April 3, 2023

MARKET RENTS and Secondary Suites/ dwellings

October 19, 2023 Update

Rental properties are back making headlines again and this time it is around the subject of Short Term Rentals (STR)s such as AirBnB and VRBOs. While the full details are not clear, the intention from the BC NDP is to shut down all non-conforming STRs and the Canadian Fed is starting to weigh in. Some are even speculating they will go beyond and include properties whose zoning may already be interpreted to allow STRs but I feel that is gas lighting the issue a bit.

There is a list of exemptions and reference to addition exemptions to be made https://www2.gov.bc.ca/gov/content/housing-tenancy/short-term-rentals They have even referenced overruling on grandfathered properties (Legal non-conforming which means they were already operating as an STR before municipal zoning bylaws were introduced) which would be a very heavy hand as legal non-conforming is typical considered an important part of protecting the bundle of rights an owner assumed they were obtaining as part of the fee simple, real property market principles.

In the matter of equity how important is it to be able to determine what is a fair estimate of market rental income? How would you obtain reliable estimates for what a spouse or partner may be earning from a property(s) they have rented or that form a part of the subject of the dispute.

You may be interested to know that, even though the parties involved may be earning or could be earning from rental income, the professionals you may need to rely on to provide an unbiased opinion of value are unable to due to a technicality in their standards. In simple terms the idea is that an appraiser or cannot or should not provide an opinion of market rent as part of an appraisal of a specific property where the rent is in whole or in part based a use that is considered non-conforming or not legal. My interpretation is that this rule is meant to protect lenders and other parties from loss where they have made a loan or other financial arrangements based on an expectation of rental income that could be disrupted. Of course, the rule can apply to many other factors in an appraisal assignment but for the purpose of this discussion I am focusing on the rental aspect. I believe this rule should not apply to appraisers but should be focused on the lending side. This is not a new rule, it has been in our standards for years but it has only recently been enforced over the last couple of years which you can read more about in my original post.

This restriction, appears to unintendedly prevent appraisers from reporting those facts, particularly for non-lending assignments. Some appraisers are relying on work arounds for some lenders by providing what is referred to as a consulting assignment where an appraiser can provide market data but not related to a specific identifiable property. So they could say something like. Two bedroom basement suites in Surrey rent for an average of $2,300 to $2,700. But they can’t refine that down to a specific property which generally does not meet most lenders requirements. The appraisal associations may interpret this as a means to circumvent a rule which could be problematic for some appraisers, particularly where a lender was not made aware of this alternate method prior to the acceptance of the assignment.

My logic for the reasoning to remove this restriction from the appraiser side is two-fold. Firstly, appraisers should report data and facts not be police or regulators. An additional consideration in this matter is that, until recently, these reports were being provided, and many loans were approved based on that income. As these loans come due for renewal over the next couple of years, those that had previously been approved may no longer be approved without that income verification, particularly in a situation where everything has skyrocketed, and they will now, more than ever, need to rely on that income.

This could be a significant number, as most people in their right mind refinanced when rates became incredibly low in the post-pandemic era. This was timely since our previous low rates were in the 5-year range before that, so there will be a significant number of loans renewing in the next couple of years. (If you’re reading this outside Canada, we generally have shorter terms of 6 months to 10 years but most with 5 year (variable or fixed) and typical 25 to 30-year amortizations, unlike much of the US and perhaps some other regions where the terms and amortization are equal or similar.) Combine that with a trend that started in the 2016 to 2018 period and exploded in the post-pandemic era, involving reliance on income due to affordability issues.

Ignoring the STR issues for a moment, it is fairly widely reported that most municipalities in BC and I understand many others have been very lenient on non-conforming rental units and increasingly over the last few years due to lack of inventory and affordability. In my local area a have begun the process of requesting data from municipalities about the rates of complaints and suites shut down. For instance, Vernon, BC, a city of about 45,000, over the past 7 years (the statutory limit for retaining the data) reported 11 complaints. They require 3 separate complaints to take legal action and only one property crossed that threshold and was shut down. I did some calculations on the number of suites, approximately 1000 identified (that number is probably higher of which 135 are registered as legal. One suite shut down out of 865 suites in 7 years is a fraction of a fraction of what the mortgage delinquency rate is .15% for all of Canada or .11 percent for BC. Those numbers get even lower if the illegal suites are greater than the 865 identified as illegal which I am sure is the case. That also doesn’t account for the fact that the shutting down of a suite does not mean a mortgagor will default.

So appraisers should report the facts about what suites rent for and what the municipal bylaws are, if the suite is conforming or not and any data they can provide about the rates of suites being shut down. The lenders then need to step up to the table and state that they will not hold the appraiser responsible if they decide to loan based on the appraiser providing true and credible data. The lender and their regulatory bodies are better able to manage those risks. That should not be the job of the appraiser.

The second part of this should be obvious by now, lenders are not an appraisers only client and there are other parties who should be able to obtain this information from an appraiser. By allowing appraiser’s to provide this information it puts value back into that portion of the profession and it keeps the demand for this knowledge where it should be, coming from an unbiased professional who should be the most knowledgeable on the subject. By taking that away from appraisers it lowers the value of that knowledge. If appraisers are unable to benefit from the knowledge, they will not be able to spend energy or resources gathering and deciphering those portions of the market.

While this is not directly related to the recent AirBnB restrictions being imposed, it is a part of the same topic and it is yet another unintended consequence of government and regulatory bodies imposing overarching restrictions on market participants.

One caveat and to my knowledge this is not specifically what sparked this conforming use issue and there was never any attempt to my knowledge to distinguish or separate these two substantially differing portions of the issue; For residential appraisers, we must be extremely cautious around STR properties. While there are a few cases where a property may be rented in STR but may have a highest and best use as Single Family, therefore, no income or going concern analysis required, which would be a commercial assignment. (These will typically be properties where landlords prefer to not rent Long Term due to distrust of the Landlord/Tenancy Regulations or they may be seasonal second homes where they may choose to bring in some extra income but those properties are not traded based on income/profit.) but drawing that conclusion can be very difficult without analyzing the income and the potential adverse appeals of neighbourhoods with high STR occupancy rates, which is why most are cautioned to avoid any property that is reported to offer an STR.

May 4, 2023 Update

THIS IS A SIGNIFICANT ISSUE. Historically there has been lenience or lack of oversight on this issue and there seems to have been some complacency where lenders appear to have been able to receive market rents or increased value from appraisals in cases where a secondary suite was not a permitted use. While nothing significant has changed in the appraisal standards CUSPAP or USPAP, the increased reliance on secondary suites and tightened guidance from the relevant appraisal associations and lending regulators such as the OSFI has placed this issue under the spotlight which has escalated in intensity over the past few months. Both Appraisal Associations in Canada have now outright and clearly stated that no appraiser will be allowed to provide market rent for non conforming suites with little exception. Lenders, brokers real estate agents and borrowers please be prepared. If a borrower is intending on borrowing with contributions from a suite, either by additional income or even the value of the suite itself, it must in almost all cases, be a presently legal use. CNAREA appraisers may be able to proceed in areas where the zoning or regulations may be changing to allow the use but they must provide documentation to prove that is reasonably probable. AIC appraisers are faced with similar issues and I have noted some conflicting information but they appear to be held to a possibly even higher bar in this respect. If you need further clarification from that Association I suggest reaching out directly to AIC Canada or a designated AIC appraiser competent to provide further guidance on the matter. Depending on your area we may be able to provide some references, so please reach out to us if you are uncertain.

On May 2nd, 2023 CNAREA provided a further update, to members only at this point. Both associations are generally aligned on this matter. Both associations have made it clear that no appraiser may provide market rent for a non-conforming suite with limited exception. CNAREA appraisers may use an Extraordinary Assumption and/or Hypothetical Condition that the suite does or will meet the requirements with an emphatic reminder that the Extraordinary Assumption and/or Hypothetical Condition must be reasonably probable, which means being well-versed on what would be reasonably probable. Depending on the jurisdiction, that is likely more than having the correct zoning and may go into physical characteristics.

Lenders and RE Agents! Ensure borrowing applicants are prepared well in advance so they can assist and avoid surprises. Don’t wait for the appraiser to ask! In many cases, the information is not readily available!

In BC, appraisers will need to contend with the Provincial Governments proposed legislation to legalize secondary suites in all or most single family zones. However, from the CNAREA wording I am not certain at this point the proposal, that does not provide any details, could be considered a probable reason to assume that all secondary suites will be permitted.

(April 4, 2023 12:05pm PDT Just received a copy of an update on Market Rent reports from AIC. The AIC has apparently released this update in response to the April 3rd announcement by David Eby that the NDP intends on passing legislation to override municipal zoning by-laws restricting suites. https://news.gov.bc.ca/files/Homes_For_People.pdf ) SO WHAT DOES ALL OF THIS MEAN? If you read the AIC wording they do give appraisers an opportunity to proceed on a reasonable probability “If there is evidence that a municipality is changing its bylaws in the near future, a Member may be able to provide a Market Rent for a Secondary Suite” so I would assume that the legislation will be enacted and an appraiser can proceed on an Extraordinary Assumption following all of the guidance with the additional verification steps they took. THE CNAREA position appears to be generally similar (as of this writing they have not specifically responded to this new announcement) but keep in mind these associations are dealing with appraisers across Canada and not just in BC. The issue of compliance with safety standards is going to become the biggest issue for everyone involved. Once again, this type of knee jerk reactionary policy will cause issues but this has been boiling to the surface for some time and nobody should really be surprised. So now you can read the rest of this blog for reference but it is almost a mute point but keeping in mind just a few days ago it was relevant and there could be some back and forth on this issue, so having an understanding of the recent history may be helpful in understanding the issues.

(April 3, 2023, 1:00 PM UPDATE On the same day that I made this post, the BC NDP Leader later announced significant upcoming proposed changes to legislation. On April 3, 2023 in the province of BC, the BC NDP leader David Eby announced that all suites in BC will be declared as legal, overriding municipal zoning by-laws. Additional plans were revealed but more on that later. This and other new proposed legislation are reported to be coming in the fall of 2023. This will undoubtedly change things in BC, with some interim complications. As this was just announced today I will follow up on the details as they unfold.)

The original post;

Market Rents Reports are still a hot topic. It appears both AIC and CNAREA, the primary real estate appraisal associations in Canada, have made it very clear that an appraiser acting under the guidance of their respective associations is not permitted to complete market rent reports for non-conforming rental properties. However, the debate is still ongoing as many clients, including some major lenders, wish to receive a market rent report for situations where the rental use may not be documented as conforming or legal. As both of the respective associations represent appraisers across the entire country, there will be innumerable scenarios where a hard line for all to follow may cause issues.

I am primarily mentioning this to advise everyone in the lending chain, borrowers in particular, that they should be prepared. Prepared for A) that they will not be able to get a market rent if the rental property is not-conforming, or that B)They ensure they have the necessary approvals and documents in place prior to submitting an application. Waiting for the appraiser to identify the issue well into the process, will only cause delays and potential hardships for everyone involved.

The real conundrum is that as of this writing, it should be reasonably clear that an appraiser cannot provide an opinion of value for a non-conforming property even if it is reasonably probable that the rental will provide the stated income with no probable interruption. Obviously, there could be many situations where providing an opinion of rent would be inappropriate and where the non-conformity issue could likely interrupt the income to be relied upon.

It appears lenders and appraisers are unable to sufficiently convince the associations that they are not taking on unnecessary risk by leaving the decision to the discretion of the individual appraiser. Understandably, some of the lender wording that I have seen is not incredibly convincing, and as noted there would be a significant inherent risk with reliance on non-conforming property income. Although I have formed my own conclusions, acting as an appraiser, I must follow my association’s lead and stand behind their statements.

What are the solutions? At a time when municipalities are under a great deal of pressure obtaining verifications, approvals or permits will often be difficult or nearly impossible to meet lending deadlines? The only short-term solution I can think of is early preparation, next to that, clearly stated instructions from lenders that they will accept the report and manage the risk decisions with the reported non-conformity issues. Even then, they would have a lot of convincing to do. At what point does that become a public service?

Obviously, the long-term solution for probably the most common issue is for the respective municipalities to clearly state conformity and identify conforming properties rather than turning the old blind eye policy as long as there are no complaints or issues. The underground rental economy must be resolved to improve better access to financing and improved rental opportunities for both tenants and landlords.

The issue of legal or conforming suites is not new however, what has been brewing and bubbling to the surface is the nuances of when a lender will be able to rely on that income which has been a complicated issue. Historically, it has been a grey area and appraisers were generally left with their discretion on whether they felt the income from a suite should be provided. However, over the last couple of years or longer appraisal association have been urging their members not to provide market rents if the use was not conforming and legally permissible. By late 2022 and early 2023 those nudges, suggestions and warnings have turned into clearly worded statements, that appraisers acting in compliance must not provide market rent reports in these circumstances. So until further notice please do your diligence and ensure that the rental unit you are anticipating income from is compliant. You can read more in my post about How do I determine if my rental property is conforming?

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