The Canadian housing market is slowing down.
Investors interested in residential real estate shouldn’t expect the 10% returns of a few years ago—more like half that, says Craig Machel, a portfolio manager and investment advisor with Macquarie Private Wealth.
“Canadian valuations have become very high in real estate and yields are squeezed, so there’s not a lot of room for growth,” he says.
Benjamin Tal, deputy chief economist of CIBC World Markets Inc., agrees. “Property prices will soften over the next two to three years and activity is already slowing down in terms of demand. For the next decade we’ll see a more subdued housing market.”
And Michael Bowman, executive vice president and portfolio manager at Wickham Investment Council, expects prices may decrease about 5% in the next two years.
This softening suggests investors are better off in Canadian forestry stocks, which will benefit from anticipated U.S. growth, or investing directly in U.S. REITs or building stocks.
Building materials
Many Canadian companies, including West Fraser and Canfor, supply the U.S. with lumber. Recent high-rise building surges in the U.S. have pushed prices up, says Tal. And low-rise building is expected to recover next in the U.S.
“Therefore, choose Canadian companies directly linked to the U.S. building market,” he says.
Companies that supply copper, used in water piping and wiring also merit consideration; this means Canadian mining firm First Quantum is worth a look, says Bowman. First Quantum recently bought Inmet Mining Corp., and is now one of the world’s largest copper suppliers.
Also, there’s only about one more year of elevated construction in the Toronto condo market before the worm turns. “So if you can find companies that supply lumber and materials to those builders, that will also be a good place to be,” says Tal.
But investors should eschew individual units. “More supply will lead to a slowdown in rental conditions,” Tal warns, noting a large percentage of buyers are investing in condos so they can convert them to rentals, and don’t intend to occupy them.
Machel expects stricter lending conditions over the next 12 months will stem the number of speculative condo investors, as they won’t be able to leverage existing properties. “This may contribute to further declines in condo valuations.”
More opportunities
But, while Canadian housing softens, its southern counterpart is picking up. More people are buying in the U.S. and prices rose 12% in April, according to analytics company CoreLogic.
So head south for better growth and yields. Investors should look at large U.S. homebuilders like Pulte, Lennar, and the Toll Brothers, as well as U.S. home construction ETFs like iShares Dow Jones US Home Construction (ITB). Bowman notes you’re buying these for growth, not income. The three-year rate of return for each has increased since the downturn —Pulte is up about 125%; Lennar 160%; Toll Brothers 105%; and ITB 100%.
He expects this trend to continue. “The economy is now standing on its own with QE easing in the third quarter of 2013, [so] I expect homebuilder stocks to increase, especially in the next year,” says Bowman.
And homebuilder sentiment is rising, suggesting construction will increase in coming months. “Builders are seeing more motivated buyers coming through their doors as the inventory of existing homes for sale continues to tighten,” says David Crowe, National Association of Home Builders (NAHB) chief economist, in a release.
In fact, U.S. housing starts rose 6.8% in May, according to NAHB. From a regional perspective, southern and western states posted the highest gains at 17.8% and 5.7%, respectively.
And if housing’s improving, then investing in mortgage lenders and banks is also a good idea. BMO Equal Weight U.S. Banks Hedged to Canadian Index ETF (ZUB) has a 1.5% dividend yield, Bowman says.
Machel adds the iShares Dow Jones U.S. Regional Banks Index Fund is another option, with yield at 1.6%. It bottomed in March 2009, when it was priced at $11 per share. Now it’s up to about $31.
“The bank valuations on the regional side is much more attractive than the big guys.”
He adds, “On the back of an economic and housing recovery, the regional banks will benefit from increased lending to residential and commercial property borrowers.”
For investors who want to stay closer to home, Bowman says there’s consistent yield in Canadian home improvement companies like Rona (1.2% yield).
Experts also suggest REITs (see “All things REIT,” this page). One such managed fund, which can’t be purchased on the TSX, is Centurion Apartment REIT, says Machel. The fund is paying 7% dividend yield annually and expected growth is 2% to 3% a year.
“It’s got liquidity on a monthly basis, is involved in multi-family residential in Ontario, and is moving further into student housing in university towns, such as Kitchener, Waterloo and London [in Ontario].”
And although investing in student housing seems risky, he notes Centurion REIT comes with stricter one-year leases for students—not the typical eight-month leases. Also, if four students are renting a four-bedroom unit and one person leaves, then the other three are on the hook for that person’s rent. Centurion REIT says its default rate for unpaid student rent is less than 0.50%.
Real estate investing drives U.S. housing
Investors have spiced up the U.S. housing recovery.
They are responsible for one-in-five resale transactions, and could remain the
driving force behind the housing market despite higher mortgage rates, says a BMO report.
“Investors are increasingly paying cash, lured by rising rents and low prices,” says Sal Guatieri, senior economist at BMO Capital Markets. “Low borrowing costs have led other investors into the real estate market.”
The report focused on investors in Florida. It suggests an investment in a typical property would, over 30 years, net an annual return that is 2.5% more than if the down payment was invested in a basket of stocks and bonds.
Guatieri noted if Orlando is representative of the typical post-bust real estate market, then mortgage rates could increase at least another percentage point before many investors think twice about real estate.
He adds, “Until then, likely in 2015, the investment tailwind on housing’s back should persist, just as more first-time homebuyers are drawn back in the game by lower unemployment, easier loan standards and relatively good affordability.”
This situation could provide benefit to Canadian property investors as well. According to another report, Canadian snowbirds are playing an important role in U.S. housing market recovery.
“There are two factors that are making Florida real estate an especially good value for Canadians,” says Jack Ablin, CIO of BMO Private Bank.
“First, Florida properties are a bargain compared to real estate in Canada. Second, the Canadian dollar remains relatively strong, arming [those] shoppers with extra buying power.”