Investment in the housing market in Canada
I’ve been privileged enough to pitch many private and institutional investors based out of Canada various properties and portfolio opportunities. From this experience, I have learned that there are a few key points for understanding the structure and unique characteristics of the Canadian real estate market.
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It is important to mention that the homeownership rate in Canada is relatively high and averaged 65.97 percent, however the sharp increase in the house and condo prices in the last decade, are continuously pushing many people to rent vs. own.
Residential living spaces follow the following property types;
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Detached Houses,
Semi-Detached Houses,
Townhomes Houses,
Condo Units,
Apartments.
Traditional houses
Traditional houses in Canada are privately owned, while the majority of houses serve as family homes, as the demand for rental properties increases, there are more houses, especially in the cities centre that are being converted to rental units properties. There is a growing number of entrepreneurs who own several rental unit properties, however, many challenges related to landlords/tenants’ affairs are pushing many private owners away from rental home ownership. Recently there are some private investors and REITs, that have entered the rental units’ houses market and are growing their portfolio fast, leveraging private equity and renovation/development capacity as well as management advantage.
Conduminiums
Condominiums are usually being developed by large corporate developers, both publicly traded REITs and private. Condo development in Canada is highly regulated. The condo units are sold to private buyers, who only pay a deposit of 20%-25%, then wait for the building to complete. The mortgage payments don't start until the building is complete, and the remainder is paid at the time of completion. The deposit is held in a trust account. The developers commonly sell at least 70%-75% of the condo units ahead of construction. Purchasing a condo as a rental property is a popular way of investment in Canada. Condo units are being leased individually vs. rental apartment buildings. All condo fees are always covered by the unit’s owner, while the tenants only pay an agreed rent and utilities.
Apartment buildings
Apartment buildings, also referred to as multi-res properties, presents one of the most fast-growing and completive housing sectors, which are going through a massive consolidation. Most of the properties are owned and managed by giant publicly-traded REITs as large portfolios. Recently many privately developed and owned smaller portfolios have exchanged hands, while the majority have been absorbed in the large REITs.
Tenants’ protection policies
Tenants' protection policies in most of the provinces in Canada play a big role in defining the market’s behavior. In Ontario as well as in other large provinces such as Quebec, Alberta, and British Columbia a legal lease agreement is the standard form provided by the provincial government with a defined set of conditions. The standard lease is signed for one year; however, it’s not being renewed after the initial lease period, but rather only the tenants have the prerogative to terminate the agreement with the prior notice of 60 days. The landlord is not permitted to evict the tenant unless they or their firsthand family member intend to move to the property. The rent increase for the existing tenants is allowed only according to the annual governmental guidance which is historically in the range of 1.75%-2.5%. An additional increase in the rent is allowed as a function of the landlord's capital investments in the property’s common areas. All landlords and tenants related disputes are arbitrated by a special legal provincially governed body called the Landlord and Tenants board, which is considered politically biased towards tenant protection. Hence, a rent increase, and an adjustment to market rent happen only in the event of a new lease.
Turnover of the units
Turnover of the units is an important variable that should be considered while investing in multi-res properties in Canada. As landlords have very little control over tenants’ eviction, the turnover is almost fully dependent on the tenants. Naturally, tenants terminate their leases as the circumstances of their lives change, the average turnover in Ontario is in the range of 5%-20% a year, and is subject to location, national and global economic growth, as well as employment rates.
The acquisition process
The acquisition process usually takes a few weeks before the binding LOI/ Sale and Purchase agreement is signed, then an additional 2-3 months on average to be approved for financing to finally close the deal. When a multi-res property/portfolio is placed on the market for sale, the broker agent is tasked with providing an informational package to potential buyers, this package is called Confidential Information Memorandum (CIM). In addition, the broker provides access to a data room that includes all necessary data/ information regarding the property. The financial analysis included in the CIM not only provides a property’s Rent Roll but also the future rent forecast based on the assumptions of the market rent and the unit’s turnover in the relevant area. In the recent decade, we have seen historically low-interest rates, thus fueling the prices and creating an environment of a “Seller’s market”. This not only caused the actual CAP Rates of the sold properties to be historically and geographically low but also pushed the transactions to be evaluated based on the projected CAP Rates. Meaning that the sellers demanded a share in the future value of the properties. In recent months, with the sharp increase in interest rates, the housing market in Canada is deflating in value, which provides an opportunity for sophisticated and risk-tolerant investors.
Investment Strategy
Investment Strategy, which is very common in the Canadian multi-res sector regards purchasing a relatively old and unrenovated property with low rent leases and then upgrading the property gradually with a respective rent increase. The older and more run down the property the higher hidden value the deal is usually offering. It’s important to understand that due to the tenant’s protection policy many properties/rented units are leased with rent rates significantly lower than the market rates. If the unit is leased for several years to the same tenant, the rent can be as low as 50% and below the market rent. As tenants leave their units due to their own life-changing events, the landlords usually renovate the units and then place them on the market with much a higher market rent rate. In addition, they usually conduct various building improvements such as renovating the lobby, halls, elevators, and landscaping while increasing the building's efficiency with a new roof, furnace, HVAC, and electricity systems. When the property goes through a facelift and upgrades, it becomes attractive to the potential tenants and the rent rates achieved can be above the average market ones. To summarize, although the properties in Canada are sold with relatively low CAP Rates, the potential hidden value can increase the projected CAP Rates up to double.