A challenged condo or home development project warrants that the developer investigate rental development as an alternative exit.
There’s been a disruption in the marketplace with the rapid rise in interest rates that we’ve seen to date, with more in store in the near future.
This disruption has affected the condominium market and the single-family home market, where a large number of buyers who previously qualified for mortgages, at lower interest rates, will now not qualify or may be more hesitant to take on debt at current interest rates – which are double the rates of just one year ago.
It’s all about “who’s buying and will they close?”
Many condo projects that are in the planning stages, or even further along in the process, now face uncertainty in the future and condo developers should be looking at all the alternatives available to them.
Which option is best for a condo project?
Should the deal be cancelled? Paused? Should the developer continue as a condo as planned, or should they consider the alternative of pivoting and building the initially proposed condominium as a purpose-built rental?
It is our initial thought that large high-rise condo towers will have difficulty penciling out as a rental because of increased construction costs and flat rents in urban areas.
Rents in suburban areas and secondary and tertiary markets have increased more than in urban markets ─ and this increase in rents can sometimes offset or at least minimize the increase in construction costs, thus making the option of pivoting to a purpose-built rental more feasible.
Each project should be looked at individually in order to determine if a pivot to a purpose-built rental would be successful.
Some condo projects will not have the qualities needed for an apartment, but others might . . .
Home builders, depending on their stage of development, have the option of looking at the BFR (build-for-rent) model. This has progressed much further in the United States and there are a growing number of examples in Canada.
The disruption in the marketplace has been caused by interest rate increases, which many believe are a short-term phenomenon.
The prevailing thought is that more damage is coming to the short end of the yield curve and that the damage to the long end of the yield curve has already occurred.
Longer-term view for apartment investors
Apartment investors tend to take a longer-term view than condo buyers.
This means that since long-term interest rates are likely to be lower than short-term interest rates, apartment developers, who think in terms of 10-year IRRs, may be more likely to pull the trigger on an apartment development than a condo development.
We believe that some projects, depending on several factors, will pencil out as successful rental developments.
Looking at a deal in three potential ways: as a condo, as a purpose-built rental, or as an affordable housing project under CMHC programs, gives the condo developer more options than just continuing with the deal or pausing the project in this high interest rate environment.
As longtime apartment development market advisors, we are pulling together expertise on the topic for all types of developers – condo, apartment and homebuilders. We’ll conduct a deeper dive into the subject during an Aug. 4 Development Uncertainty: Condo and Home Builders seminar.