The Canadian Government Just Put Real Estate Investors In Its Crosshairs

Canada tacitly notified property investors just before the holidays – likely in hopes it would go under the radar. A newly elected Liberal Party of Canada (LPC) distributed mandate letters. These letters contain orders to be carried out by the Minister and are usually rather dry. A major exception is the letter of mandate from the housing minister, which targets real estate investors. The minister was instructed to cut profits, deter speculation and limit leverage. Here are the key takeaways.

Canadian real estate investors face taxes, many of them

Canadian real estate is 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 notable ones:

  • Excessive rent. The Income Tax Act will be amended to require landlords to disclose rent – before and after the renovation. With a minimal renovation done and rents skyrocketing, you could be charged a tax to reduce profits. In the event of an execution, landlords could reconsider these renovations.
  • Anti-flip tax on home ownership. Are you planning to flip a property for less than 12 months? You may have to pay an anti-flip tax. Pinball machines may be a small segment, but they reduce liquidity and replace it with a more expensive unit. This marginal buyer has a disproportionate influence on home prices, similar to money laundering.
  • Review of tax incentives for real estate investment trusts (REITs). REITs are a type of mutual fund used to hold real estate and generate income through rent. They are not taxed on the income or profits made, which makes them tax efficient businesses. REIT holders pay taxes on withdrawals from the REIT, but these can be deferred or reduced through registered accounts. That has made them extremely attractive in recent years.

Canada will seek to limit the advantage of real estate over productive investments

Investors will see barriers erected to limit the attractiveness of real estate. There are currently many incentives to invest in real estate versus other areas. These include debt and tax benefits that attract a disproportionate amount of capital. For the first time since the 1960s, residential investment has recently overtaken productive investment.

Such a disproportionately large housing investment sector can lead to problems. Even without correction, the diversion of capital from productive investment means fewer jobs. This was one of the factors that resulted in Canada having the lowest GDP growth rate in the OECD. By putting some hurdles in place, the country is likely hoping to get money back into productive growth. Here are some of the most important measures:

  • Review the investor deposit requirements. Investors may soon need more for a down payment, which limits leverage. This is a move that other countries have recently taken, including New Zealand.
  • A temporary ban on foreign buyers. The ban would only apply to home ownership that is not for recreational purposes. Canada does not track beneficial ownership or confirm the information when it does. If they don’t know who the beneficial owner is, they have no idea who owns the house. This is mostly window dressing.
  • Curbing “excessive” profit for investment properties. The ambiguously worded directive does not go any further. However, it just says that they will do so while protecting small, independent landlords at the same time. This most likely means that they are looking for institutional landlords. No plan usually means they are doing very little.

Real estate investors have always been a double-edged sword, regardless of the country. The positive is that they provide capital (and incentives) to builders and increase supply. It is no coincidence that in times of high price increases, most of the construction is going on.

At the same time, they are not a charity. Your incentive to provide this capital is solid returns. The higher the return, the more capital you sunk in the market. In the words of banking regulators, this can become a self-fulfilling prophecy. Investors often pay more because they expect higher returns and break away from all fundamentals.

It remains to be seen how serious this administration is with the measures, but there is a big indication that it is. Canada is injecting significant resources (i.e. loans, subsidies, etc.) into developers. This is a sign that the state is preparing to seize the incentive in case other investors are diverting capital.