Government Key to Resolving Canada's Real Estate Challenges

The stability and resilience of Canada's real estate market – which has withstood every economic downturn for the past 40 years - are undisputed. Yet, both single and multi-family sectors currently grapple with notable challenges. One concern is the widening gap between housing supply and an ever-increasing demand, largely attributed to Canada's growing population. With the existing rental stock falling short, the impact is felt significantly in the rental sphere.

This mismatch, says Adam Dean, Vice President & Portfolio Manager at CMLS Asset Management, has resulted in an upward pressure on rents. It is a double-edged sword: while it's beneficial for lenders as it ensures the preservation of value, it translates to rising costs for renters.

“From a valuation standpoint, it's something that we really like about the market and are comfortable investing in that universe,” Dean says. That being said, Dean acknowledges that the flip side reality is less than favourable for tenants who face rising rents, sometimes by several hundred dollars monthly when they need to relocate.

The solution to narrow this gap, he believes, hinges on even greater levels of government intervention.

“Government has done a great job with initiatives to help to bolster new affordable rental supply through different insurance products and even direct government funding, but it has a long way to go in terms of closing that gap,” he says.

The year leading to 2022 posed further challenges for the Canadian real estate sector. Developers and investors found themselves in a spiral of escalating costs, from construction materials to labor. Add to this mix, the spike in interest during construction phases, owing to the prevalence of floating rate debt, and the picture gets even more complex. This scenario inevitably has translated to a need for more up-front equity and a subsequent dependence on consistent rental returns post-construction to safeguard a project's economic feasibility.

Given that it is unlikely for costs to decrease naturally, government programs like the MLI and CMHC's insurance products are essential to promote affordable rental construction in Canada and address the housing supply gap, Dean says.

“It's hard to think of solutions that don't involve government,” he says. “(Government can) spur the development of affordable rental construction in Canada. I think that is what's needed to continue to help close that gap.”

On the Single-family residential real estate side, Dean believes its allure remains high as ever as a lucrative investment domain. Here, investors are presented with an array of robust investment options, primarily via mortgage investment corporations. Despite potential property value fluctuations nationwide, the investment dynamics, particularly the strategy of capping investments to a 60-70% loan-to-value ratio, ensures that capital remains shielded from drastic market swings.

The multi-family residential sector in Canada offers unique challenges, distinguished by its expansive loan structures and sizable properties. This domain’s opportunities may be less frequent and come with greater financial obligations.

“On the multi-residential side of things, it is a little bit of a thinner, investable universe. And again, that is just because there's larger loan sizes, there's larger borrower responses, larger properties. So, you need scale to be able to access that market in a manner that works,” Dean says.

Dean points to external factors, such as supply chain disruptions and U.S. rent control policies, that can indirectly affect the Canadian economy and interest rates, as a concern. These elements, combined with the gap between Canadian and U.S. median rates, don't necessarily mirror the Canadian economic landscape but could push rates up in an already over-leveraged consumer market, leading to instability. “So, I think those are concerns that we have,” he says.

He also mentions the need to monitor emerging markets like China, especially if there are continued signs of economic slowdown. Despite these global concerns, Dean's primary focus remains on the Canadian market, specifically on the interest rates and their impact on a market currently carrying significant leverage.

“It all comes back, in terms of us being focused on the Canadian market, to what happens to interest rates and how that affects a market that has a decent amount of leverage embedded into it right now,” he says.

But in the face of these complexities, Dean remains optimistic, particularly about the fundamentals of the underlying real estate being financed.

"Whether single family or multi residential, it comes back to…the significant imbalance of supply and demand and what it's going to take to close that gap. There are negative implications to that, but from an investment perspective, and investing in the debt on those assets, there's just a whole lot of downside protection to values and strong fundamentals that's going to drive income levels.”