Housing Program. On an actual cost basis, the cost of rent supplements is slightly higher (8%) than the cost under the Affordable Housing Program. On net present value basis, rent supplements are less costly, by 17%, than the Affordable Housing Program.
( However, if a competitive tendering process results in contracted rents that are 5% below the market average - which is a highly possible outcome, given current and expected market conditions - then the costs of rent supplements are substantially lower than the costs under the Affordable Housing Program. On an actual cost basis the rent supplement approach has an estimated cost 19% less than the Affordable Housing Program and on a net present value basis the cost is 38% lower. For a given amount of subsidy dollars the City would be able to assist about 50% more needy households if it used a rent supplement approach rather than new construction subsidies.
( If rent supplements are provided in situ for tenants in their existing situations, many of those tenants will be paying rents that are 5%, or even more, below the market-wide average. There will be many situations in which the costs for rent supplements are even less than in this second scenario and the cost savings resulting from rent supplements will be even larger than this analysis indicates.
There are additional considerations:
( There is uncertainty about the actual costs of new development under the Affordable Housing Program because development costs for apartments have increased rapidly and are continuing to increase. It is possible that projects that have already been committed will require further subsidies beyond the $70,000 figure. It is also possible that in future there will be increases in the required amounts of subsidies.
( During the past five years the average rent in the City of Toronto has increased by only 0.2% per year. Continued slow growth in rents may cause rental revenues of Affordable Housing Program projects to fall short of expectations, resulting in a need for future operating subsidies.
( The analysis assumes that Affordable Housing Program projects will not require any reinvestment. Over a 25-year horizon, that is a strong assumption and needs for reinvestment may necessitate additional subsidies.
( A rent supplement approach would give the City flexibility to provide partial subsidies. Rather than reducing rents to the point at which they are equal to 30% of incomes, in some circumstances the affordability gap could be partially reduced. For the households assisted, a partial subsidy will be better than no subsidy and this would allow the City to stretch available dollars further.
RISK MANAGEMENT
There are upside risks for subsidy costs under the Affordable Housing Program, whereas with a rent supplement approach these risks would be borne by property owners. The City, as well as the federal and provincial governments, would not be exposed to these risks under a rent supplement approach.
Yet another consideration is that commitments under a rent supplement program can be made for relatively short periods of time, perhaps five years. This will enable the City to take full advantage of current slack conditions in the rental market, as well as to avoid subsidizing new construction at a time when development costs - and therefore the associated subsidy requirements for the Affordable Housing Program - are very high. Should these market conditions change in the coming years and shift to the financial balance in favour of new development, then the City would have flexibility to shift funding away from rent subsidies.
Providing rent supplements within the existing stock of housing will, to some extent, stimulate new demands for rentals, which would contribute to lower vacancies and may result in rents increasing more rapidly than they might otherwise, thereby increasing the costs of rent supplements. This indicates that a comprehensive program response ought to include some expansion of the rental inventory.
The City of Toronto's consultation paper indicates that about six rent supplement opportunities will be created within the existing housing stock for every one unit that is newly built via the Affordable Housing Program. This ratio appears to be about right and should be sufficient to offset any demand that is stimulated by the rent supplements.
With a rent supplement approach the City would be able to provide financial assistance to tenants with their current dwellings. For the tenants this would eliminate the expense, inconvenience and disruption of moving. From the perspective of the City, it would reduce the cost of assisting tenants and it would avoid the financial risks associated with the construction of new rental housing - risks that are clearly very high at this time.
The preceding is an excerpt from Rental Market Opportunities in the City of Toronto, Implications for Assisted Housing Programs, a study commissioned by the Greater Toronto Apartment Association. For information about the full report, see the web site at www.gtaaonline.com. Will Dunning is Principal of Will Dunning Inc., an economic research firm specializing in housing market analysis. For more information, see the web site at www.wdunning.com. |