RBC’s Recent Report on Rental Housing: Some Comments

RBC’s economics department recently (September 25, 2019) released a report written by Robert Hogue, a senior economist with the bank, entitled Big City Rental Blues: A Look At Canada’s Rental Housing Deficit. You can download a PDF copy of the RBC report via the following links.



Discussions about rental housing are music to my ears, so I downloaded the RBC report and read it. Working my way through, I found I had concerns with some of the points being made, so in this post I’ve pulled out a couple and used them as jumping-off points for further discussion.

High vacancies stabilize rents?

On page 1 the report states that “the market is deemed to be at equilibrium when the vacancy rate is 3%,” for which no source is given, although the report promises more information. On page 4 the report states that “historically across Canada’s top 14 urban markets, a rental vacancy rate of slightly more than 3% has been accompanied, on average, by zero real rent increases—that is, nominal rent rising at the rate of inflation.” The report implies that the 3% number is a benchmark based on historical data, but again no source is given. I’ve never heard of this 3% number or rule anytime during my fifteen-plus years in the rental housing industry. Where does it come from? Is it a rule-of-thumb Bay Street uses, or something internal to RBC? Is it based on research the report’s author has conducted, or is it based on analysis by CMHC or Urbanation or some group that tracks rental housing? I wish the report identified the source or the underlying methodology.

Let’s put aside the 3% and look at this more generally. Does a higher vacancy rate mean lower rents? Basic ‘supply and demand’ theory suggests that that in a high vacancy situation landlords will drop rents to fill vacancies to get rent revenues flowing again. However, there are reasons why landlords with high vacancies might not want to lower rents but instead raise them. First, in provinces with rent controls like Ontario, it’s rarely possible for landlords to raise rents by more than a small percentage per year (some new buildings are exempt from rent controls and I’ll discuss those separately). Landlords know they need to push rents upwards by a significant amount on turnover, the only time they’re able to do so, because if they don’t they risk ‘locking in’ the existing, pre-increase rents when the unit leases and is again restricted to the annual allowed increase. This means that it can actually make sense, if your building is under rent controls, to let units sit vacant for a while and hold out for higher rents than to rent units immediately at the same rents or with minor rent increases. Second, landlords in a high-vacancy market can choose to market vacant units harder to distinguish them from the competition and hopefully fill them without lowering rents, and possibly fill them at higher rents. I realize spending more money on marketing effectively lowers the ‘rent’ which the landlord brings in, but this cost will be cancelled out if it helps achieve a significantly higher rent. Third, landlords need to compensate for the revenue loss of high vacancies by extracting more rents for units which do get leased. This means higher rents.

As I noted, some rentals are exempt from rent controls in Ontario. The legislation and regulations have changed with every government, but basically buildings built after 1991 have been exempt from rent control, except for the small number of rental units built during a less-than-a-year period in 2017 and 2018. Because new and recently built rental buildings are expensive to construct, they need to achieve high rents to pay for the whole thing, which means that even in high vacancy markets new buildings need to achieve high target rents—they have no alternative, in fact, but to achieve the highest possible rents.

In no case, therefore, do high vacancies necessarily mean lower rents paid by renters.

Rented condominiums are part of the rental supply?

On page 3 the report looks at supply and demand, again. The charts compare completions and under construction rental apartments and condos, and show the percentage of condos which are rented. The accompanying text focuses on Toronto, stating that “Condo investors could potentially add more rental units by buying into the existing condo market. However, it’s improbable these alternative sources can deliver the high numbers… necessary to balance the Toronto rental market.” Although that’s correct, the problem is that condominiums available for rent cannot play much of a role in helping to meet demand for rentals in Toronto because they aren’t really rentals, or to be more precise, they aren’t reliable rentals. Why?

Several years ago I was told about a study conducted by a Toronto-based condo research firm which found that the supply of condominiums-for-rent in Toronto is gradually absorbed into the ownership market, in other words, newly constructed condos which were rented gradually shifted from being renter-occupied to owner-occupied over a period of ten years. This means that condos-for-rent need to be replenished each year by new condo construction if they are to provide a long-term supply of rentals. But at any time some of those condos being rented—or all of them—could be taken off the rental market, leaving only purpose-built rentals to meet demand for rentals. Condominiums available for rent therefore do not constitute a supply of stable, reliable, or long-term rentals and should not be considered so, especially when discussing demand or depth-of-market since they artificially inflate supply and understate the true “rental deficit” (as the report terms it). Basically, you simply can’t count on condo-rentals to help solve the rental housing shortage, so you shouldn’t count them in rental housing supply calculations.

Rent controls discourage new development?

On page 4 the report dismisses rent controls, “which only helps existing tenants only and discourages new rental supply”. Existing tenants deserve help as much as prospective tenants, in my opinion, so that’s not a good reason to dismiss rent control. Once existing tenants leave and new tenants move in, the new tenants become existing tenants and just as deserving of rent control protections as the previous existing tenants.

Does rent control discourage the development of new rentals? I’m sure it has for some developers, especially those with sites or projects which have narrow feasibility margins. But whenever someone claims that rent controls discourage the development of new rentals I always point out that CMHC data shows that a large number of purpose-built rentals were built during the 1980s and 1990s in Ontario, the period when rent controls had been in place long enough that developers would have know anything they constructed during that period would fall under rent controls, which means that rent controls did not discourage new development compared to the pre-rent control period. Today, of course, new rentals are exempt from rent controls in Ontario—and have been since the late 1990s—so the slow pace of new rental development we’ve seen since 2000 is likely due to other factors, not rent control.