In Canada, especially in heated real estate markets like Vancouver and Toronto, pundits are looking at the rush of condominium construction and wondering if this will be bad for the real estate market.

Thus far, however, the condominium market has defied expectations and continues to grow.  One reason for this is that while some of the demand for new condominium units might be real estate speculation, it’s not an investment that just sits there and does nothing. The populations of Canada’s major cities continue to grow, and these people need somewhere to live. This demand has generated a shadow rental market within these condominium buildings that have given condominium speculators enough income to make their mortgage payments.

This has led pundits to wonder if the shadow rental market is sucking demand from the purpose-built rental apartment market. I would argue this is clearly not the case. Already, you are seeing new buildings going up that are expressly purpose-built. Moreover, the shadow rental market isn’t taking anything away from the purpose-built rental market. Instead, I would argue that the shadow market is acting as an incubator for the purpose-built one.

The Rise of the Lifestyle Renter

When looking at the purpose-built rental apartment market, it’s important to note that there are two types of renter: the shelter renter, and the lifestyle renter.

The shelter renter is someone who rents strictly based on need. They need a place to live and they can’t afford mortgage payments. They settle for a place in a location that they can afford. This is too often seen as the stereotypical renter.

Especially in recent years, we have seen an increasing number of lifestyle renters who rent by choice. These renters can afford to buy a home or a condominium and make mortgage payments. He or she, however, does not choose to, for a variety of reasons. Perhaps they want to save their down payment for other things. Or perhaps they don’t want to be tied down to a particular address.

Lifestyle renters have the disposable income to choose where they live, and they are increasingly choosing not to live in large homes out in the suburbs, but in smaller apartments surrounded by amenities in the downtowns of cities. As there has been the lack of rental product in Canadian cities, these lifestyle renters who want modern buildings and top-of-the-line amenities wind up entering the condominium rental market, directly fuelling the condominium boom.

The Risk of No Tenure

Lifestyle renters who choose to rent inside condominium buildings do so at their own risk. They’re moving into buildings which have no tenure as rental buildings. If, all of a sudden, the owner of the unit decides he wants to sell the unit, and the new buyer wants to live there rather than handle tenants, the tenants have no protection.

In purpose-built rental apartment buildings, all units are built to be rented. The whole building is handled by one manager who is responsible for upkeep and security. That manager is responsible for applying credit checks and looking into previous landlord history, et cetera. You know that your neighbours have been screened just as you have. In rented condominium units, there is no single manager doing the same credit checks. You don’t have that same consistency, or clear responsibility.

On the management side, condominium rentals don’t stay in the marketplace forever. Rental apartments function much better for managers when there’s a whole building to manage, thanks to economies of scale. With condo owners renting out a single unit, if it’s empty for one month, you’re 8.5% vacant, and that’s a hard gap to swallow. Condominium owners are always in a precarious position when it comes to renting; cash flow can be tough, and managing just one or two units is difficult.

I believe that condominium rental units won’t stay in the rental pool for more than a few years. They are too difficult to manage as individual units and don’t have the cash flow for investors. I also believe that the condo rental marketplace is full of lifestyle renters who would much rather live in a purpose-built rental building if one was available. They want the protection and consistency that the condominium rental market cannot provide.

A Lot of Pent-up Demand

This pent-up demand is one reason why a number of condominium developers have shifted their developments towards purpose-built rental. Just as Tim Horton’s was the incubator that got Canadians into drinking coffee, new purpose-built rental apartments are the Starbucks that will come along and offer a better product with more choices for lifestyle renters.

So the rental condominium market is far from a threat to purpose-built rentals. Indeed, they are shaping up the market, increasing lifestyle renters’ expectations for quality. And once developers see that lifestyle renters are willing to pay for their quality and demand for choice, developers will move to meet that demand.