The future of condominium development is in the Middle

For decades, Toronto's development landscape has been shaped by the tower condominium. Driven by factors like lender requirements for pre sales, strong demand for investable product, the ability to use deposits as equity and costly regulations, the physical and legal architecture of the city was, for a period of time, seemed ordained as if from on high. But with permanent (or at least, long-term) changes to the interest rate and regulatory environment, developers specializing in the condominium space will need to think about diversifying their product offerings to reflect how these changes are creating a new development arena in Toronto.

The need to change is primarily driven by how condominium construction is financed, and who buys the end units. Traditionally (and almost exclusively), condominium construction has been financed by lenders who, as a precondition to funding, require developers to sell 60% or more of their units in advance. Buying in advance can mean buying far in advance - atypical tower can take 4-6 years from sales to occupancy, with some projects stretching out for more than a decade. This timeline - and in particular, its uncertainty - makes it difficult for end-users to commit to purchasing. I take myself as an example - 6 years ago, I was a single young professional living in a ~500 square foot unit. Today, I’m a husband and father of 2 beautiful girls. If I purchased 6 years ago for occupancy today, I don’t know that I would have picked the right unit, or even the right neighbourhood, for my family. Some people are better predictors of the future than I am, and will take the plunge, but 6+ years is a long time to wait for your family home.

This is where investors enter the picture. A significant portion of pre-construction condominium units are sold to investors who don’t intend to reside in the unit themselves, but intend to rent the unit out or sell for a profit on assignment. In an era of low interest rates and ever-rising housing prices, this made sense. So long as the trend was rising prices, investors could confidently buy into projects and either assign or hold, time being their greatest ally. Defiance of the usual logic of investing followed, as investors bought and held units with negative cashflow, where rents failed to cover the mortgage, taxes and common expenses. Investors were compensated (or so they thought) by steadily rising equity in the property.

The nature of the buyers dictated the built form of condominium projects. Investors look for the best return on their dollar, and with condominiums priced per square foot, but rents not scaling the same way, smaller units - 1 bedrooms and bachelors - have been preferred to larger units. Despite many municipalities using their best efforts to force developers to include 3 bedroom units, those would often be the last to sell, near completion, because the market wants what the market wants.

A new reality is setting in - interest rates won’t stay low forever, and perpetual price growth isn't real. For a true investor, price must be a function of returns earned by the asset, and the return on an investment in a residential condominium property is rent. There's little that can be done to improve that return on a residential condominium unit - an investor can improve finishings to attract somewhat higher rents, but the floor plate is usually as efficient as possible, there is no extra land or air in which to construct additional space and a change of use will be strictly prohibited by the declaration (think zoning but virtually impossible to change). For an investment in a pre-construction condominium unit to make sense, cashflow, not speculative future value, must be the determining factor.

Compounding the trends against the condominium tower are the incentives being offered by various layers of government to encourage purpose-built rental development, chief among which are the Canada Mortgage and Housing Corporation funding programs for construction and insurance programs for refinancing, as well as the new full rebates on HST offered by the federal and Ontario governments. On the CMHC side, the insurance programs (MLI and MLI Select) offer 50-55 year amortization periods loans (among other benefits, which helps properties cashflow in a way current condominium units, with 25 or 30 year amortized loans, cannot. And on the HST front, effectively removing HST from purpose-built rental give an automatic shot in the arm to purpose-built rental investing, with all other things being equal, purpose-built rental now costing around 8% less to the developer (HST is 13% in Ontario, but with HST fully rebated, input tax credits will be lost, so I’m ball parking the benefit a little lower).

This isn’t theory -Bullpen & Batory’s GTA High Rise Land Insights Report for Q1 2024 forecasts about 10,000 sales for this year, the lowest since the early 2000s. The same report discusses developer optimism about a bounce back, but for the reasons above, it’s difficult to see how pre-construction condominium tower units - at least, at current price levels, which can't go down much lower given the high cost of steel and concrete construction - can’t maintain the same market share. They will continue to sell, but at a slower pace and with much more consideration given by buyers to the current and projected market conditions of the project. To keep building steady and to lessen reliance on the investor class, developers should consider adding new development strategies to their portfolio.

This should include embracing ‘missing middle’ building typologies - multiplexes and small apartments - to develop homes for sale not just to investors, but to primarily owner-occupiers. This isn’t to denigrate investor participation in development, but to acknowledge that their needs can be met by a growing purpose-built rental industry, as limited partners, shareholders, or even as direct developers of new properties. Torontonians looking to own their own home -whether for security of tenure, for the pride of ownership, as a forced savings vehicle or otherwise - are the underserved market right now, and targeting product at them opens up new development possibilities.

With shorter construction timelines - multiplexes can be delivered within a year from shovels-in-the-ground, and small apartment buildings within two - buying into a pre-construction missing middle housing project can be an attractive option for families looking to secure a place in a desirable neighbourhood, next to good schools, parks and amenities. So why hasn’t this been part of the condominium development landscape for the last few decades?

I don’t have the full answer, but a significant portion of the blame lies with zoning and other municipal roadblocks. When most residential land in the city was zoned for single-family housing, going through a muti-year rezoning process wouldn’t be feasible if the outcome would only result in a handful of new units. The direct and indirect costs, together with the headache of going through a frustrating and discretionary process, needed to be amortized over a large number of units to make it worthwhile.

This has changed. With Toronto’s Expanding Housing Options in Neighbourhoods program, every residential lot in the city can now have a multiplex and a garden suite built on it as-of-right, and many of our major streets are now zoned for 30-60 unit apartment buildings. The permissions aren’t perfect (especially set-backs and amenity requirements on major streets) but even projects that don’t quite fit the current zoning can move forward with a higher degree of certainty, and a much shorter development timeline, minor variances being, by their nature, easier to obtain than a full rezoning.

Further regulatory changes can be made that will make missing middle typologies even more attractive to owner-occupiers. A crucial one will be eliminating the requirement for dual-stair egress above 2 storeys. This requirement leads to one of two outcomes: in larger buildings, a floor plate that requires a long interior hallway and units with only 1 or 2 exterior facing walls with windows, and in smaller buildings, a mishmash of staircases and elevations within a unit, to avoid the interior hallway. Allowing for single-stair egress will free up some buildable square footage, but more importantly, it will enable more attractive floor plates, and help architects design units that really feel like homes.

Operating at scale will be a challenge. With fewer units at each site, development offices will need to be lean and mean on these projects, and replicate scale however possible - whether by building standardized packages that can be replicated on similar lots across the city, or assembling lots in one area to roll construction crews quickly from site to site. Benefits to scale and standardization can be compounded by investing in panelization technologies that may not make sense for individual sites can return benefits by turning large parts of the construction process into an assembly line that can roll from project to project. The small size of each condominium also means creative solutions are needed for amortizing common expenses across units, which may include cross-condominium property management projects, amalgamations or developing for self-management - the latter may be a necessity, as qualified property managers are already in short supply.

Education will also be a challenge. Language will need to adjust - condo is too often used as shorthand for a box in the sky, so we’ll need to develop a new shorthand to refer to family-sized condominium units closer to the ground. The market as a whole will need to adjust to the idea of paying common expenses on a family home - with good, transparent budgeting, this shouldn’t be too difficult, as many of the costs included in common expenses are already costs of homeownership, but will take some time.

Make no mistake -the tower condominium is here to stay. This is especially true in the amenity rich downtown core, and next to rapid transit stations. But across the city, missing middle condominiums may be the best option for developers who want to smooth out project delivery timelines and stay in the condominium space while serving homebuyers looking to secure their long-term place in the most desirable neighbourhoods. Moving quickly to capitalize on new opportunities will come with risks, but the future will be here faster than we think.

The above article is for information purposes only and is not legal advice. If you would like to consult with Ben on an upcoming project, please email [email protected] ?