At the start of November, the Canadian government updated its immigration targets for the next three years. Authorities in the North American nation are aiming to have 465,00 new permanent residents in 2023, 485,000 in 2024 and 500,000 in 2025.
If these numbers become a reality, it would result in population growth of close to 4%. It will also continue a pattern we’ve seen over the past couple of years, as the Canadian government has sought to encourage immigration to grow its economy and prop up an aging workforce. Indeed, by the end of this year, it’s likely that at least 430,000 new immigrants will have arrived in Canada.
Whether or not you believe these are good policy decisions, it’s hard to see them not having a meaningful impact on the Canadian economy and one area where this is likely to be particularly pronounced is in real estate.
According to Canada’s state housing agency, the Canada Mortgage and Housing Corporation, there is going to be a shortage of 3m housing units by 2030 in the country if current demographic trends and building rates continue. This is despite the fact that housing is already more expensive, relative to average income, than at any point since the early 1990s.
It’s this dynamic that explains why the managers of Middlefield Canadian Income (MCT) find Canadian real estate such an attractive proposition. In a tough 12 months for markets, MCT has managed to deliver positive returns for shareholders. That’s in large part because of the commodities and financials businesses in its portfolio, which make up a large proportion of Canada’s stock market. But the trust also has a large weighting, equal to a little over 25% of the portfolio, in real estate investment trusts (REITs).
For the residential REITs in the portfolio, the supply and demand dynamics described above are likely to be the main driver of returns in the years ahead. However, there are other factors at play too.
Like its southern counterpart, Canada’s central bank has been aggressive in hiking interest rates to counteract inflation this year. The most recent 50bps took place on December 7th and means the base rate for the Bank of Canada now stands at 4.25%. This has filtered on to mortgage providers, who are now charging home buyers much more to borrow. A quick scan of Canadian mortgage price comparison site WOWA shows that the lowest fixed-rate mortgage available is 4.5%.
As a result of this more people are renting properties instead of buying them. According to Canadian property letting site Rentals, the average monthly rent paid by Canadians was 12.4% higher in December this year compared to 12 months ago. In commercial centers like Toronto and Vancouver, the figure was typically over 20%.
More housing would alleviate these problems but here too there are problems which seem difficult to surmount. Materials are now much more expensive due to inflation and labour costs are also high because of a shortage of workers.
Some local authorities have also increased taxes for building new residential sites. For instance, Toronto’s city council announced it would be hiking these rates by 46% in August. The result is that a company building a new two-bedroom apartment in the city will have to pay local authorities over CAD$80,000. Perhaps unsurprisingly then, real estate research firm Urbanation has found that a third of developments in the Greater Toronto Area planned for 2022 have been cancelled.
All of these dynamics should create positive tailwinds for the residential REITs in the MCT portfolio. But Canadian REITs have seen their discounts widen substantially so far in 2022. Many of MCT’s holdings, for example, have ended up trading at 30% discounts to their net asset value (NAV) and the trust itself is now trading at an almost 11% discount.
This seems largely due to real estate’s sensitivity to interest rate hikes, which have historically led to falls in property prices. That possibility should not be ignored and it remains a real risk.
However, with many REITs now trading at steep discounts, there’s an argument to be made that any fall in valuations which may stem from rate hikes has already been priced in. There have also been some reassuring signs here. In early December, investment group Blackstone acquired six industrial sites in Toronto. The group paid CAD$270 per square foot. Similar industrial REITs in the MCT portfolio are currently valued at CAD$170 per square foot, or nearly 40% below the rate at which the Blackstone acquisition just took place.
And even though discounts widening hasn’t been positive for MCT’s short-term performance, they’ve also enabled MCT manager Dean Orrico to add to existing positions this year in Canadian Apartment Properties REIT and Granite REIT, which invests in logistics and industrial sites.
That’s not a guarantee of success, nor does it mean short term volatility is likely to dissipate. However, it’s a sign that the managers remain confident about the long term prospects of Canadian real estate. And given the Canadian government’s own immigration plans, as well as the favourable economic environment currently in play, it’s easy to understand why that’s the case.
Disclaimer
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. You will usually pay brokerage fees to your dealer if you purchase or sell units/shares of investment funds on the Toronto Stock Exchange or other alternative Canadian trading system (an “Exchange”). If the units/shares are purchased or sold on an Exchange, investors may pay more than the current net asset value when buying and may receive less than the current net asset value when selling them. There are ongoing fees and expenses associated with owning units or shares of an investment fund. An investment fund must prepare disclosure documents that contain key information about the fund. You can find more detailed information about the fund in these documents. Mutual funds and investment funds are not guaranteed, their values change frequently and past performance may not be repeated. Certain statements in this disclosure are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as “may”, “will”, “should”, “could”, “expect”, “anticipate”, “intend”, “plan”, “believe”, or “estimate”, or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what Middlefield Funds and the portfolio manager believe to be reasonable assumptions, neither Middlefield Funds nor the portfolio manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.
This material has been prepared for informational purposes only without regard to any particular user’s investment objectives or financial situation. This communication constitutes neither a recommendation to enter into a particular transaction nor a representation that any product described herein is suitable or appropriate for you. Investment decisions should be made with guidance from a qualified professional. The opinions contained in this report are solely those of Middlefield Limited (“ML”) and are subject to change without notice. ML makes every effort to ensure that the information has been derived from sources believed to reliable, but we cannot represent that they are complete or accurate. However, ML assumes no responsibility for any losses or damages, whether direct or indirect which arise from the use of this information. ML is under no obligation to update the information contained herein. This document is not to be construed as a solicitation, recommendation or offer to buy or sell any security, financial product or instrument.
