Canada quietly put real estate investors on notice, right before the holidays — probably hoping it slips under the radar. A newly re-elected Liberal Party of Canada (LPC) distributed mandate letters. These letters contain orders for the Minister to execute and are usually pretty dry. A big exception is the Minister of Housing’s mandate letter, which puts real estate investors in its crosshairs. The Minister has been ordered to cut profits, deter speculation, and limit leverage. Here are the key takeaways.
Canadian Real Estate Investors To Be Hit With Taxes. Lots of Them
Canadian real estate has been lucrative for investors, and the Government wants a cut. The mandate includes various investor taxes, and reforms to reduce “excessive” profits. Here are the most noteworthy ones:
- Excessive rent surplus. The Income Tax Act will be amended to require landlords to disclose rent — pre and post renovation. If a minimal renovation was executed and the rent surges, you might be hit with a tax to reduce profit. If executed, landlords might reconsider those renovictions.
- Anti-flipping tax on residential property. Planning on flipping a property for less than 12 months? You might have to pay an anti-flipping tax. Flippers might be a small segment, but they reduce liquidity and replace it with a higher priced unit. This marginal buyer has a disproportionately large impact on home prices, similar to money laundering.
- Reviewing tax incentives for Real Estate Investment Trusts (REITs). REITs are a type of investment trust to hold real estate and generate income through rent. They aren’t taxed on the income or gains made, making them tax efficient entities. REIT holders pay taxes on the disbursements from the REIT, but those can be deferred or reduced by registered accounts. This has made them extremely attractive over the past few years.
Canada Will Attempt To Limit The Advantage of Real Estate Over Productive Investments
Investors will see hurdles erected to limit the attractiveness of real estate. There are currently many incentives to invest in real estate over other areas. This includes leverage and tax advantages, attracting a disproportionate size of capital. Residential investment recently overtook productive investment for the first time since the 1960s.
Having such a disproportionately large residential investment sector can create problems. Even without a correction, diverting capital from productive investment means fewer jobs. This has been one of the factors leading to Canada having the lowest GDP growth in the OECD. By putting up a few hurdles, the country is probably hoping to get money back into productive growth. Here are some of the key measures:
- Review investor down payment requirements. Investors might soon need more for a down payment, limiting leverage. This is a move that other countries have recently adopted, including New Zealand.
- A temporary ban on foreign buyers. The ban would apply only to non-recreational residential property. Canada doesn’t track beneficial ownership, or confirm the info when it does. If it doesn’t know who the beneficial owner is, it has no idea who owns the home. This is mostly window dressing.
- Curbing “excessive” profit for investment properties. The ambiguously worded directive doesn’t elaborate. It only says they’ll do so while also protecting small, independent landlords, though. Most likely this means they’ll be looking into institutional landlords. No plan usually means they do very little.
Real estate investors have always been a double-edged sword, regardless of the country. The positive is they provide capital (and incentive) for builders, increasing supply. It’s not a coincidence that the most building happens during periods of high price growth.
At the same time, they aren’t a charity. Their incentive for providing this capital is making solid returns. The better the returns, the more capital gets sunk into the market. In the words of the bank regulator, this can become a self-fulfilling prophecy. Investors often pay more because they expect higher returns, detaching from any fundamentals.
How serious this government is about the measures remains to be seen, but there is one big sign they might be. Canada is injecting significant cash (i.e. loans, subsidies, etc.) to developers. This is a sign the state is preparing to pick up the incentive if other investors divert capital.