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Summary of brief submitted to the House of Commons Standing Committee on Human Resources, Skills and Social Development and the Status of Persons with Disabilities (HUMA) regarding the financialization of housing.

By Steve Pomeroy, Industry Professor and Executive Advisor at the Canadian Housing Evidence Collaborative (CHEC), McMaster University

Presented on June 9th, 2023

Key Points

  1. The critical issue before the HUMA study is the degree to which undesirable externalities (loss of existing affordable housing) are caused by financialized entities like Real Estate Investment Trusts (REITs) vs other actors and, would regulatory or tax reform to REITs address these issues?
  2. There are many facets of housing financialization, going well beyond the characterization of financialized landlords, particularly REITs, including:
    • The federal government through its housing agency, CMHC, is directly implicated as an agent of financialization through the creation of Canada Mortgage Bonds. As is CMHC’s development of mortgage-backed securities (MBS) in the late 1980’s – financial mechanisms that converted home loans into investable and tradeable financial instruments to increase liquidity and expand the supply of home finance which supports an expanding housing market.
    • Pension funds have long been active as investors in rental assets to store capital and to generate cash flow to service pension obligations and as such represent another long-standing form of financialization.
    • There is a significant impact from the expansion of small-scale investors in housing, which is having a larger impact than financialized firms and financial elites.
  3. A combination of reinforcing factors stalled rental production after the mid 1980’s, including:
    • The introduction of strata title legislation in all provinces from 1967-1970 made it more challenging for rental development to secure multi-residential land;
    • The introduction anti-inflation legislation in 1975, under which the federal government urged provinces to adopt rent controls to suppress rent inflation (and suppress potential returns on investment);
    • In the context of high inflation, all input costs—land, materials, and labour—became increasingly more expensive (while the ability to cover high costs was suppressed by the aforementioned rent controls);
    • Demographic shifts: boomers began forming families and sought detached ownership, reducing rental demand and following cohorts were smaller in scale, so didn’t replace exiting demand.
    • A program of broad tax reform, which removed the very favorable tax treatment of rental investment income and capital;
  4. This lack of supply was initially offset by easy access to ownership. After wallowing between 62-63% for thirty years (1966-96) the homeownership rate increase from 63% (1996) to 68% in 2006 (and then peaked at 69% in 2011). The consequence for the rental sector was that, between 1996 and 2006, 800,000 renters transitioned to become owners.
    Flash forward to 2016 this “pressure release valve” has been shut down by a combination of excessive home prices and macroprudential policies (e.g., stress tests and more stringent CMHC qualifying criteria) that make it extremely difficult for first time buyers to access ownership. The consequence is they remain renters and do not create the vacancies that tenure transition did in the earlier decade.
  5. Alongside this group of “stalled exits” from pent up buyer demand, additional rental demand is now being created by high immigration levels. While the target for new permanent residents is increasing, the far larger impact of immigration is from temporary foreign workers (TFWs) and international students.
  6. The consequence of these increased demand pressures in the rental market is upward pressure on rents. And this pressure is exacerbated at the lower end of the rental market by an absolute shortage of low rent homes, worsened by an ongoing process of erosion as rents inflate well above affordable levels – a process enabled by provincial rent regulations that allow vacancy decontrol in most jurisdictions. Existing tenancies are limited to an annual guideline increase; but vacated units can adjust to market. It is this regulatory mechanism, in combination with strong rental demand, that has created an environment that enables inflationary behaviors and practices.
  7. At a more extreme level, this also creates an incentive for asset owners/landlords to try and encourage or force existing tenants to leave – including “reno-victions” and “demo-victions.”
  8. Low purpose-built rental construction from 1996-2016 was compensated, in part, by the shift to condominium development and the emergence of a new form of small-scale landlord – individuals purchasing condominium units as rental investment properties (secondary rental market).
  9. Between 2011 and 2021, census data reveals that the number of rental units in condominium properties (so investor owned) almost doubled (from 419,000 to almost 800,000 nationally; and in Toronto alone from 81,000 to 178,000). This is double the growth of the financialized REIT sector. These small-scale landlords more frequently evict on the basis that they require the unit for personal use, or due to a sale to an owner occupant. And such evictions are far more frequent in comparison to evictions due to renovation.
  10. Erosion of the lower rent stock occurs via two parallel processes – absolute loss due to demolition and redevelopment of the older lower rent properties; and rent creep, where the structure still exists, but due to vacancy decontrol rents are rapidly inflating and moving above the affordable range.

Conclusions and recommendations

The foregoing analysis has revealed that the issues contributing to the ongoing phenomenon of rent gouging and renoviction, and the dramatic ongoing erosion of lower rent options, are pervasive and relate to a wide range of investors, of which REITs are a very small fraction. These behaviors have more to do with the transformation of rental housing into an attractive asset class, in large part due to an insufficient supply of rental housing to address pent up residual demand from potential buyers and a large cohort of non-permanent residents, including students. And this is enabled by provincial rent regulation that permits vacancy decontrol.  A narrow fixation on reforming tax treatment and regulation of REITs is therefore unlikely to have a significant effect, nor will this alone reverse the trend of excessive rent increases and erosion of the low rent stock.

Recommendation 1: Request the provinces revise current rent regulation to (at least temporarily) remove the vacancy decontrol mechanism to moderate the excessive increases in rents (while new construction catches up to excess rental demand related to immigration).

Recommendation 2: Direct CMHC to establish more stringent conditions to limit rent increases for investors utilizing mortgage insurance to purchase existing low rent properties.

Recommendation. 3: Encourage the ongoing pivot of REITs toward investment in new rental supply, rather than purchase of existing assets.

Recommendation 4: Encourage institutional investors and pension funds to review and update ESG investment guidelines to minimize the practice of renoviction and large rent increases in properties in their portfolios.

Recommendation 5: Request that the government amend the National Housing Strategy to create a funding and financing mechanism, including the use of low-rate financing, to enable non-profit entities to acquire existing lower rent properties to preserve and protect low rents and isolate these assets from excessive rent inflation.[1] This could take advantage of the disposition of REIT properties that they seek to sell into a nonprofit affordable fund or trust.

Recommendation 6: Encourage Immigration, Refugees and Citizenship Canada (IRCC) to review and recalibrate issuance of international student visas and temporary foreign worker permits to better align with new rental supply; and direct CMHC to provide low-rate financing incentives to facilitate construction of purpose-built student housing to better manage rental demand from international students.

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Video recording of Steve Pomeroy’s presentation: