Are Federal Housing Incentives Working?

Tens of billions of dollars later, what's really going on?

Canada’s housing crisis has definitely attracted a lot of attention. In response, we’ve seen a host of program launches, including:

• Rapid Housing Initiative

• Housing Accelerator Fund

• Co-operative Housing Development Program

• Canada Secondary Suite Loan Program

• Canada Housing Infrastructure Fund

• Urban, Rural, and Northern Indigenous Housing Strategy

• Canada Rental Protection Fund

• Affordable Housing Fund

And that’s just what’s coming from the federal government. Some of those initiatives are now administered as part of the Affordable Housing Fund. That fund includes the Apartment Construction Loan Program (ACLP) - formally known as the Rental Construction Financing Initiative (and before that, the Affordable Rental Housing Financing Initiative). Because the ACLP is particularly heavily funded, I’d like to use this post to take a deeper look.

There’s value in asking ourselves two questions:

1. Does the program make sense from a real-world perspective?

2. Is the program actually successful?

The Business Case for ACLP Loans

The ACLP provides long-term, low-cost, CMHC-insured loans of at least $1,000,000 for construction projects by for-profit or non-profit developers. The loans could cover as much as 100 percent of costs. Applicants must have experience and a financial profile appropriate for such a venture.

Projects must result in total residential rental income at least 10 percent below their gross achievable residential rental income. In addition, at least 20 percent of units must offer rents at or below 30 percent of the median household income in the target market.

Beyond that, projects should be built for a minimum of 15 percent more efficiency in energy consumption and GHG emissions than the applicable reference model building codes. To their credit, the program recently introduced greater flexibility in that area.

To assess whether a project with such constraints is even possible, I ran the numbers for a hypothetical 100 unit property using a 50-year amortized loan for $25 million with a fixed rate of 4.5 percent. I included both the costs and offsetting operational savings associated with complying with the added environmental requirements. I also assumed that:

• The average rental price for a unit in my target market is $2,600 per month

• The median household income is $75,000 (30 percent of this would be $2,250 monthly)

• We’d experience a 90 percent occupancy rate

• We’d spend 40 percent of our Gross Achievable Residential Rental Income (GARRI) on ongoing operating costs

Rough estimates based on those assumptions suggest that, after accounting for vacancies, rental discounts, and operating expenses, we’ll see an annual net operating income of around $1,617,840. Our annual mortgage payments (assuming 4.5 percent on a $25 million, 50 year loan) would be around $1,258,169.

That would give us an annual operating surplus of $359,671. On paper, at least, the program makes sense, although it is perhaps a bit too close to the edge for comfort.

Considering the new capital gains rate

If the goal of the ACLP was to inspire developers to undertake new construction projects, then we need to look at this from an all-of-government perspective. With those razor-thin profit margins, investors will be looking to potential gains from an eventual sale of their property. And recent changes to the capital gains tax will have an impact on that calculation.

Consider this scenario. After ten years, our developer wants to cash in on his investment. He’ll still owe $23.8 million on that $25 million loan and selling the property will probably gross around $40 million. That’ll trigger a capital gain in the area of $15.5 million.

Under the old system, where only 50% of capital gains were taxable, that gain would cost him around $2.3 million (assuming a 30% marginal tax rate). But under the new Liberal capital gains regime that taxes 75% of those gains, our developer will be on the hook for an extra $1.15 million in taxes.

Given the tight profit margins and the many risks involved, that tax penalty alone could be a deal breaker.

Is Anyone Using ACLP Loans?

Concerning the ACLP, the Canada Mortgage and Housing Corporation (CMHC) recently reported:

“As of March 2024, the federal government has committed $50.97 billion to support the creation of over 146,000 units and the repair of over 286,000 units.”

But we have no idea how the program is actually going. How many units are currently under construction and how many are occupied? Considering that its first $2.5 billion in funding was announced all the way back in 2016, that’s interesting. The Globe and Mail already noted the lack of performance data for this program back in June 2023, and it doesn’t look like much has changed since.

I asked an experienced real estate analyst for his thoughts on the program. (Full disclosure: he’s also my son-in-law.) Here’s part of what he told me:

NYC and Los Angeles probably have the best commercial real estate capital available in the entire country and, nevertheless, both face affordability problems. Both of those markets are giant case studies demonstrating how having lots of financing capital will not in itself solve affordability problems. What they share in common is high demand for limited space (uncontrollable) along with a convoluted regulatory environment and inefficient government (controllable).

Financing 100% of anything ignores Econ 101 and will almost certainly cause malinvestment and fraud on a massive scale.

So it wouldn’t be barking-mad crazy for a developer to take advantage of the ACLP program, although it’s not going to be a particularly attractive proposition. But the program probably won’t directly address the real roots of the housing affordability crisis and is far from a guarantee of positive outcomes. And providing this level of financing to players with no skin in the game is begging for trouble.

I hope to explore one or two other federal housing initiatives in future posts.