From Boom to Balance: A Strategic Look at Canadian Residential Real Estate Investing
December 5, 2024
Dynamics shaping the market have shifted, making the extraordinary returns of the past increasingly difficult to replicate.
The Changing Landscape of Canadian Residential Real Estate Investing
Stu Morrow, CFA | Mawer Investment Counsellor
Canadian residential real estate has long been a cornerstone of wealth creation, driven by property appreciation and rental income. For decades, investors benefited from rising demand, limited supply, and historically low interest rates. However, the dynamics shaping the market have shifted, making the extraordinary returns of the past increasingly difficult to replicate. Challenges such as higher borrowing costs, slowing rental growth, and government policy measures aimed at curbing speculation require investors to rethink previous successful strategies.
This article will explore:
- the evolving Canadian housing market,
- the key factors influencing its performance, and
- what investors should consider when navigating this new landscape.
The Role of Investors in the Canadian Housing Market
In 2023, over 20% of Canadians were classified as residential real estate investors (owns at least one residential property outside their principal residence), according to Statistics Canada. Investor enthusiasm has been driven by factors such as rising property values, a persistent housing shortage, and an influx of immigrants following the pandemic. These forces have positioned Canadian housing as a top-performing asset class, especially in urban centers.
Chart 1: Inflation-Adjusted Home Prices in Canada vs. G7 Countries
Sources and notes: International house price databased sourced from Dallas Federal Reserve: https://www.dallasfed.org/research/international/houseprice. Data reflect real, or inflation-adjusted, home price indices for select developed countries with similar economic, demographic, and policy frameworks as Canada. Home price indices were based on local currencies. Past performance is no guarantee of future performance, and you cannot invest in an index. National home price indices may not reflect regional or idiosyncrasies within certain municipalities or neighborhoods. Note that most investments in residential Canadian real estate are in apartment condominiums. In 2023, Statistics Canada found that 42% of Ontario condos were held as an investment (non-owner occupied), compared to just 15% of single-family houses.
As seen in Chart 1, Canadian home prices outpaced those in other G7 countries after 2015. While home prices in Canada followed inflation-adjusted trends similar to its peers from 1975 to 2015, recent years have seen prices soar. This growth reflects a unique combination of demand drivers and constrained supply that set Canada apart.
Demand and Supply Dynamics: Then vs. Now
Population Growth and Housing Demand
Immigration-fuelled population growth has long been a critical driver of housing demand in Canada. The acceleration of this trend after 2015 placed significant upward pressure on property prices. Chart 2, based on Statistics Canada data, illustrates this population growth spike, which bolstered demand even during economic uncertainties.
Chart 2. Population Growth and Its Impact on Housing Demand in Canada (1973–2024)
Source: Statistics Canada
However, recent policy measures aim to temper this growth. The federal government has extended the Prohibition on the Purchase of Residential Property by Non-Canadians Act until 2027 and lowered annual immigration targets to 1% growth by 2026. While these measures may not immediately affect housing demand, they are expected to reduce rental market pressures over time, potentially slowing rent growth and softening investor returns.
Immigration’s influence on demand is also shifting. While Canadian cities have historically experienced upward price pressure from newcomers, changes in policy may moderate this demand. The extension of the Prohibition on the Purchase of Residential Property by Non-Canadians Act through 2027 and reduced immigration targets will likely decrease housing demand in the coming years.
Interest Rates and Affordability
Interest rates have historically played a pivotal role in shaping housing demand. Following the 2008 global financial crisis, real interest rates (adjusted for inflation) fell below zero, making borrowing cheaper and encouraging investors to assume additional leverage. This environment spurred substantial price growth as demand surged.
Chart 3: Canadian Real Interest Rates Over Time
Source: Refinitiv. Real Interest Rate represents the Bank of Canada rate less the corresponding monthly Canadian Consumer Price Index (CPI).
As illustrated in Chart 3, real interest rates rose above 2% in 2024 for the first time since 2006. Higher borrowing costs have dampened demand and constrained affordability. The delayed effects of these rate hikes are expected to further weigh on the housing market, creating headwinds for investors relying on leverage.
Housing Supply Challenges Persist
Canada faces significant challenges in meeting its housing supply needs. The Canadian Mortgage and Housing Corporation (CMHC) estimates that an additional 3.5 million housing units will be required by 2030 to restore affordability. However, regulatory barriers—including zoning restrictions, development fees, and geographical constraints—continue to limit new construction.
Chart 4: Affordability Gap – Real Home Prices vs. Disposable Income
Sources and notes: Real Home Prices Index (RHPI) and Real Personal Disposable Income (RPDI) data was sourced from the Dallas Federal Reserve: https://www.dallasfed.org/research/international/houseprice. The Dallas Fed study took data from OECD HH disposable income, inflation adjusted using the Personal Consumption Expenditure index. Household disposable income is the sum of household final consumption expenditure and savings. Income includes wages and salaries, mixed income (income from self-employment and unincorporated enterprises), income from pensions and other social benefits, and income from financial investments. It is less taxes on income, wealth, social security contributions paid by employees, the self-employed and the unemployed, interest on financial liabilities, and the change in net equity of households in pension funds.
Chart 4, sourced from the Dallas Federal Reserve and OECD data, highlights the affordability gap has widened since the 2010s as home prices have outpaced disposable income growth. While government housing initiatives aim to increase supply, their impact remains uncertain. Investors should consider how greater supply might affect rental markets and long-term price growth.
Canada’s chronic housing supply shortage continues to worsen affordability. With the CMHC estimating that 3.5 million units are needed by 2030 to restore balance, developers face regulatory and cost challenges that slow new construction. Until these barriers are addressed, the imbalance between supply and demand will persist, further elevating housing costs.
Another key factor contributing to the housing affordability crisis is the disconnect between wage growth and home price increases. Data from the Bank of Canada indicates that average wage growth has lagged housing price appreciation by an average of 3% annually since 2010. This growing disparity has placed homeownership out of reach for many Canadians.
The wage-to-price ratio is at a historical low, with average wages growing at just 3% annually, while housing prices have increased at a rate of 6%. This widening gap means that fewer Canadians can afford to buy homes, contributing to the growing demand for rental properties and driving up rental prices.
The Economics of Negative Cash Flows on Rental Property
Negative cash flows are becoming increasingly common among Canadian residential real estate investors, particularly in the condominium market. Data from Capital Economics shows that over 80% of newly completed condos in the Greater Toronto Area (GTA) generate negative cash flow when purchased with standard financing. Rising operating costs, property taxes, and stagnant rental growth exacerbate this challenge.
Chart 5: Slowing Rent Growth in Key Cities
Sources and notes: Capital Economics, Rental.ca (Rents in Canada Decline for First Time Since COVID).
Rental growth trends, shown in Chart 5 (based on Rentals.ca data), reveal a decline or stagnation in key urban centers like Toronto, Vancouver, and Calgary. In October 2024, average asking rents for all residential property types fell 1.2% year-over-year, marking the first decline since the pandemic. Reasons for the softening trend in asking rents include an increase in purpose-built rental construction projects completed since 2018, recent changes to our immigration policy previously mentioned, and more recent softening in the labour market. Investors relying on rental income to offset carrying costs may face increasing financial pressure as rental markets soften.
While some investors have relied on leveraged real estate for price appreciation, rising costs and declining rental income threaten the traditional investment model. With rental growth stagnating or declining in key urban centers, investors should carefully assess cash flow projections before committing additional capital.
Evaluating Opportunity Cost and Diversification
Real estate investments have traditionally been considered a stable way to build wealth. However, the high entry costs, illiquidity, and leveraged nature of these investments make them riskier in today’s changing market. Compared to financial assets such as equities, residential real estate requires significant capital and offers limited diversification even with a substantial portfolio of investments.
Chart 6: Historical Returns – Real Estate vs. Equities
Source: Canadian Home Price Index, nominal (Dallas Federal Reserve), Canadian Equities (Bloomberg, S&P/TSX Composite Index), US Equities (Bloomberg, S&P500 Index in CAD), in nominal dollars including inflation, before fees, transaction costs, dividends or income and taxes. Past performance is no guarantee of future performance, and you cannot invest directly in an index. All data has been presented is in Canadian dollars, based on monthly returns converted to period specific compound annual growth rates (CAGR%).
As shown in Chart 6, equities have generally outperformed Canadian residential real estate in terms of total return over the past 50 years. While housing provided strong returns during certain periods, equities delivered greater long-term growth potential and liquidity. Investors should consider these differences when evaluating opportunity costs and risk-adjusted returns.
While Canadian housing has performed well in the past, equities have historically outpaced real estate when considering total returns over long cycles. Investors should take a diversified approach, taking into consideration the overall strategic asset allocation breakdown between public investments in cash, bonds, and stocks, and private investments in credit, real estate, and equities.
Regional Variations in the Housing Market
Canada’s housing market is highly regional, with significant differences in performance between cities and provinces. In places like Toronto and Vancouver, home prices have stagnated, and rental growth has slowed. Meanwhile, cities in Alberta, particularly Calgary and Edmonton, have experienced more stability, with more affordable prices and steady demand. These regional dynamics can affect the returns on investment, making it critical for investors to tailor their strategies to specific markets.
Regional trends are important to consider when investing in Canadian real estate. For example, Toronto and Vancouver are seeing stagnation in home prices and slowing rental growth, while cities like Calgary and Edmonton continue to offer more affordable housing with steadier price trends. Investors should look beyond national trends and evaluate specific markets to optimize returns.
Strategic Considerations for Investors
In this evolving market, a strategic approach is essential for investors seeking to navigate new challenges. Below are some key considerations:
- Reevaluate return expectations: Investors should prepare for lower returns, particularly in markets with slowing rental growth and higher borrowing costs.
- Diversify across asset classes: A balanced portfolio that includes equities, bonds, and other asset classes can reduce concentration risk and improve resilience. For investors with sizeable investment portfolios in residential real estate, consider diversification across property types, and regions to further reduce idiosyncratic risk.
- Plan for scenario variability: Assess investments under different economic scenarios to understand risks and rewards.
- Consult trusted advisors: Engage financial and tax advisors to optimize strategies and manage leverage effectively.
- Extend investment horizons: Compared to previous housing market cycles, short-term opportunities for profits may be fewer and far between, so long-term thinking is essential going forward.
Canadian residential real estate remains a vital component of wealth-building strategies, but the market’s evolution demands a more nuanced approach. The factors that previously drove extraordinary returns—such as low interest rates, strong population growth, and constrained supply—are shifting, and investors must adapt their strategies to align with this new reality.
If you already invest in Canadian residential real estate or are considering doing so, it’s worth connecting with your Investment Counsellor to discuss how some of these new and evolving market considerations may play a factor into your strategic asset allocation and overall wealth plan.
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