Entries from April 2023 ↓

What works?

Does taxing stuff make it cheaper? Like, ever?

Rarely, but sometimes. For example, the Progressive Conservative government in NS recently slapped a hefty 5% transfer tax on any non-local buyer. That’s $75,000 more on a $1.5 million seaside property, whether the new owner lives there most of the time or not. Since the bulk of that province’s higher-end property market is driven by Upper Canadians, things are going south. Combined with the federal two-year ban on foreign buyers, there’s no reason for realtor joy.

BC has brutal taxes, too. Huge annual vacant home levies, the anti-Alberta spec tax, plus a longstanding penalty for offshore barbarians. But they didn’t work. Prices in YVR barely dipped over the past year of rate hikes, and are on the move up again.

Ditto in Toronto, which has its own tax on underutilized houses (so does Ottawa, and now Hamilton), plus double land transfer tax and a province-wide surcharge for foreigners. The LTT alone is $65,000 on the typical detached resale. Despite this, and mortgage rates which have more than doubled, prices and sales are swelling. In fact, there are bidding wars, offer nights, blind auctions, packed open houses and buckets of FOMO.

Property taxes are increasing rather wildly in most major centres. Real estate commissions have not come down from the traditional 5%, despite crazy selling prices, and there’s HST on top. That sure adds up when the bill is $100,000 + HST on a two-mill deal. Plus, if you have to sell too soon (within a year) and make some coin, there’s the new federal flipping tax to contend with.

Now some people want more tax. They look to Singapore for inspiration. By the way, there are 5.5 million people in that island nation – about the same as Toronto. And it’s actually a similar size to TO’s land mass (but far smaller than the GTA). Here’s a comparison…

Comparing the land mass of Singapore to that of the City of Toronto.

The going price for a bungalow in Singapore these days is $9.7 million (Canadian). Two-bedroom condos average $1.5 million (C$). Despite that, the home ownership rate is 88.9% (2021). Five-year mortgage rates are just over 4%.

The big difference? Tax. Singapore residents pay a fraction of the income tax Canadians do. For example, while HNW folks here are dinged for 54%, in that country the system maxes out at 22%. Most people pay around 15%. There is no tax on dividends, capital gains or inheritances. The sales tax of 7% compares with 13% or 15% in the land of beavers and Tim Hortons. So, more disposable income has helped push property values skyward in a place with no room to expand. Also the fact all real estate gains are tax-free has stoked the fires of speculation and investment.

To dampen that, last week Singapore brought down the hammer on those who want to buy real estate other than to live in. Residents will now have to pay 20% transfer tax to buy a second property and 30% for a third – substantial increases.

Would this approach work in Canada?

Some people say so, believing that if investors were shoved out of the marketplace there’d be more space for owner-occupiers. After all, 20% of all Toronto residents now hold more than one property. Just over 40% of Nova Scotia real estate is owned by investors. So perhaps layering on even more tax would help crush demand and drop prices?

Maybe. But investors almost always rent out their units, helping to create more choice for tenants. Without that housing the vacancy rate everywhere would crash and rents spike as a result.

Besides, with all of the tax now heaped on housing, prices have not declined. The opposite. Today we’re witnessing exactly this phenom as the 2023 spring rutting season market brings out buyers despite all the tax and financing headwinds (7% stress test).

Clearly Canada is at a crossroads. Houses are less affordable than ever. The recent correction is over. Mortgage rates will be lower by Christmas. Banks have never seen so many mortgages not being paid down, nor have they ever had to extend amortizations like this. Governments at all levels have utterly, completely tanked at finding a comprehensive way to regulate real estate. Now we have a patchwork quilt of conflicting policies which create buyer demand on one hand and punish purchasers and owners on the other.

We know the federal Libs have failed. Do we know what the Cons would do? It’s time to ask.

About the picture: “This is Parker (Flat haired Labradoodle) as a puppy,” writes Kyle, in Calgary. “She now weighs 65lbs and is MUCH bigger!  I’d send a picture of my kids but puppies are cuter!”

Have a beast to share? Send a picture to ‘[email protected]’. 


Office space

DOUG  By Guest Blogger Doug Rowat

Pessimism. A little bit is fine. Too much is dangerous.

When respondents were asked in a 2016 survey whether global poverty was getting better or worse, the vast majority (90%) answered ‘worse’. In reality, the number of people in extreme poverty has been falling for decades with more than 1 billion people having been taken out of poverty since 1990.

Unfortunately, the finance industry isn’t immune to the reality-distorting effects of excessive pessimism either. And, at present, fund managers are definitely pessimistic. The latest Bank of America fund manager survey, for example, indicates that fund managers’ exposure to equities relative to bonds has hit the lowest level since March 2009:

Bank of America fund manager survey: net % overweight equities vs bonds

Source: Bank of America Global Research

But it’s worth looking at the March 2009 reading. It marked the start of a decade-long bull market. This should have been the moment of peak OPTIMISM and fund managers should have had, in a perfect world, their heaviest net overweight to equities. Alas, pessimism clouds better judgement.

Are fund managers correct to be this pessimistic currently? Probably not. And indeed equities have been performing well with the S&P 500 up 15% already from its October 2022 lows.

So pessimism can lead to forecasting errors, which can affect not only broader portfolio positioning, but outlooks on more specific areas of the market as well. Let’s examine one such area, an area that’s been plagued by near endless pessimism since the start of Covid: the Canadian office-property sector.

Covid, needless to say, was a horrible grind. We were locked in our homes for months. We fought in grocery stores for the last scraps of toilet paper. Wearing a mask became as routine as carrying a smartphone. The health care system teetered on the brink. And the downtown core of every major Canadian city? Deserted. The outlook for the office-property sector justifiably darkened.

To be clear, the broader Canadian REIT sector has actually weathered Covid well with the Bloomberg Canadian REIT Index generating an annualized total return of 10.6% over the past three years. However, the office REIT space hasn’t participated in this upside. The recent underperformance of office REITs has been stark:

Canadian REIT performance by sub-category

Source: Bloomberg; Turner Investments. Specialized and health care REIT categories removed due to lack of representation.

But is further pessimism warranted? Has the redheaded step-child of the Canadian REIT world suffered enough?

The massive office REIT sell-off has meant that valuations and yields have become attractive. Office REITs now yield 9.2% on average, a significant premium to the other REIT sub-categories, and on a price-to-funds-from-operations (P/FFO) basis (a common valuation metric for REITs, lower the better) office REITs are remarkably inexpensive:

Canadian REIT sector key metrics

Source: Bloomberg; Turner Investments. Specialized and health care REIT categories removed from table due to lack of representation.

Office vacancy rates in Canada obviously soared during Covid and still stand at a staggering 17.7%. (It is, however, worth noting that while an almost 18% vacancy rate isn’t good, office property vacancy rates are often in the double-digits even during the good times.) But the commercial real estate market, though it’s a slow moving beast, eventually reacts to supply-demand imbalances. Office space inventory under construction has been declining for more than three years and office construction starts have also dwindled. It will take time, but supply’s starting to come in line with demand.

National office construction starts (MSF)

Source: CBRE

Demand’s also set to increase. Royal Bank’s now insisting that its workers return to the office 3-4 days a week (https://www.theglobeandmail.com/business/article-rbc-employees-hybrid-office-work/). The policy of Canada’s biggest bank will likely set the tone for all businesses nationwide. And Royal’s likely following the example set by US banks. Axios reports that US workers are rapidly returning to the office. Share of employees in ‘financial activities’ working remotely has dropped significantly from 55% in 2021 down to only 33% at the end of 2022:

Share of US employees working remotely by industry

Click to enlarge. Source: Axios. Fully or partially working remotely.

Canada lacks data that’s as current, but to the mid-way point of 2022, the Canadian trend was similar to the US’s. According to StatsCan, 24% of Canadians worked exclusively from home at the start of 2022, but this had already declined to 19% by April 2022.

Like it or not, WFH is coming to an end.

Office REITs (and the office-property exposure within diversified REITs) have been a thorn in the side of the overall REIT sector for years, but, in my view, this is likely to change.

I’m – dare I say it? – optimistic.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.