I’ve been intimately involved in the affordable housing crisis for many years. Recently, I identified 14 causal factors that have led me to conclude that the purchase and rental of affordable housing will never happen until “affordability” is properly defined and the word “sustainable” is added to the front of that phrase.
One of the least understood and arguably the most abused affordable housing misperceptions is what I call The Affordable Housing Paradox: the higher the property tax, the lower the property value on which the amount of property tax is based.
Property tax is based on the assessed market value of an investment property, which is established from the property’s net operating income. NOI is calculated as all the revenue of every kind of the property minus all of its operational expenses of every kind. Excluded from this calculation are capital expenses (capex) and financing costs (particularly interest). The NOI is then divided by a market-established capitalization rate (cap rate), which you can think of as a one-year return on investment to the buyer (not seller). The result is the baseline value of a real property.
Cap rate is arguably the most difficult concept for new real estate investors, tenants and many Realtors to properly understand but it’s also critical to understanding property value and affordability. All lenders, the Municipal Properties Assessment Corp., informed Realtors and other property value-assessing entities call this calculation process the Direct Capitalization Method, although Realtors call it the Income Approach (versus cost and comparison approaches).
In Ontario, the Residential Tenancies Act (RTA) has an above-guideline increase process that indirectly assigns a multiresidential property tax of 20 per cent of the total revenue of buildings that comprise seven or more rental units, and 15 per cent for six or less units.
A curious dynamic of the NOI-cap rate calculation is that the higher the operating expense, the lower the property value. Property tax is an operational expense; the higher the property tax, the lower the property value. So, the more a municipality raises its taxes, the more equity it takes away from owners, which lowers the property value on which the property tax is based.
This is the Affordable Housing Paradox. The government’s multi-decades rent control program reduces income without controlling related expenses. Tenants, their advocates and the politicians who cater to uninformed tenant votes all believe the tenant wins with low rents. However, the lower the rental property’s revenue without a corresponding decrease in related expenses results in decreased NOI. Lower NOI leads to lower property value so property taxes also decrease because of the assessed lower value.
Low property tax sounds good at first blush but that really means less money for essential tenant services such as affordable social housing, adequately and competently staffed fire and police departments, education, garbage pickup, bylaw officers, legal aid, infrastructure construction and maintenance, social assistance programs, hospitals and much more.
It would seem that the simple solution would be to increase property taxes… but that increase once again reduces property value and so goes the vicious paradoxical circle.
Additionally, and also contrary to popular misperception, Ontario residential tenants pay the municipal property taxes, not landlords. This is built into the RTA. Landlords collect property tax on behalf of tenants in the same way that retailers and service providers collect HST on behalf of consumers. That means the government is covertly making all the market-rent-paying tenants cover the financial obligations and duty of the low-rent-paying tenants to cover the costs for the critical municipal services.
Since the mid-1970s, there’s been almost nothing at any level of government that addresses how to increase housing supply to meet demand. Incentivizing multi-billion-dollar developers and their billionaire owners is unwarranted. If government provides the right impetus, these companies will line up to build housing.
The National Housing Strategy is a start but it’s toothless without the proper organizational infrastructure and political will to implement it. Almost all housing affordability initiatives, strategies and tactics today address how to limit housing demand or such programs inadvertently contribute to increasing demand. For example, financial breaks for first-time homeowners may sound great but that incentive only increases the number of prospective buyers competing for the same diminishing housing inventory. Conversely, increasing the qualification bar for mortgages may have removed 200,000 Canadian families from the pool of competition but those same families didn’t move out of their rental properties, so the blockage at the top has a cascading effect of locking out new and low-income tenants from the low (“affordable”) end of the rental market.
Half of the solution to any problem is properly defining the problem. No one has “properly” defined the problem so no one can properly solve the problem. I mentioned that I’ve identified 14 major causes of rental and purchase housing unaffordability. They collectively occur at all levels of government in Canada. I believe the only way to resolve the housing crisis in its many forms is for the federal government to take the lead in establishing a vertically integrated, multi-level-government housing agency similar in organizational structure to the U.S. Homeland Security agency that compels all levels of government to share all information with each other related to their mandate and to work with each other to a common end.
Chris Seepe spent 35+ years in I.T. before entering commercial real estate a decade ago. He’s a published writer and author of two books on “landlording,” course instructor, president of the Landlords Association of Durham, and a commercial real estate broker of record at Aztech Realty in Toronto, specializing in income-generating and multi-residential investment properties. Call (416) 525-1558, or send him an email.