It’s the dream of millions: to own a house and plant your flag on a piece of property. This achievement, which for many begins as soon they start collecting a pay cheque, is tangled with emotion, memories and attachment. It can be overlooked, therefore, that these bricks and mortar often represent a person’s most significant investment asset. For the high-net-worth, expanding their real estate portfolio is a more cold-blooded transaction aimed at generating long-term appreciation and/or rental income.
The appeal of real estate investing is that it’s a hard, tangible asset compared to stocks and bonds, which are valued subjectively and, as a result, susceptible to volatility. Diversification is, as they say, the only free lunch in investing so your portfolio should include both. There are, however, distinctive pros and cons that should be understood before creating your real estate empire.
On the plus side, real estate is relatively easy to understand – you buy, maintain or enhance your property, rent it out if you want, and then look to sell at a higher price. The downside to this process is that, compared to buying a stock, it’s harder work. It’s also expensive, illiquid, incurs significant transaction costs, and there is no guarantee you’ll make a profit. However, there can be tax benefits, it’s an effective hedge against inflation and, crucially, over time the profits can be sizeable.
Residential real estate
Within a year of the Great Recession, housing values in Canada’s largest city began increasing just as they had prior to the downturn, owing to savvy investors pouncing upon falling prices. In that respect, investors reinvigorated a real estate market that had, at the time, suffered its greatest setback since just before a previous recession at the dawn of the ‘90s.
It’s recoveries like this that partially explain why residential real estate is the most popular asset class in Canada’s largest cities. Most salient of its largely indomitable fundamentals is the relationship between supply and demand: Canada’s population is growing at its fastest rate since 1957—the highest since 1913 when the country began tracking growth. The chasm between the number of ownership and rental homes available relative to demand overwhelmingly tilts in the latter’s favour.
In May 2021, Scotiabank released a report empirically demonstrating that, of G7 nations, Canada produced the fewest number of homes per capita (427 units for every 1,000 people) between 2016 and 2021, as a consequence of elevated immigration and a dawdling pace of new-construction delivery. Since that report’s release, Immigration, Refugees and Citizenship Canada (IRCC), a federal agency, has raised permanent-resident settlement quotas several times, each becoming more aggressive than the last. The IRCC’s 2021 mid-range target for new permanent residents was 405,000, and after welcoming 431,645 the following year, it declared a more ambitious plan that saw 471,500 admissions in 2023, with 430,000 to 542,000 expected this year and another 442,500 to 550,000 in 2025.
However, these figures belie how many newcomers Canada has actually received, omitting non-resident permit workers, family reunification and successful refugee claimants—as reflected by Canada’s population surging by over a million people in the 12 months ending July 2023. For context, Statistics Canada reported that about 2% of Canada’s population growth during that period was the result of domestic fertilities outstripping mortalities.
Another key consideration is planning departments in Canada’s largest cities are constricted by red tape, to the chagrin of big city building associations. A report from the Residential Construction Council of Ontario (RESCON) revealed rezoning approval from the City of Toronto averaged six months in 2006, however, wait times reached 18 months a decade later—and the site-plan approval process has regressed to equally painstakingly slow wait times, too. According to industry insiders, wait times for both permitting processes in 2024 are even longer than they were when RESCON released its report.
Why should investors care?
All these factors have conspired to create ideal conditions for residential real estate investors. The dearth of new housing completions relative to Canada’s surging population—especially in its largest cities, which drive their respective provincial GDPs thanks to diverse economies that attract people from the world over—have helped investor-landlords’ rental incomes carry their monthly mortgage outlays. That isn’t the only boon for investors. Unlike the stock market, which is attractive for rapid liquidity extraction, real estate is a long-term investment, and thanks to population growth alone—to say nothing of the potential for hugely improved public transit structure in many places—appreciation is ultimately the name of the game for investors. And in a city like Toronto, where home values have doubled in the last decade, the sky’s the limit.
COVID-19 and interest rates
The pandemic scuttled the majority of project launches in 2020, choking the pipeline of precious supply that could have become occupied between 2023 and 2026. Additionally, the Bank of Canada implemented a quantitative tightening regime in March 2022, hiking its overnight lending rate 10 times, and causing lenders to adopt exceedingly conservative mortgage criteria for both consumers and developers, causing more delays in new project launches. The confluence of COVID-19 and a rising interest rate environment has consequently truncated the housing supply at a time when rental housing demand in Canada is at an all-time high.
Industrial real estate and REITs
There are other avenues to investigate beyond residential real estate. Arguably the hottest real estate sector in Canada is industrial, within which sub-2% vacancy rates in key markets are commonplace. In the Greater Toronto Area alone, rental rates are 3.5 times higher than they were in 2020, reaching $18.50 per square foot. Similar market conditions define the landlocked Lower Mainland and Greater Montreal, Canada’s second-largest conurbation.
The popularity of industrial real estate is driven by e-commerce’s emergence, and while it gained a considerable chunk of market share in the retail sector pre-pandemic, COVID-induced lockdowns propelled the sector to greater heights. Traditionally the domain of manufacturers, logistics and distribution companies, which require substantial warehousing capabilities, are driving tenancy demand today, and landlords are capitalizing by foregoing typical 10- and 15-year lease terms for three- to five-year pacts.
But even if you have a rare appetite for buying a warehouse and being responsible for filling it with tenants, industrial real estate is a heavy lift, metaphorically and literally. Real estate investment trusts (REITs) make it more accessible. These trusts are companies that own, operate or finance income-generating property, like industrial warehouses or apartment buildings. They trade like stocks so are much more liquid than regular real estate investments, and pay dividends, which is attractive for those seeking a regular income stream.
REITs work by pooling capital from investors, meaning you don’t have to invest nearly as much as you would if you were buying a property. REITs, whether industrial or residential, can be a good diversifier and mean someone else is doing the grunt work for you. Investors should proceed with their eyes open, however. You risk losing money if the value of your REIT drops due to the property becoming less valuable, while a rise in interest rates can eat into the REIT company’s profits. Selecting the right business in the right location is fundamental - not all REITs are created equal.
In conclusion, if you have the capital, the real estate sector is full of opportunities, depending on your time horizon and liquidity preferences. Real estate forms a vital part of your portfolio whether you own one property or three. If you’re ready to make a move, be discerning, do your research, and consult your Wealth Advisor who can put you in touch with a Q Wealth Portfolio Manager.
