The in-person RealREIT 2022, held at the Metro Toronto Conference Centre on Sept. 8, gave its attendees a welcome return to live conferences after a two-year virtual hiatus. What has typically been a full day of real estate promotion bordering on puffery was much more subdued this year given the economic and interest rate landscape.
RealREIT, multi-family space, real estate has been out of favour this year, industrial and multi-family
In this column, we share some highlights and our takeaways for the multi-family space.
-A dour economic backdrop: With the theme of the kickoff presentation titled “Economic turbulence in a Canadian context,” there wasn’t much in the way of positives for the forthcoming year.
Perhaps the lone upbeat note was that COVID restrictions have eased globally and the expectation is that they won’t rise again. With that comes easing supply chain problems and ultimately inflation.
Nevertheless, with inflation still high today, as well as aggressive monetary tightening, tougher financial conditions, fiscal drag, commodity shocks, Chinese headwinds, and the Ukrainian war all still looming, there are plenty of negative forces at work. As such, growth is expected to slow sharply into 2023, leading to a recession (estimated by the RBC economist at 70 per cent).
The Bank of Canada is likely to follow their latest 75 basis point hike with one or two more (aggregating into another 75 basis point increase) before possibly cutting in the second half of 2023.
All this sets the stage for a choppy backdrop for REITs where growth is essential to offset net asset value (NAV) erosion driven by capitalization rate expansion-driven. (Capitalization rates are calculated by dividing annual net operating income by total current property market value.)
Quality differentiation has become crucial again, and strong operators and capital allocation will be necessary given a rising cost of capital.
Industrial and multi-family the clear favourites
With almost the entire sector trading at significant valuation discounts, real estate has been out of favour this year. It was clear, however, that industrial and multi-family are where most are placing their chips in advance of a recovery.
With cap rates undoubtedly moving higher, cash flow growth is required to offset shrinking NAVs and those two asset classes, with undeniably strong fundamentals, are believed to be the best bets to deliver.
The view is that once rates stabilize (and in the case of multi-family, once regulatory fog dissipates), this is where capital will flow first and foremost.
Retail and office are thought to present unneeded risk, without compensating through either excess growth potential or valuation discounts. With differentiation mattering once more, stock picking again becomes a required talent.
Despite rumours, Trudeau’s report still set for fourth-quarter release
There was a rumour going around the conference that Prime Minister Justin Trudeau’s promised report on the financialization of the housing market was being pushed back into next year.
We confirmed with Michael Brooks, CEO of the Real Property Association of Canada (or RealPAC) and the man on the phone spending half his day lobbying for apartment landlords, that this is untrue.
As of late September, the timeline is as follows: a consult with the government is expected in October with the report’s release and policy measures due out by year-end (likely December).
REIT tax status change unlikely but tax on repositionings could occur: We have long stated that we believe the fear that the government will remove the tax status of multi-family REITs is unfounded and those closer to the situation tend to agree.
However, it is possible that some tax is levied on repositioned units. What is being taxed (gross rent, incremental rent, etc.) and by how much is still unknown, and the hope is that if more education can be delivered to those in power, this may be prevented, or at least minimized or offset.
Some believe that by jumping in bed with the NDP, the Liberals tied their hands. Still, the federal government understands that lack of supply is the key issue, and support from corporate landlords – the ultimate builders and buyers of the new product – is undisputedly vital to remedying this.
It is estimated that $40 billion of new housing is required to bring the country onside with its dire lack of supply. It would be unwise for Trudeau & Co. to damage these relationships or the incentive to attract that capital; however, whether they realize that yet is uncertain. Indeed, between now and December, edification must be top priority.
Other quick hits
-A cement shortage (due to a lack of powder) is imminent, further compounding input cost inflation on new construction meaning that another decrease in new supply is possible for 2023 (year-to-date in 2022, new housing supply is down seven per cent compared to the same period in 2021).
-Between HST, development charges, parkland dedications and other government charges, about 25 per cent of the cost of a new development flows to government (in Ontario). Government incentives are crucial to delivering new affordable supply.
-At the apartment panel, the consensus view on further capitalization rate expansion was an increase of 15 basis points to 50 basis points, with Class A at the lower end and Class C at the higher end of the range though until transactional activity returns, this is ultimately a guessing game.
-Montreal, the most international student-heavy market in the country, has been slow to recover but early 2022 third-quarter leasing has shown a marked improvement over the first half of 2022.
This is an edited version of an article that was originally published for subscribers in the October 14, 2022, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
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Investor's Digest of Canada •1/3/23 •