Overall, Canada’s real estate investment trust (REIT) sector has been a dismal place to allocate money to this year. The TSX diversified REIT index has slumped close to 20% since the end of 2022 after starting on such a strong footing. In June, the index fell below technical support near 1100 and has been unable to move back above 1200 since May. Commercial real estate has been hampered by a low uptake on back-to-office work, while industrial real estate activity has been restrained by concerns over a potential recession developing.

 

 

 

Beneath the surface, however, the residential space has performed much better and developments this week suggest things could get even better.  Canada has been dealing with an extreme housing shortage since the pandemic, compounded by supply constraints, reduced availability of labour, and excessively high costs relating to development (such as building permits). On top of that, the country is dealing with an explosion in population growth which is only adding to demand for housing and rentals.

 

 

The shortage has meant that growth in rents would remain strong through 2023 and this was reflected in a gain of more than 20% in the TSX Residential REIT index by the peak at the end of July. There was a pullback in August, but the tone was improving into this week. Yesterday we had the announcement from the Trudeau government that it was going to remove the goods and services tax on the construction of new rental properties. After the news broke, Ontario said it too would get rid of its share of the sales tax.

 

This decision was not really that surprising considering the pressure that has been mounting on governments at all levels to deal with the high cost of rent, on top of higher inflation in other categories of consumer spending. In August, the federal government said that it was looking for a number of measures aimed at boosting housing supply and the GST removal was clearly part of this packaged strategy. The dilemma for the government is that any meaningful boost in housing and rental supply could (and probably will) cause property prices to decline, which might have a detrimental effect on households given the amount of wealth tied to property. For now, it appears that the government is willing to take that risk in favour of getting rents to cool off.

 

Since the lows seen in great financial crisis, Canadian multi-unit housing starts have climbed at an average annualized rate of about 10%. In June, starts rose to 220,000 on an annualized basis, coming closed to the record high of 224,000 set in 2021. While it will take time for the effects of the GST change to show up in the data, it would seem likely that starts will reach new highs before the year is out. 

 

One question for investors is how a potentially large increase in the supply of rental units will impact rents and therefore revenues for REITs. The response on Thursday was unequivocally positive, with the TSX residential REIT index gaining more than 2.5% - the best showing since November of last year. The four members of this index saw gains from 1.3% to 3.8%, and Canadian Apartment REIT (CAR-U) rose 2.7%. 

 

 

There is another way to play the residential space though and that is through real estate services; this group was already slightly ahead of residential REITS this year. Following the government announcement, this sector gained and is now up just north of 20% for the year, compared to an 18% lift in REITs. A mid-size player in the group – Tricon Residential – had also seen a pullback in August but saw a positive lift from the tax news. In the Spring, Ally and I moved into the stock on the premise that rental demand in Canada and Florida would remain strong and it’s possible that an increase supply of units could also see acquisitions by Tricon and other improvements.

 

Coming into the summer, we saw opportunities in Canada’s two largest sectors (financials and energy), as well as real estate, and less room for extended gains in tech. Energy has certainly delivered since May and now we could be looking at continued gains on real estate.

 

On behalf of the Pyle Group, have a wonderful weekend.   

 

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. He and his clients may own securities mentioned in this column. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.