February 10, 2022
As restrictions continue to be lifted regarding the COVID-19 pandemic, companies in virtually all sectors are heavily investing in capital expenditures (CapEx) as consumers start accessing goods and services they have largely been cut off from throughout the pandemic. In the rental housing sector, many property managers had to suspend capital work planned for 2020-2021, and could only address emergency and necessary maintenance and capital needs in their buildings in order to remain in compliance with public health guidelines. Now, they are facing a backlog of capital needs to be addressed in a relatively short timeframe. These CapEx costs are posing a significant financial burden on Ontario landlords in the short term, even as the increased spending restimulates the economy. Several strategies have the potential for landlords to mitigate CapEx spending increases to maintain their bottom line.
A long-term strategic capital expenditure plan should be the first line of defense in ensuring no unforeseen large capital expenses creep up on landlords. Not to be confused with operating expenditures (OpEx) such as wages, taxes, insurance, equipment maintenance, etc., a thorough CapEx plan should include information on assets which provide a long-term benefit to the landlord and tenants, such as structures (foundation, windows, parking lot resurfacing, etc.), equipment (computers, security systems, printers, etc.), and appliances (laundry machines, stoves, refrigerators, etc.).
The CapEx plan should consolidate asset line items, along with funding requirements, projected time to break even on the investment, return on investment, the lifespan of the asset, and a replacement plan including the approval process. Typically, a CapEx plan will cover 5 or 10 years, and regular reviews and tracking against the plan will allow business owners to plan and budget resources for upcoming capital needs, without being blindsided by large unaccounted for expenses. Even with the suspension of much capital work throughout the pandemic, a thorough and consistently reviewed plan should mitigate surprise capital expenses following the loosening of restrictions.
Digital-First and Systemized Approaches
Many services and processes have necessarily moved online throughout the pandemic to allow for appropriate social distance. A digital-first approach could be applied to several items in the CapEx process, such as sensor-based condition monitoring, software for tracking and knowledge sharing, and digital storage of asset information for remote access. Also, a digital-first approach could mitigate some of the more operational costs associated with maintaining assets; when applied efficiently, this could prove to extend the life of certain assets, lowering CapEx costs. Applying standards in a systematized approach when reviewing the capital plan and maintaining assets on a regular basis will allow for greater up-to-date understanding of how a company’s assets are faring compared to the plan, and allow for easier maneuverability in mitigating risks and issues as they arise.
Above Guideline Increase
The annual rent increase guideline is a provincially set figure which represents the maximum amount a landlord can increase rent for tenants in a given year (for reference, the 2021 guideline is set at 2.2%). There are a few exceptions to the guideline maximum, for which landlords must apply to the Landlord and Tenant Board (LTB) for an Above Guideline Increase (AGI). The maximum increase permitted in these cases is 3% over the guideline maximum. One scenario where an AGI is generally applicable is where significant capital work has been recently completed in a building. For the LTB to approve an AGI for capital expenditures, the capital work in question must be:
- significant renovations, repairs, replacements, or new additions to the building or to individual units
- completed and paid for within an 18-month period that ends 90 days before the date of the first rent increase requested in the application
- considered an “eligible” expense, such as:
- is necessary to protect or restore the physical integrity of the complex
- is necessary to maintain health, safety or housing standards
- is necessary to maintain plumbing, heating, mechanical, electrical, ventilation or air conditioning systems
- provides access to persons with disabilities
- promotes energy or water conservation, or
- maintains or improves the security of the complex
A capital expenditure is not considered a valid rationale for a rent increase above the guideline if the item is replacing something which did not require replacement at the time.
COVID-19 Pandemic-Related Issues
Operating cash flow for many landlords was impacted greatly throughout the pandemic, due to deferred or unpaid rent, as well as needing to pay for personal protective equipment, cleaning and sanitizing supplies, and higher staffing costs due to increased cleaning requirements and potential hazard pay. Capital budgets should be completely separate from operating budgets, thereby remaining unaffected by a drop in operating revenue. Regular reviews of the capital plan and an established approval process will also allow for greater maneuverability in reallocating funds, or deferring work and funds to a later time.
Supply chain issues and staff restrictions and shortages are adding to the CapEx hurdles experienced in the housing industry. As landlords seek to address the backlog of capital work to be done, they may be faced with fewer staff and longer wait times for supplies and equipment. Capital planning should be adjusted as needed, should additional time and resources be required to complete scheduled capital work.
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