Further Thoughts on the Budget and Housing
Last week, we examined the new housing road map laid out in the 2024 federal budget. This week, we’re offering a few additional thoughts on two related issues: the importance of private sector investment in rental housing and the impact of investors in the real estate market.
Encouraging Private Sector Investment in Rental Housing
Although Canada has only recently begun to address the shortage of rental housing, it’s a train wreck that has been decades in the making. The problems and potential solutions at the federal level were identified many years ago.
About 25 years ago, economist Frank Clayton looked at the impact of federal tax legislation on the rental housing market. His study revealed that changes in the federal tax system since the early 1970s had discouraged private investment in rental housing. Although the federal government has recently implemented some of the changes suggested in Clayton’s report, they may not go far enough to fully address the issue.
As noted in the report, prior to the 1971 tax reform, recaptured capital cost allowance (CCA) could be deferred if property in the same CCA class was bought in the same tax year as the sale, for an amount equal to the sale proceeds. In a recent report, CIBC economist Benjamin Tal highlighted the benefits of a similar rollover provision in the U.S. rental market, which incentivizes developers to reinvest the sale proceeds from one project into new real estate ventures to defer paying capital gains taxes. This practice encourages funds to stay within the sector.
A 2022 study by E&Y (formerly Ernst & Young) demonstrated substantial indirect economic benefits from this rollover provision. Tal suggests that implementing a similar provision in Canada would “not only incentivize the development of rental units in Canada but also, at the margin, it would improve economic growth and efficiency.”
Combating the Financial Boogeyman
In the US, the proportion of single-family housing owned by homeowners has been increasing over the past eight years. This trend has driven homeownership rates to some of the highest levels seen since the period just before the great financial crisis. The supply of for-sale homes has been limited, partly because existing homeowners have been hesitant to sell, preferring to hold onto their current low-rate 30-year mortgages.
Small local investors own more than 95 per cent of single-family rental properties. This majority ownership by small investors is a political target that legislators are unlikely to challenge. Rather than targeting this large segment, legislators have focused instead on the 3 per cent of single-family rentals owned by large investors. Within this space, reporting has predominantly focused on acquisitions, neglecting to consider net flows, which have often been negative for investors since 2016.
Large investors are not new to the U.S. housing market. Following the 2008 financial crisis, investors in the single-family market played a crucial role by stabilizing the distressed housing market. From this perspective, they filled a critical void and provided essential support during the challenging period following the crisis.
Laurie Goodman from the Urban Institute points out that large institutional investors often purchase homes in need of repair. For various reasons, these investors can make the repairs more efficiently than individual homeowners. They compete with other professional house flippers to enhance the quality of the housing stock through these upgrades.
Research indicates that investor participation produces other benefits. A recent paper by Joshua Coven of NYU found that investors not only decreased the supply of owner-occupied homes but also increased the supply of homes available for renters by 69%. This expansion enabled individuals facing financial constraints to move into neighborhoods with previously limited rental options.
Despite there being no signs that institutional investors are looking to acquire existing single-family homes, our federal government is addressing concerns about the financialization of housing and will consult in the coming months and provide further details in the 2024 Fall Economic Statement. It’s reassuring to see measures being taken to safeguard home ownership from potential future threats, whether real or perceived.