The Rise of Private Equity in Canadian Residential Real Estate: Challenges and Solutions

July 5, 2024

By Allwyn Dsouza, Senior Analyst, Research and Insights, REIC/ICI

As part of a set of housing policies aimed at tackling strained housing affordability and a severe shortage of homes, the government plans to restrict private-equity involvement in the residential real estate market. This move is driven by concerns that private equity funds wield significant financial power, disadvantaging ordinary buyers.?? Calls for such action have increased since private equity and hedge funds entered the housing market after the pandemic. However, validating these concerns is challenging due to limited data, particularly given the minimal disclosure requirements for these funds.

The decision by lawmakers is influenced by testimony heard by the parliamentary committee indicating that the 25 largest investment firms, including REITs, private-equity firms and asset managers, collectively own about 350,000 apartment suites, or 20% of Canada's rental housing with more than six units.[1] The primary concern is that institutional buyers will corner the market and sharply increase rents driven by a profit motive, unlike traditional mom-and-pop landlords, who are mainly looking for a steady source of income. Moreover, individual landlords are fragmented and cannot control the market.?

Further, a rapid increase to 20% within a short period does raise concerns, particularly when considering parallels with developments in the United States. Trends in the U.S. often foreshadow those in Canada.?Investor involvement in the U.S. housing market emerged roughly fifteen years ago in response to the GFC (Great Financial Crisis) and subsequent foreclosure crisis of 2008. Since then, corporate purchases of single-family homes had surged to 28% in 1Q2022, as reported by the Harvard Joint Center for Housing Studies. According to the industry publication Private Equity Real Estate, by 2030, investors may potentially oversee up to 40% of the US housing market.[2]??However, it remains uncertain whether Canada will experience a similar outcome, primarily because the extent of the institutional investor issue in Canada is unclear. This ambiguity stems from a scarcity of available data, as there is no centralized database that comprehensively tracks residential investment.

The issue in the U.S. originated from the housing downturn and the GFC. During the 2010s, the U.S. constructed fewer homes than in any decade since the 1960s. Foreclosures resulted in numerous vacant and deteriorating homes. Private equity firms stepped in to assist sellers by offering upfront cash when traditional buyers were scarce and institutional support was lacking. However, the devastated homebuilding industry failed to increase new residential construction adequately to meet future homebuyer demand. Surviving builders encountered mounting zoning and cost challenges. Therefore, it was not solely private equity ownership but rather the sluggish increase in housing inventory that contributed to rising prices and rents. Private equity entities are opportunistic and tend to capitalize on crises rather than causing them. The combination of a lack of new entry-level homes and more buyers drove up home prices and rents. The rise in house prices and rent have significantly increased institutional investor demand for homes.??

In Canada, the situation post-GFC wasn't as severe, but recently, private equity funds have turned their attention to the rental market, seeking stable returns after the pandemic. Typically, private equity prefers commercial real estate due to better yields and easier management. However, with the decline in demand for commercial properties due to the work-from-home trend, they shifted focus. Purpose-built rentals became attractive in this inflationary climate, especially as residential rents soared by 50% since 2019, compared to just a 10% rise in commercial rents.?

Figure 1.0

While some reports claim that REITs own 20% of Canada’s purpose-built rental housing, other estimates suggest a much lower figure. Without accurate data, decision-making could be compromised. Neither Statistics Canada nor the CMHC provide data on institutional ownership of multifamily properties. Associate Professor Martine August of the School of Planning at the University of Waterloo estimates that REITs went from owning no suites in 1996 to 10% of Canadian apartments by 2020[3]. According to a 2022 report by SHARE, the six largest REITs in Canada own about 126,132 units, making up 6% of the primary rental market.[4]?

We also looked at data from Statistics Canada to gauge the level of institutional investor activity. While it is true that more than one in five owners of residential real estate in Canada is an investor, a large majority are individual investors.??

Figure 2.0

Note: This is a count of owners without reference to how many properties they own.?

The analysis revealed that investors showed a stronger preference for condominium apartments over houses. As seen in Figure 3.0, the percentage of houses used as investments ranged from 14.3% in New Brunswick to 20.1% in Nova Scotia, averaging 15.6% across five provinces. In contrast, 39.4% of condominium apartments were used as investments (see Figure 4.0).?

Figure 3.0

Figure 4.0

Business-owned investment properties were more prevalent in the condominium apartment sector than in the housing sector, reaching a high of 13.4% in Ontario. This segment, which encompasses institutional investor holdings, is crucial for our analysis. However, this 13% also includes smaller corporations, partnerships and investment vehicles formed by high-net-worth individuals, making it challenging to accurately gauge the extent of institutional ownership in housing.?

Moreover, considering the relatively high proportion of individual investors, the data suggests that the issue isn't the ownership of rental housing by private equity and hedge funds, but rather the broader problem of the financialization of housing. The financialization of housing refers to the growing dominance of financial actors in the housing sector, which is transforming the primary function of housing from a place to live into a financial asset and tool for investor profits.?

The government’s withdrawal from housing oversight and regulation in the 1970s, 80s, and 90s paved the way for financialization, setting the stage for the soaring housing costs Canada has experienced, especially in the past decade. ?

Until the 1980s, federal and many provincial governments funded various programs supporting affordable housing development. These interventions included subsidies and tax breaks for cooperatives, non-profits, and social housing providers. From the 1940s to the 70s, governments invested directly in publicly owned housing and offered tax incentives to developers of purpose-built rentals.

However, since the 1980s, Canadian governments have relied almost exclusively on the private market to meet diverse housing needs. However, affordable and social housing are not well-suited to private markets, which operate with a profit motive.?

Instead of making private equity a scapegoat for the perils of the industry, it would be prudent to evaluate possible solutions or even make them a part of the solution.?

A look at the suggestions made by the Office of the Federal Housing Advocate (OFHA) and a thorough debate on the pros and cons can be a starting point.[5]??

Firstly, the government must establish a comprehensive database on the beneficial ownership of housing. Additionally, it is crucial to limit financial ownership of housing. Most European countries have caps on the number of rental units an investor can hold in an area.?

This measure will address the primary concern currently sighted regarding private equity players, which involves their potential dominance of significant portions of the market in specific localities or sub-districts, either directly or through their portfolio companies.??

Despite its drawbacks, private equity plays a crucial role in housing by providing capital and a reliable buyer for developers. If a ban were implemented, approximately 13% of potential buyers could be excluded from the market. At this stage, such a move could significantly impact condo prices, which are already declining, and the future supply of rental units. Decisions of this nature should be well-researched and based on proper data, avoiding knee-jerk reactions to public opinion.?

A proper consultation with industry leaders, participants, and stakeholders is essential. REIC, a leading member organization of professionals in the real estate industry and a pioneer in real estate education, emphasizes that addressing the housing affordability gap requires everyone's involvement. A collaborative approach is key to developing effective solutions.?

Figure 1.0 Statistics Canada Table: 18-10-0255-01 , Rental.ca , and REIC analysis

Figure 2.0 Statistics Canada, Canadian Housing Statistics Program (CHSP) and table 46-10-0069-01 .?

Figure 3.0 Statistics Canada, Canadian Housing Statistics Program (CHSP) ?

Figure 4.0 Statistics Canada, Canadian Housing Statistics Program (CHSP) ?

[1]?Canada to Restrict Private-Equity Investments in Housing Market — Update

[2] CBC: Big Investors Eye Canada’s Home Market

[3]?The rise of financial landlords has turned rental apartments into a vehicle for profit

[4]?State of the Sector

[5]?The financialization of housing in Canada: A summary report for the Office of the Federal Housing Advocate. ?

Allwyn Dsouza is REIC’s Senior Analyst, Market Research and Insights. He can be reached at [email protected] . Media enquiries can be directed to [email protected] .