The prices of residential homes in Vancouver and Toronto have continued their uphill climb, causing organizations like the Canada Mortgage and Housing Corporation to issue warnings about the vulnerability of those markets.
“Even in a global context, Vancouver ranks as perhaps the most overvalued housing market in the world,” says Chip McKinley, senior vice-president and portfolio manager with Cohen & Steers in New York. Among other real estate funds, he manages the Renaissance Global Real Estate Fund.
Still, a Canadian-driven housing – and economic – crash isn’t McKinley’s main concern. “Canada’s economy is very stable and healthy, and we don’t expect a recession any time soon,” he says.
Instead, in relation to his real estate outlook, he’s watching China’s economy and its drivers.
Why? First, if you look at what’s driving demand for Vancouver real estate, you see the market isn’t “being propped up by healthy economic growth – growth is not particularly strong in Vancouver,” says McKinley. Instead, demand is “coming from overseas investors, particularly from China,” he says.
Typical real estate investors from that region “are mostly affluent people who are trying to get capital out of China,” he adds. “They have fled to mature, attractive cities with good rule of law and relatively low barriers to flows of capital in and out of the country, as well as low restrictions to buying residential properties. And Vancouver fits that bill perfectly.”
Read: Fewer foreign buyers purchasing properties in Toronto
Further, Vancouver’s housing market isn’t the only one being propped up by Chinese investor demand. The same overseas investment trend is driving up residential real estate prices in Sydney, Australia, “and that’s why Sydney is the second-highest most overvalued city in the world from a residential point of view.”
The final reason McKinley is monitoring China’s economy is “there are arbitrary and unpredictable [economic] events that could cause a rapid pullback and, thus, [a pullback] in buyer demand for property types all over the world.” If that happened, “we’d have a […] problem; when China slows down, or if there’s some sort of large disruption, then […] that could be painful for everyone,” in the real estate space.
But REITs would be spared
If there were a serious correction in the value of and demand for homes in Canada, it would be a problem for the economy. “But, ironically, [that] would not actually affect REITs at all – at least not directly,” says McKinley.
The main reason is “listed REITs in Canada don’t actually own apartments or houses,” he adds. So, while “there [would be] indirect effects if there were a housing correction,” McKinley doesn’t foresee REITS suffering under that scenario.
But if a housing crash occurred in the context of an overall economic recession, he’d be more concerned about REITs. As McKinley points out, the possible effects of a recession include business spending and consumer spending contracting. Further, he adds, recessions “rob businesses of the cash flows needed to maintain their locations, or their occupancies, in the properties owned by a lot of REITs.”
Read: Calgary, Edmonton lead Western Canada in commercial property sales
As a result, “You’d see retail stores closing down, companies reducing square footage of the office space that they occupy, and demand for warehouse space could contract.” However, whether or not that occurred would be “dependent on the magnitude [of such an event], and that’s a fairly unknowable thing,” McKinley concludes.
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