With the creation of RRTZ, the province of British Columbia has enabled a new tool for Municipalities, to protect and secure rental housing from the multiple market forces that put it at risk. However, in our latest report, “Residential Rental Tenure Zoning: The Economic Effect on the Delivery and Maintenance of Rental Housing”, Professors Tom Davidoff and Owen Heany from UBC Sauder School of Business, explore the different economic ramifications of implementing RRTZ. The study shows that, although RRTZ is likely to meet the goal of slowing redevelopment to condo, it will probably raise new challenges for landowners of which policy-makers need to be aware.
In a typical market, we could expect landowners to redevelop once the cost of waiting to redevelop (discount rate times the residual land value) becomes larger than the gains from waiting to redevelop (current net operative income plus the expected capital gains on land). However, this dynamic changes when RRTZ removes the option of redeveloping to condo and properties see their value affected, as the value per square foot in purpose-built rental (PBR) buildings tends to be lower than in condo buildings. Though this difference is very sensitive to the context, we can expect landowners to be more willing to redevelop in higher density settings and vice versa.
The authors were able to estimate that under the current market conditions, upon the implementation of RRTZ, redevelopment could be delayed roughly 13 years. Moreover, one of the examples used in the report shows that such a delay could reduce the value of a property by up to 40%.
What seems logical is that, under these circumstances, rental property owners would be more willing to invest in maintenance and improvements to the buildings as they will perceive the returns from that investment for a longer period. However, this might be the opposite of the reality. The report notes that “unscrupulous or cash-constrained rental property owners might find it advantageous to reduce maintenance to such an extent that the building becomes unsafe without major repairs that necessitate removing tenants for a long period”. In this way, they might be able to realize increased rents generated by a substantially repaired building.
The study reveals that rental property owners face a different issue. In many cases, landlords depend on their borrowing capacity to finance any improvements and to make needed repairs in some cases. The amount of money they can obtain through mortgage financing is bound either by the total value of the property or by the potential to generate income. Given that the latter is currently the dominant constraint in borrowing, upon the application of RRTZ to a building, there is a limited risk of lost borrowing capacity due to reduced property value when RRTZ forbids condo redevelopment, especially in prime locations and very depreciated buildings.
The findings in this report bring to light the need for a more holistic approach to RRTZ. Without adequate, complementary policies in place, the implementation of this tool might end up harming the people it is intended to help. Cities using RRTZ must consider and plan for the risks associated with it to be able to protect renters and rental buildings. As explained in the report, such effects will differ from case to case and, in some, RRTZ might do just fine on its own. Some additional measures that should be considered when applying RRTZ include:
- Tenant protection policies could help renters in PBR buildings where major renovations could allow landlords to raise rents sharply in order to catch up with market prices. Special attention should be given in situations where rent controls are in place.
- Incorporate density bonuses and other up-zoning strategies to increase potential property values if the intent is to encourage the redevelopment of PBR buildings to higher densities under rental tenure. These measures could encourage interest in building new rental supply under current market conditions.
Because these policies will be subject to a property’s local context, the overarching policy goal should be to protect the security of renters while supporting the maintenance and expansion of the purpose-built rental housing stock. This report shows just how important it will be for municipalities using RRTZ to consider the effects that it could have on the value of properties and the corresponding behaviour of property owners and real estate developers. RRTZ is unprecedented and its implementation must be carefully considered and monitored to achieve desired social benefits.