The Financing and Economics of Affordable Housing Development: Incentives and disincentives to private-sector participation — Full 50-page Research Report

The development of multi-unit residential housing is a complex, costly, capital-intensive, and risky business, particularly for the major players: real estate developers, owners of rental buildings, and financers of development projects and long-term mortgages. All expect their financial returns to be commensurate with the risks they assume, and all need to cover their investment of time, money, and expertise.

The purpose of this paper is to help a broader audience unfamiliar with real estate finance to understand the economics of the major for-profit players, or “how they make money.” Better understanding of the for-profit real estate business and the issues faced by for-profit players in rental development should help generate ideas for incentives (or ways to overcome disincentives) to stimulate greater private-sector involvement in creating affordable multi-unit rental housing.

The paper uses simplified financial models to explain and compare the economics of for-profit condo development, for-profit apartment development, and affordable rental development. The models show that a for-profit developer would need to charge luxury rents of more than double an affordable rent level to reach a minimum acceptable profit margin. Charging lower rents means insufficient income to cover interest costs – that is, bankruptcy. This is why it is not economically attractive for the private sector to participate in the creation of multi-unit rental housing, particularly in large urban centres like Toronto.