How a Direct-to-Buyer Development Charge System Can Save Homebuyers $68,000
The best part: It's mostly paid for by big banks and developers, not governments.
Highlights
A previous MMI piece illustrated how transitioning to a transparent, direct-to-buyer development cost charge (DC) system can reduce the price of a new condo in the City of Vancouver by over $68,000. This led readers to ask for more details on how the system would work and where the savings come from.
Under the current DC system, the builder or developer pays DCs when they receive a building permit. They are financed through a construction loan, which carries interest. The developer then marks up the DCs and interest, incorporating them into the final price. Because these costs are embedded into the price, they are subject to HST and land transfer taxes.
In a transparent direct-to-buyer development charge system, DCs are treated similarly to HST and land transfer taxes, and are listed as a separate line item on the price of a home, rather than being embedded in the home price. The homebuyer pays them on closing. Because DCs are now treated as a separate tax, they are made exempt from HST and land transfer tax, eliminating a tax-on-tax situation.
In our Vancouver Condo scenario, the homebuyer sees the price of their home reduced by $68,216. These savings are the result of $14,766 in reduced interest payments to the big banks, $21,795 in reduced revenue to developers, $8,355 in reduced federal taxes, and $23,301 in reduced provincial taxes. The municipalities do not see a reduction in taxes or DC revenue in this model; however, they do receive their DC payments later than in the current system, which does have an opportunity cost.
Ultimately, it is up to the provinces to adopt such a system, but the federal government can play a role by committing to exempting DCs from HST under a direct-to-buyer system and making the adoption of such a system a requirement in housing and infrastructure funding agreements with the provinces.
How to lower the price of a new home by $68,000 with one simple trick
A previous piece, "British Columbia Can Substantially Lower Housing Costs with One Simple Trick”, used a case study of a newly constructed condo in Vancouver to show how the adoption of a transparent, direct-to-buyer development cost charge system could lead to the home's cost to the buyer falling by over $68,000.
A number of readers reached out, wanting to learn more about the mechanics of a system that can lead to lower home prices, increased transparency, and the elimination of the unfair tax-on-tax on development charges. Here is a primer.
How the development cost charge system currently works
In most development charge systems (sometimes referred to as “development cost charges”; we will use the acronym DCs), the developer pays for DCs and related fees when obtaining the building permit, typically using a construction loan that accrues interest as the home is being constructed. They then apply a markup (to meet the minimum profitability requirements of obtaining financing) to those DCs and the accrued interest, and embed those costs into the final price of the home. The buyer pays for the home upon legal possession, which, in the case of a condo, can be several years after the developer obtains the building permit. Because the DCs (plus interest and mark-up) are embedded in the final price, they are subject to GST, PST, and land transfer taxes (also known as property transfer taxes), creating a tax-on-tax situation. These cascading costs add tens of thousands of dollars in additional expense to the cost of a home.
How a transparent direct-to-buyer development charge system works
When a buyer agrees to purchase a new home, the DCs (and related municipal fees) are listed as a separate line item on the invoice for that home. The municipality agrees to “lock in” those DC rates at the time the initial deposit is made, thereby creating cost certainty for the buyer. Because those DCs are listed as a separate line item, assessed to the buyer (rather than the developer), they do not need to be financed by the developer, nor are there any margin requirements associated with them. The developer is bypassed entirely, and instead, the DCs flow directly from the homebuyer to the government.
When the buyer pays for the home upon legal possession, the developer remits the cost of the DCs to the municipal government on behalf of the buyer, in the same fashion that they remit the GST to the federal government.
When DCs are embedded in the final price, they cannot be exempted from GST, PST, or land transfer taxes. But by listing them as a separate line item and treating them as a direct-to-buyer tax, they can be exempted from those taxes, in the same manner that GST is not charged on land-transfer taxes. This saves the buyer thousands of dollars by eliminating taxes on DCs.
Edited to add: Currently, homebuyers can typically include HST payments in their mortgage and amortize them over the life of the mortgage, whereas typically LTT is paid entirely upfront by the homebuyer. A transparent, direct-to-buyer development charge system should treat development charges similarly to HST, ensuring they can be rolled into a mortgage. Additionally, governments should consider reforms that make it easier for LTT payments to be included in mortgages, thereby reducing upfront costs for buyers.
Eliminating taxes on DCs is also the right thing to do. While there is merit to having new homebuyers contribute financially to the construction of new roads and libraries that benefit the entire community, charging them sales taxes on their contribution to public goods is unjustified.
Who pays for the $68,000 savings to homebuyers?
Economists famously have the saying, “There is no such thing as a free lunch”, and that would seem to apply here, as the savings to homeowners are from reduced revenues for other actors in the system. For our Vancouver condo example, the savings break down as follows:
Big banks: $14,766
The financial institutions that provide the construction loan to the developer see their interest revenue drop by $14,766, as the developer now needs to take out a smaller loan since they are no longer financing the development charges through the project.
Developers: $21,795
Yes, developers. The dirty little secret in all of this is that developers make money on development charges and related fees, assuming the project is developed in the first place. Financial institutions, when making construction loans, require projects to meet a minimum profitability threshold to ensure they are not taking on too much risk. The developer then has to mark up all of their costs in their pricing to ensure they are meeting, if not exceeding, that threshold. Remove some of those costs, and the threshold for profitability is lowered.
Despite this revenue drop, in most cases, developers would benefit from governments adopting a direct-to-buyer DC system. Extra costs can render a project economically unviable, preventing the home from being built at all. Larger loans lead to higher risk and negatively impact the company’s debt-to-equity ratio. There is also a risk for the developer that development charges may increase before the permit is obtained. Finally, there is an administrative burden on the company, as it must act as a flow-through entity for these costs.
In short, while the developer does receive financial compensation under the current DC system, it is insufficient in relation to the additional risks and costs. By instituting a direct-to-buyer DC system, the developer experiences less hassle, and the buyer benefits from lower prices.
Maybe there is a free lunch here after all.
The federal government: $8,355
The federal government loses $8,355 in revenue, as the price of homes is now lowered; consequently, GST revenue falls, and the GST is removed from DCs. While a small cost to the federal government, it eliminates the ethical issues surrounding the assessment of sales tax on contributions to public infrastructure, and the federal government will recoup some of these costs through increased homebuilding volume.
The provincial government: $23,301
While British Columbia does not assess PST on new home sales, it does have a provincial property tax (PTT). The cost reduction in our example is unusually large, as the drop in sticker price now makes the home eligible for a PTT rebate. In general, the size of provincial tax savings from a direct-to-buyer system is highly dependent not only on the size of DCs but also on how provincial taxes on new homes are structured.
Municipal governments: $0 (Sort of)
There is no reduction in tax or DC revenue under this system, except in a handful of areas, such as Toronto, which would see a small decrease in land transfer tax revenue. However, under this model, municipalities would receive their DC revenue upon legal possession, rather than upon issuing a building permit. This delay has an opportunity cost for the municipality, as a dollar today is worth more than a dollar tomorrow.
Implementing a direct-to-buyer DC system is relatively straightforward and would increase fairness and transparency
Provincial governments would ultimately be responsible for adopting a direct-to-buyer development charge system, though both the federal and provincial governments would need to exempt direct-to-buyer development charges from the taxes they assess (HST, land transfer taxes, and the like). The federal government can accelerate this process by committing to removing the HST from direct-to-buyer development charges and by making the adoption of a direct-to-buyer model a requirement of future federal-provincial infrastructure and housing funding agreements.
The benefits to the buyer are numerous. Not only do they receive lower prices, but they are also no longer burdened by the unfairness of being assessed HST on their infrastructure contributions to the community. A transparent billing model ensures that buyers know exactly how much they’re paying in development charges and related fees. It is a win-win-win system that governments should adopt as soon as possible.