There’s a lot of talk lately about a new bill that was passed recently by the Ontario government that might make condos more expensive for new homebuyers in the near future.
On the surface Bill 197, known as the COVID-19 Economic Recovery Act, is a fairly broad piece of legislation that doesn’t seem all that relevant to home buyers, but that is certainly not the case.
This new legislation could very well lead to increased costs for condo developers in Ontario. And as most people in the real estate world already know, condo developers are not in the habit of incurring losses.
Developers are forced to pass on the additional costs to homebuyers by raising the total price per square foot.
For the provincial government, the argument is that these changes will promote more affordable housing, but there isn’t sufficient evidence to back these claims.
What is evident on the surface is that these changes will bring about increased development charges and other fees that condo developers have to pay.
Oftentimes when the costs are too high, developers aren’t able to proceed with the project or end up including these costs into the final purchase price.
To be honest, no one can really blame developers for passing on additional costs to buyers because they’re certainly not in the business to lose money or operate at a loss.
Some argue that developers are greedy and only care about their bottom line. While this may appear to be the case, the reality is that there are a lot of objective factors that go into how developers price condos in the GTA and beyond.
Developers are not simply pulling random price per square foot numbers out of thin air.
The PSF is calculated quite carefully and takes into consideration changes in legislation such as Bill 197 that puts additional burdens on developers to provide affordable housing.
Essentially, Bill 197 is part of the province’s Bill 108 known as the More Homes, More Choices Act, and adds new changes in three key areas: development charges and levies, community benefits charges, and parkland dedication fees.
Development Charges and Levies
Various municipalities across the province have been advocating for the changes passed in Bill 197, which includes changes to the Development Charges Act.
Development charges are fees collected by cities for the development and redevelopment of land. These development charges that builders have to pay are a primary source of funding for municipalities to use towards other growth-related capital costs.
With the passing of Bill 197, development charges and levies will likely be going up.
Development charges and levies are not new fees and taxes that condo developers have to pay, but when new laws are introduced or old ones tweaked they can have a significant impact on condo prices.
What’s interesting is that the issue of government fees, levies, and taxes have been problematic even before Bill 197.
A recent report by the Altus Group for the Building Industry and Land Development Association (BILD) showed that Toronto has the highest government charges in North America.
The report shows that these charges add an additional $222,000 to the cost of an average new single-family home and $124,000 to the cost of an average condo development in the GTA.
Community Benefits Charge
Under Section 37 of the Ontario Planning Act, the new community benefits charge enables municipalities to request benefits in exchange for density-increasing amendments for development zoning.
Before Bill 197, there really wasn’t any calculation in place to determine what developers owed municipalities under the infamous Section 37.
The amendments to Section 37 now allow municipalities to impose community benefits charges towards land in order to pay for capital costs of services and facilities required as a result of the development or redevelopment.
Although there is a stipulation that the community benefits charges will not exceed 4% of the value of the land in question, these charges indirectly bias most GTA condo developers.
The only developments and redevelopments that are exempt or excluded from the community benefit charges are buildings that are fewer than five storeys tall or only have 10 residential units in total.
Most pre-construction condos in Toronto exceed these limits and unfairly target GTA condo developers who are known to build taller developments.
Parkland Dedication Fees
There is another change to what is called parkland dedication fees that appears to be beneficial to homebuyers.
The requirement under Bill 197 has a provision that ensures Ontario developers are dedicating enough green spaces to the developments they’re proposing.
While on the surface this seems like good news for homebuyers, it places another unfair disadvantage to Toronto developers who may not always be able to meet these expectations due to limited development space.
Residential developments are typically required to dedicate five percent of land towards green space, however developers in a densely populated city like Toronto don’t always have the ability to accommodate a lot of green space to their developments.
Developers do have the option of paying the city cash instead, but this can get quite expensive.
As an example, the Province of Ontario uses a formula of one hectare of land per 500 units, which is equivalent to approximately $20,000 to $60,000 in parkland fees in the 905 area code alone.
In addition, municipalities have the option of requiring that land be used towards park or other public recreational service as a requirement for any development.
Developers can dispute and appeal these fees, especially if the municipality has not provided proper justification for its parkland needs and requirements.
Consideration of Hard and Soft Costs
If we look back to the mid-1990s, the Progressive Conservatives actually gave developers a bit of a break on the development charges they had to pay for new projects.
Mike Harris was at the helm during that time and although developers were required to pay all of the expected hard costs, they were also only required to pay 90% of the soft costs.
The hard costs were not discounted because infrastructure costs were a burden the city had to pay because of local population growth.
The soft costs, on the other hand, were money municipalities needed to offer services for that growing population, such as parks and recreation, libraries and social housing.
The introduction of Bill 197 ends the 10% soft cost discount developers were receiving. Now developers pay the full costs of the development charges.
This is unfortunate for both developers and home buyers because ultimately that cost is going to be passed back down to the purchaser.
And according to the latest 2020 Canadian Cost Guide released by the Altus Group, the estimated hard and soft construction costs for new residential condos in the GTA for a 40-60 storey building ranged from $225 to $310 PSF.
It is important to keep in mind that there are assumptions about costs that may or may not play a role in the final build.
Take for example the potential trade disputes across the border that historically put tariffs on Canadian steel and aluminum, political turmoil in the United States, and rising consumer debt.
In addition, there could also be a shortage of professional contractors and skilled workers in some markets that make it very difficult and risky to predict exact construction costs.
Impact of COVID-19 on Land Prices
There is no denying that the ongoing pandemic has taken a toll on Toronto condo rental prices. But, what about land prices?
COVID-19 has caused borders to close and there was a trend in people perhaps choosing to live in the suburbs because of new work-from-home rules.
While rent prices dropped almost 20 percent year-after-year in downtown Toronto, the cost of land has not faced a similar fate.
Even the idea of rental rates dropping is truly a short-term trend brought on as a result of the ongoing pandemic.
Once borders reopen and immigrants flood the market rental rates are likely to resume their competitive edge, particularly in a market like Toronto.
Now the difference between rental prices and land prices on a whole is that developers are not building for the short term.
Most projects take at least 5 to 10 years from the date the land was acquired to final occupancy. This is an important point to reflect on because developers have long term plans in mind and are not as easily affected by short term trends.
In general, land prices are far more stable. And while no one can predict the future it is unlikely that we’ll see a negative affect on land prices any time soon.
Overall, developers spend a lot of time understanding the new and resale condo market conditions and factor in all of the fees and charges involved before settling on a firm PSF per unit.
For example, after considering the cost of land, construction costs, and other development charges, levies, and taxes, a price per square foot is chosen that may only leave the developer with a $150 PSF profit.
There is also consideration for zoned and unzoned land where a developer purchases land in either category. If the land is unzoned then this can create more risk for a developer because there can be additional costs and approvals necessary to make it work.
Toronto Has Highest Costs Per Square Foot for Condos
As average Toronto pre-construction condo prices exceed the $1,000 per square foot mark, it is important to quickly look at why that is the case.
What we see today is that developers are competing against one another for land and with the scarcity of land in Toronto it is not surprising that land values are increasing.
Meanwhile, we are also seeing fewer lots that are readily available to develop because of this shortfall in available land.
The outcome is one where the cost of land can only go higher for developers.
We can see this reflected in the earlier chart by the Altus Group comparing low-rise and high-rise costs in the GTA, Canada, and the U.S.
In addition, the 2020 Canadian Cost Guide gives us more concrete data regarding these costs. In the chart below we can see that there are a number of other variables that contribute to real estate development and infrastructure construction costs.
The report will help buyers understand more clearly why Toronto has one of the highest overall costs per square foot for condos across Canada.
So if someone is wondering why the cost of similar real estate asset types differ between cities like Toronto and Montreal, then the cost guide by the Altus Group will help.
This report shows us that the cost of labour and materials varies between markets, as do the standards and specifications for the various building types that exist.
For example, the specifications for a mid-level quality condominium in Toronto typically has higher building specifications than the same mid-level quality condo project in Halifax.
Also, the things that people often overlook when calculating costs are items related to climactic and code-specific variances that exist among cities.
As an example, an HVAC system that is setup in a city such as Edmonton or Calgary will be much different than the HVAC system required in Toronto.
Builders must factor in these variances that are ultimately reflected in the final costs.
There are also often overlooked costs related to premium materials and high quality finishes that are typical in Toronto.
It could be that the design and style that is customarily expected by clients in Toronto is different from those of another city that has a demographic with different needs or requirements.
Premium finishes differ from market to market, but things such as premium flooring, cabinetry, appliances, luxe condo amenities, and even upscale exteriors add to the overall costs.
Another often overlooked cost are things related to underground parking garages where premiums may exist depending on their location, soil and ground water conditions, as well as depth.
Someone reading this may be thinking this is over the top, but the reality is that cost is not something developers take lightly. Developers must factor in all related costs they incur when pricing pre-construction condos.
What any home buyer or investor needs to realize with these costs is that builders and developers are not pricing condos out of thin air or superficially. Cost is a real and highly technical calculation that is carefully planned before any condo project is brought to market.
That being said, investors should get comfort by knowing that historically condo prices have remained fairly constant over the past 25 years.
Impact of Increased Land Costs on Investors
Condo investors should not be too concerned with land costs associated with new condos in cities like Toronto because the intention of buying that asset should be to hold it for the long-term.
At minimum, most condo projects take at least three to five years to complete, which means today’s pricing is not the biggest factor.
Forward-looking projections on condo values often show a moderate price increase over the time it took to construct that new condo.
So if the rental market is not the greatest today, the long-term investor should not be making short-term decisions based on today’s market conditions.
Long-term projects for both the rental market and condo sales value are almost always net positive.
And while growth in different regions differ depending on location, historical data tells us that the condo market performed quite well.
For example, in the City of Toronto the rental market pre COVID-19 saw appreciation of over 30% and sales of new condos rise 58% over the past five years.
So yes new rules and government legislation such as Bill 197 can make condos more expensive, but as a real estate investor your long-term goals are the key to financial success when investing in the GTA condo market.