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Finding the Third Way

July 26, 2011

This week Toronto citizens will be lining up at the City Council’s Executive Committee to speak for or against a raft of proposed budget cuts. The debate has been framed as an either/or battle: raise taxes to cover a $700+ million budget shortfall, or cut services.

Toronto Community Housing’s $600 million-and-climbing capital backlog has likewise been framed as an either/or dilemma. The right says cut services: sell off 900 houses, trim operating budgets and forget about community development. The left says wait for the federal or provincial governments to step up to the plate.

Is there a third way – one that doesn’t depend on either selling out TCHC’s tenants or waiting for senior governments to act? According to a recent publication by the Social Housing Services Corporation, the answer is yes.

In his report, Financing Capital Improvements and the Renovation of Social Housing in Ontario, real estate financing expert Stewart Pearson looks at opportunities to refinance or recapitalize social housing to keep buildings in good repair. None of the options involve selling off buildings or cutting services to tenants. None involve increases to existing public subsidies.

We’re not the only ones with a problem

The report makes clear that TCHC is not the only one facing a capital repair crisis.  The problem extends to the approximately 260,000 social housing units across Ontario.

Many of these homes are over 30 years old – the age when any building, no matter how well built or maintained, typically needs to be refurbished. Most housing providers have been setting aside money every year, just as condominiums are required to do, in a capital reserve. (The exception was the old public housing inherited from the Province with no capital reserves at all. For these buildings, the crisis has been a long time in the making.)

But these capital reserves are not enough. Until all housing providers do a proper building condition assessment (housing readers take note!) we won’t know the full extent of the shortfall. But a 2002 study estimated that every unit would need to contribute $1,250/year to meet its needs — a figure confirmed in a 2006 study. The actual contribution? $560/unit.

And it’s not as if social housing providers can just raise rents, or even borrow the money to do repairs. According to the report’s best estimate, only 13% of units have excess cash flow that could be assigned to reserves, and 83% of Ontario units do not have the cash flow needed to qualify for additional debt.

But there is some good news too. 

Most social housing was financed through 35 or 50 year loans. Within 15 years 60% of those loans will be repaid and all will be repaid within 22 years.  In the meantime, current mortgage interest rates are much lower than they were in the 1980s and early 90s when most social housing was built. As these mortgages roll over, costs have been going down and so have public subsidies.

The housing sector has also done its part to pool resources. Mortgage renewals are managed centrally by the Ontario Government to get the best interest rates. And housing providers invest their capital reserves in a province-wide investment pool to get better returns than they could on their own.

Finally, social housing has proved to be a sound investment. CMHC insures social housing’s mortgages and, depending on the funding program, bills the province for any money it pays out. In fact, not a single social housing provider has defaulted. Private-sector rental apartments, retirement homes and long-term care facilities insured by CMHC can’t make the same claim.

A way forward

Within this framework, Pearson looks at a few options open to the private sector that won’t really help social housing in today’s environment — and one option that just might work.

He proposes a “wrap-around mortgage vehicle,” where:

  • payment for a housing provider’s CMHC-insured mortgage is taken over by a new lender, and a new loan agreement is registered. Under this agreement, the lender advances money for capital repairs, and agrees to fund the outstanding renewal balance.
  • interest due on the new funds is accrued until the original mortgage matures. At that time, the total outstanding funds – the remaining principal, the capital repair advance and the new lender’s interest costs under the original mortgage — are re-amortized based on a continuation of the housing provider’s previous mortgage payments.

The aim is to create a win/win/win: CMHC’s requirements are met; the new lender gets a respectable rate of return; the housing provider gets money now and monthly payments it can sustain; and we all benefit from renovated buildings available to serve the next generation.

Pearson also floats an idea from the UK – equitisation – that focuses on the value of equity financing rather than debt. It’s not an idea that will work in the Canadian regulatory environment, but it brings fresh thinking from a country experiencing unprecedented public spending cuts.

The $1.4 billion that got away

I’m no financing expert. But I hope those of you who are will dip into Pearson’s report. In the meantime, I can’t help observing there is a bigger issue.

Social housing subsidies are, for the most part, tied to mortgage payments. As these mortgages are paid off, the Federal government will save an estimated $1.4 billion / year.

Municipalities don’t benefit from this windfall. But they’re the ones on the hook to replace any units that become too run down to live in – an obligation that extends even after the mortgage ends. And they will be replacing these units at today’s prices, not the $50 – $100,000 they cost when they were built.

I understand Mayor Ford has some connections with Canada’s Finance Minister. It might be a good time to get on the phone.

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