The search for Akelius-proof rental investment

“We don’t just need housing supply. We need the right supply.”

It’s an important message advanced by Ryerson City Building Institute’s Cherise Burda, Creative Housing’s Jennifer Keesmaat and many others.

But as we consider new housing development, let’s also give a thought to the “right supply” we already have: the over 600,000 purpose-built rental homes that house most of Toronto’s low and moderate income families.

It’s a supply we can’t take for granted. According to CMHC, by 2020 — just two years from now — 80% will be 40+ years old, 66% will be 50+ years old and just over 25% will be 70+ years old.

The non-profit housing sector, which was built at roughly the same time, shines a light on the investments that will be needed. For example, Toronto Community Housing is marching through a ten-year plan to invest $44,400 per unit — $2.6 Billion altogether – in its 58,500 homes.

For TCHC, the key to re-investment is a proper funding formula. For private landlords, we have a separate system to facilitate re-investment. That system allows long-time landlords to continue to raise rents by the Rent Increase Guideline even after they have paid off their mortgages and their expenses drop. The surpluses generated by these rents can then be re-invested directly in the building or leveraged to re-finance. Landlords can also apply for an Above Guideline Increase for extra-ordinary capital expenses. And when tenants move out, the landlord can refurbish units and recoup the costs through new, higher rents.

Raising rents to do repairs? Or doing repairs to raise the rents?

The problem with this system, of course, is that many tenants’ incomes have not kept pace with even the Rent Guideline, let alone Above Guideline Increases or rents on vacant units. According to the 2016 Census, 166,095 renters in Toronto CMA pay more than 50% of their incomes on housing.

But there is another problem. Our current system is based on the premise that landlords may need to raise rents to pay for repairs and upgrades. But what about landlords who reverse the equation: who want to do repairsfor the purposeof raising the rents.

Take, for example, Akelius: the Swedish-owned investment corporation that owns 47,177 rental units in Europe and North America. Akelius makes money by raising rents.  According to their surprisingly candid 2017 Annual Report, Akelius avoids luxury properties where rents have already peaked, and has recently sold their profitable but stable buildings in Swedish or German mid-sized cities. Instead their strategy is to “cherry-pick” buildings in “metropolitan cities with a soul,” political stability, a strong business climate, high walkability, a growing population, and a younger population than the national average: Berlin, Hamburg, London, Paris, Copenhagen.

In North America, acquisitions are focused on just five centres. Forty-two per cent of Akelius’ North American portfolio is in Toronto — a city it describes as “one of the ten most financially powerful cities in the world” (p. 26) — followed by Montreal, New York, Boston and Washington.  In a 150 page report on international operations, Parkdale and Brooklyn were singled out for “strong improvements.” (p. 12). Unit upgrades are described as “profitable and optional.” As the report notes, “Akelius upgrades because it is profitable and our customers appreciate high quality.” (p. 58)

Company-wide, Akelius’ average rate of return to investors was 12.5% in 2017, 20.7% in 2016, and 17.7% in 2015. Across Canada, the growth in Akelius’ rental income was 9.5% in 2017, with a growth in net operating income of 28.2%. (p. 89)

The returns in Toronto? A 7.25% increase in rents/square foot between 2016 and 2017 (p. 26). Akelius’ summary of international rent regulations notes that in Toronto “new rents are set freely. . . . When modernizing properties, the rent for existing tenants can be increased by up to nine percent above the regulated rent over a period of three years.” (p. 76)

I haven’t had a chance to read up on Timbercreek, Starlight or other companies that seem to have a similar model, but the risks of this approach to rental investment are clear.

What can be done?

Some of it is already being done. Tenants are alert, organized, and have had some success in rolling back rent increases. Governments have, over the years, offered low interest or forgivable loans for energy retrofits or other upgrades in exchange for continued affordability. And the Tower Renewal Project offers an inspiring model for rejuvenating post-war “towers in the park” while achieving a host of other goals.

What else should we be thinking about?

Giving tenants first right of refusal when their properties are sold. It’s what they do in Washington DC.  The DC “Rental Housing Conversion and Sale Act of 1980” requires owners selling their buildings to give tenants the first opportunity to buy it. In buildings where more than 50% of tenants want to convert their building to a co-op or condominium, and more than 50% have low- or moderate- incomes, the District will help tenants organize and provide technical assistance and low-interest loans to buy the building. And the District is now developing regulations to reserve its own right to buy buildings with 5+ rental units (with 25% of units deemed affordable) if tenants aren’t interested.

How do they pay for this initiative? Through the District’s housing trust fund. DC is required by statute to contribute at least 15% of land transfer taxes on all property sales to the fund, and tops up that contribution with general city funds, with federal block grants to fund tenant organizing. Is this an approach that might work in Weston, or other parts of Toronto where gentrification has not yet taken hold?

Fair property taxes. Earlier this month I wrote about equalizing property taxes between homeowners and rental housing to reduce operating costs without cutting into the repairs budget. The key, of course, will be ensuring tenants receive the benefits in reduced rents or in upgrades they actually want. Otherwise we are just boosting Akelius’ investment returns.

Different kinds of rent control. I understand entirely why activists want to eliminate AGIs and vacancy de-control. But I’m wondering whether there are other options that would give both landlords and tenants the predictability they both crave, while allowing landlords who have historically kept their rents low to upgrade their buildings when they need to. A topic for another blog!

Helping tenants pay the rent. Housing benefits are the most targeted way to support the lowest income renters. Would they work in an Akelius building, or just fuel rising rents? Perhaps the City would need to position itself as an “activist investor” who makes sure its own financial contributions to rents are paying off in quality stable housing.

Other ideas? The comment box awaits!