Navigating the Canadian Real Estate Landscape: Challenges, Opportunities, and the Role of Alternative Investments Amid High Mortgage Rates

Preface

Hundreds of species of wildlife inhabit the wetlands of Port Perry. As you drive through, you’ll notice its pristine grasslands – seemingly untouched – bountiful with fish, birds, and mammals. Drive a little further and you’ll see rows of corn and wheat, quickly growing as the autumn season approaches. It’s like a scene from Country Magazine where you’re transported to rural Europe. Then, a large, obtrusive sign shouts in your face: “WATERFRONT HOMES FOR SALE: STARTING IN LOW $1,000,000s!” You finally remember you’re in Ontario.

Urban Sprawl isn’t unseen in rural towns. Canada’s 2024 budget aims to build 3.87 million homes by 2031– an attempt to combat the housing crisis declared in December last year. One of the many goals of this decision was to make “housing more adorable for incoming Canadians.” [1] Surely, then, more than 45% of Canadians should be able to afford a condo… right?

Struggling Canadians

Few challenges have garnered more criticism than the Canadian housing crisis. With the recent interest drop failing to attract prospective buyers, Canadians are more afraid than ever to explore the real estate market. That, or the sheet price of housing, is still unaffordable, and sellers aren’t willing to drop 38% to pre-pandemic prices. I remember in 2019 when my family could rent a 3,000 sq. ft house in Whitby for a “mere” $2,700/month. These days, you’re lucky to pay $3,000/month for a sardine tin downtown, utilities not included. Not much has changed since 2020, and as the housing market borders recessionary territory, sales have not been this low since the 2008 recession (excluding early COVID-19 lockdowns). [2] The homeownership market has similarly outrageous numbers: as of June 2024, the average house in Toronto is $1,110,600, up from $798,400 in June 2019.

Perhaps Canada’s unaffordable housing was the final nail in the coffin, prompting many to leave the city for a cheaper, more peaceful life with less traffic. In what is known as “The Great Reshuffle,” many people migrated outwards, from Toronto to Whitby or from Whitby to somewhere like Port Perry. Ironically, this urban sprawl has caused the pricing of urban and rural properties to draw nearer. Since 2016, the price difference has narrowed from 33% to just 10% last year. [3] In part, this was exasperated by low interest rates in 2020 (2.45% compared to 6.95% now), where people who would not usually participate in the real estate markets could afford sizeable mortgages. We now see that the average house in Whitby is $992,000 and $1,087,000 in a small town like Port Perry.

Fig 1. The increasing degree of urbanization. As of 2023, 80% of Canada’s population lives in urban areas. This rate has steadily increased as agricultural advances have reduced the need for remote labour.

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So, who can afford housing in Canada?

I wasn’t surprised to learn that Canada’s personal debt exceeded its GDP. With the highest in the G7, many Canadians are extremely vulnerable to economic crisis as they can’t recover from job loss, inflation, or interest rate hikes. Aled ab Lorweth points out that “not all debt is bad [as it] allows households to purchase costly items such as cars and houses.” However, he also highlighted that debt does not go away when people lose their jobs, but until the debt itself is paid off. [4] This is especially true for young Canadians aged 35-44, with the highest average debt reaching $541,851 and are susceptible to job loss amid Canada’s economic downturn. Not only does this discourage home ownership for young populations, but it creates a snowball effect in which the economy slows and enters a state of ‘secular stagnation.’

Those over 65 have an easier time, with an average debt of $127,836. [5] This is further shown: As of 2018, only 21% of those aged 65 and older had a housing mortgage, compared to 34% of the population. We see that baby boomers bought their first houses between the ages of 25 and 30, compared to over 36 as of 2022, where the average Canadian must earn around $200,000-$237,000 annually to qualify for a house in 2024. As a result, people are having to resort to alternative methods to get their foot in real estate.

Fig 2. Average debt has steadily increased since 2019; the recent decline is an effect of the Covid-19 pandemic where people borrowed money.

Alternative Investments

Young Canadians are finding alternative ways to invest in real estate, including REITs, joint ventures, or impact investments.

REITs

“Real Estate Investment Trusts are companies that own, operate, or finance income-producing

real estate across a wide range of property sectors.” [7] They operate like mutual funds, where firms manage portfolios with real estate as their investment. REIT properties include commercial and residential real estate, in which they gain capital by investing in income-generating properties such as leasing space and property rent (Equity REITs), financing real estate (Mortgage REITs), or both (Hybrid REITs).

Currently, investors should be wary about investing in REITs as they are affected by the failing real estate market—high interest rates, struggling department stores, and frightened buyers and renters all contributed to the 8.9% decline in the industry since 2023. [8] Regardless, the diversification they provide from traditional investments benefits portfolio hedging, especially in times of stock market growth that investors are wary about.

For those interested in this investment: It’s recommended to hold off on this until the real estate market improves. Combined with their poor performance due to the dying real estate market, these companies heavily invested during COVID-19 during low interest rates. Long story short, they were inclined to accumulate massive amounts of debt and must now pay them off at higher interest rates, leaving little to the investor. That is not to say all REITs are underperforming– Forbes recommends many from the US, though I wouldn’t be too keen on all the taxes.

Joint Ventures

A joint venture is when two companies agree to pool their funds for (in this context) investing in real.

Estate. Oftentimes, this requires accurate market data and real estate information, and it’s also worth noting that most joint ventures regard commercial real estate and lots of money, which you probably don’t have. For example, the CN tower was almost a joint venture between the Canadian National and Canadian Pacific railways. Sometimes, you can have a “small-scale” joint venture in which you have time and knowledge, and the other person has funds. This option assumes you already have experience, which is highly unlikely, considering that few can afford a condo.

Other (Affordable-ish) Alternatives

Rent-to-own: An increasing number of Canadians are resorting to this option, which removes the need to provide a down payment. However, this can become complicated as buyers still must qualify for the mortgage payment if they wish to buy.

MICs: Mortgage investment corporations allow you to invest in various mortgages, own a portion of the company, and benefit from their income through dividends. They are less volatile than REITs as they do not involve physical properties. A more stable option is MICs, which don’t require much capital. [9]

Implications of Investments

Alternative investments have seen a stark rise in popularity. In particular, REITs have been deemed one of the most successful public investment sectors since their creation in 1993. As of April 2024, the nine leading REITs in Canada had a market capitalization of CAD 39 billion [10], with the most significant investment in luxury rental properties. As more people flock to these alternative investments, it becomes a question of how mortgages and the Canadian economy are impacted.

In their simplest forms, REITs invest in companies with the resources to develop and revitalize. Yet, they also benefit investors who drive up prices to excessive amounts, creating a barrier between the average person and the real estate market. In a snowball effect, those who earn through alternative investments make the real estate market more difficult to enter.

On a macro scale, alternative investments have been deemed a “force for good,” [14] helping to invest in various real estate, from social housing to hospital sub-sectors. Given the new influx of immigration, social housing is of particular interest. The Canadian government recognizes this— various tax advantages are offered such that investments like REITs are not taxable on rental income. Instead, “shareholders are taxed on a REIT’s property income.” [14]

Fig.3 REIT's performance in last 20 years compared to other investments, showing it beats every other passive investment vehicle

Future of The Canadian Real Estate Market

The future of Canada's housing market seems bleak. While the economy suffers, so do Canadians. Their average mortgage is over half a million dollars, over 60% have given up [13], and those who are "lucky" enough to own one have over 70% of their net worth tied up, where in reality, it should be no more than 30%. People are struggling, and it becomes more challenging to survive in Canada's urban metropolises as the months go by. Alas, there is light at the end of the tunnel.

Lately, it has been predicted that the transition to a buyer's market (in urban areas such as Toronto and Vancouver) and increasing mortgage interest rates will deter investors and impact the condo and low-rise development rate as demand decreases. Despite this, the Bank of Canada's recent interest drops and anticipation of another rate cut make many optimistic about the future of the housing market and alternative investments. There is expected to be a shift towards a balanced market by mid-2025. Until then, Canadians must turn to alternative investments to continue surviving, while the lucky boomers may continue to watch from afar in their mansions.

Fig 4. House sales are incredibly low, although the market somewhat comes alive when rates are decreased or paused.

Conclusion

In conclusion, as the Canadian real estate market faces ongoing challenges, including high housing prices and increased mortgage debt, many Canadians are seeking alternative investment strategies to navigate this landscape. While traditional homeownership remains out of reach for many due to soaring property values and tightening financial conditions, options such as REITs, joint ventures, and MICs provide viable pathways for those looking to invest in real estate without the burden of direct property ownership. However, with recent fluctuations in interest rates and the economic uncertainty ahead, potential investors must carefully consider their options and stay informed about market trends.

For those able to secure affordable mortgages, there is still an opportunity to enter the real estate market, particularly as interest rates are expected to stabilize or decrease. In the meantime, alternative investments may offer a practical and potentially profitable route for Canadians aiming to build wealth in a challenging economic environment. As the market evolves, staying agile and open to new opportunities will be key for those looking to thrive in Canada's dynamic real estate landscape.

References

[1] Government of Canada. (2024, April). More affordable homes. Department of Finance Canada.

[2] CIBC Capital Markets. (n.d.). Canadian Economics Report. CIBC.

[3] CBC News. (2023). Bank of Canada and housing. CBC News.

[4] Canada Mortgage and Housing Corporation. (2023). Risks to Canada's economy remain high as household debt levels continue to grow. CMHC.

[5] Loan Canada. (n.d.). Average debt by age in Canada. Loan Canada.

[6] Statistics Canada. (2021). Canadian real estate trends. Statistics Canada.

[7] Investopedia. (n.d.). Real Estate Investment Trust (REIT). Investopedia.

[8] Simply Wall St. (n.d.). Canadian REIT market analysis. Simply Wall St.

[9] Cooper Pacific. (2019, August). MIC vs REIT: What’s the difference? Cooper Pacific.

[10] Statista. (2024). Market cap of leading REITs in Canada. Statista.

[11] Google Search. (n.d.). How much net worth tied into a house in Canada. Google.

[12] Government of Canada. (n.d.). Understanding housing finance. Publications Canada.

[13] Ipsos. (n.d.). Six in ten Canadians who don't own a home have given up on owning. Ipsos.

[14] Grant Thornton. (2020). REITs as a force for good. Grant Thornton.

International Energy Agency (IEA). (2024). Global EV Outlook 2024.

U.S. Energy Information Administration (EIA). (2024). Short-Term Energy Outlook - June 2024.

McKinsey & Company. (2024). A Year of Electric Vehicle and Mobility Trends.

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World Nuclear Association. (2024). Nuclear Power in the World Today.

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