There's no doubt that 2023 has been a much slower year for real estate investment. From declining sales to cancelled projects, fewer homes are coming on the market as newer projects become less financially viable for developers and investors.
The question, then, that's top of mind for everyone is: how, when, and where is this (hopefully) going to change? To understand what's happening on real estate's investment side, STOREYS spoke with Josh Lerner, the Senior Vice President of Investments at Harbour Equity, to walk us through the issues that plagued 2023, and what he expects to see in the new year.
The Capital Issue
The biggest mountain developers had to climb in 2023 was funding projects, Lerner said. Not only in terms of acquiring capital in the first place, but also in terms of knowing how much a project was actually going to cost. As inflation and interest rate hikes worked their way through the system, Lerner says it was hard to get any visibility in terms of final project costs.
"We didn't know what things were going to cost from a financing cost perspective, and that made it challenging," he said.
Although the spring and its pause in interest rate hikes offered some brief stability, the Bank of Canada's subsequent raises and maintenance at 5% interest rates have made financing a year-long struggle.
"It's the combination of developers being short on capital and a lack of institutional capital. This limits the ability of developers/owner-operators to get the liquidity they need,” Lerner said. "The larger institutions are not really investing, although Harbour continues to seek new opportunities with experienced well-capitalized groups."
Even condo projects, which are typically easier to get financing for, have seen serious challenges this year as more and more buyers move to the sidelines, affecting pre-construction sales, which are needed to secure construction financing.
"You need to have pre-sales to secure construction financing for a condo, and that has been a challenge in this elevated rate environment," Lerner added.
"It is all ultimately tied to interest rates. Capital constrained developers with too much debt across their portfolio thought they could service their debt — and they probably could, when prime was 475 basis points lower, and [they] probably even thought they would have been fine at 275 basis points lower — I just don't think anyone was prepared for the magnitude and speed of the increases."
Opportunity In Alberta
One region that proved successful investment-wise in 2023 for Harbour Equity was Alberta, with Lerner calling cities like Calgary "a really good growth story" thanks to their relative affordability.
"They still have some of the cost pressures I referenced, but they're just starting from such a lower point," he said. "The land is cheaper, there [are] much lower development charges, city fees — all the stuff people talk about in Toronto and Vancouver that make the cost of development so expensive."
This translates to a more affordable end product — something that, in the current environment of high interest rates, people are drawn to. The median price of a detached home in Q3 in Calgary was $635,000, according to the Canadian Real Estate Association — significantly more affordable than the well-over-$1M prices seen in Toronto and Vancouver.
Alberta has also experienced an influx of inter-provincial migration in recent years, with recent Statistics Canada data revealing that from July 1, 2022 to July 1, 2023, Alberta experienced the fastest year-over-year demographic growth out of all the provinces and territories in Canada.
"[Alberta] was successful in terms of us making investments. Time will tell how successful those investments are, but we've got great partners and we're excited about the Alberta market," Lerner said. "We think that the ability to offer a much more affordable product should win out. From a macro perspective, you've still got a lot of immigration and people are going to keep being drawn to those markets where things are more affordable. We continue to evaluate opportunities in other markets, including Toronto and Vancouver, but they are more challenged due to slower market conditions compared with Alberta."
Looking More To Rentals
One housing type that piqued more interest in 2023 than it has in recent years, from an investment perspective, Lerner says, is rentals — thanks in part to an influx in demand and a subsequent rise in rent prices.
"As rates stayed high, people that would normally buy a house were forced to rent and you saw rents go up considerably," he explains.
Month after month, prices hit new record highs in a number of Canadian cities. In Toronto, average asking rents surpassed $2,900 per month. In Vancouver, they reached $3,316 by August.
"There's still an open question about cap rates and values for these assets, because there haven't been as many trades, but I think as long as rents go up, investments should be successful by and large. You can always hold it." Lerner says.
Rental-specific financing from CMHC has made rental projects somewhat more attractive, but it's not without its downsides. The MLI Select program provides reduced interest rates and longer amortization periods on multi-unit mortgage loans across Canada, but Lerner notes the wait times to get approved have grown lengthy.
"It's almost like a mini entitlement period," he says. "You have to bake in — even if you're buying something that's shovel ready — it's gonna be six to nine months, although they have apparently accelerated their processing times recently."
Another boost came in the form of the federal government dropping the GST on new rental builds, with some provinces following suit, dropping their provincial sales tax on new rentals. Lerner called it a "positive tailwind on the cost side for a lot of these projects."
Bracing For 2024
Looking ahead, Lerner says he's "cautiously optimistic" about 2024 and what the market will bring, but it won't be smooth sailing for all. With 2023 having seen a number of developers struggle financially, having to cancel, sell off, or have their projects enter into receivership, that likely won't come to an end come the new year.
"I think you're just going to see more of that, where groups that were overextended are going to look for fresh capital to come in and help preserve the viability of their projects," Lerner said.
"I don't think anybody was quite prepared for the speed and magnitude of the interest rate increases, and a lot of real estate is financed with debt, so that has a material effect on projects."
By nature, developers have to be optimistic when it comes to the market and the risks it poses. "Developers take a leap and tend to believe they can navigate a challenging market," Lerner says. But that has to be balanced with some caution when the market takes a downturn to protect themselves and their investments. For Harbour Equity, that's meant making fewer investments than they otherwise would have.
But looking forward, Lerner believes "there'll be some good opportunities coming over the next six to 12 months.” Exactly what kind of opportunities those will be, however, is another question entirely.
"It's hard to say just because things have been so volatile," he adds.
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This article was produced in partnership with STOREYS Custom Studio.
