In a previous edition, Winter 2000 of Skyviews,
I outlined a method of 'Measuring Upside'. This analytical
method was devised to measure what seemed to be an unrestrained
upward rent trajectory. The pendulum has swung the other
way and a 'rental-supply-shortage' mind-set that developed
over twenty-five years is giving way to the realization
that the affordability of home ownership and the continuing
delivery of investor-purchased condominium units are imposing
a degree of equilibrium on the traditional apartment market.
In this new market context, three types of rent structures
have emerged:
Firstly, many buildings continue to have long-term
tenants whose rents remain suppressed by the lingering effects
of the previous rent control system. While the Liberal government's
intention to repeal vacancy decontrol seems clear, this
structure provides the capacity to absorb guideline rent
increases to offset increases in operating costs. Depending
on the degree, this rent structure may be able to absorb
above-guideline-increases. Of course this structure is the
most desirable. A recent sale of a rather average 41-suite
building in the 416-suburbs with this type of structure
reflected a capitalization rate of only 6.7%. A half point
premium may apply to buildings outside the GTA.
In an 'at market' rent structure, rents for
incoming tenants roughly match those for the existing tenants.
While there is no rental growth, or erosion, a building
with a flat rent structure is exposed to net income erosion
as operating expenses rise. Expected increases in utilities
are of particular concern. Recent sales of buildings in
Toronto with this type of rent structure have reflected
cap rates in the low to mid-7% range. Once again, a half
point premium may apply to buildings outside the GTA.
Many landlords were adept at managing buildings
under the soon to be repealed Tenant Protection Act. In
addition to rent gains achieved under vacancy decontrol,
above-guideline-increases were achieved under the operating
expense and capital recovery provisions of the Act. While
their rent trajectory was impressive through the late 1990s
and into 2002, these buildings are now exposed erosion as
the rents for incoming tenants fall below rents for existing
tenants.
The question is: How do you determine which
type of structure a building has? As an appraiser, I have
devised the 'Internal Comparison' tool for profiling rent
structures. It compares the total monthly rent to rent levels
that have been achieved on recent apartment turnovers.
To illustrate this point, take three identical,
1960's walk-up 'brick boxes' that are found in clusters
in may established neighbourhoods. Each building has 10
1-bedroom and 10 2-bedroom suites. Buildings A, B and C
have total monthly rents of $16,500, $18,000 and $19,000
respectively. In the past six months, several one and 2-bedroom
suites have been rented at $850 and $950 respectively. If
all tenants turned over at these 'market' rates, the total
monthly rent would be $18,000. On this basis, building A
has upside of about 9%, building B is 'at market' while
the rent structure at building C is exposed to erosion by
about 5%.
These scenarios are more pronounced in the GTA where rental
growth has been sharp in the past several years. The rental
growth curve has not been as steep outside the GTA as such;
the exposure to erosion is typically less. While these points
set out a general valuation context, the parameters of value
will be specific to each building.
This 'Internal Comparison' presents the ability
to profile a building and determine the degree to which
upside, or erosion exposure exists in the rent structure.
For more information:
Sandy Mandel, AACI,
P. App.
Sanford Mandel & Associates Inc.
Tel: 416-489-4883
Fax: 416-487-9539
Sanman@sympatico.ca
