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Construction & Real Estate

Powering the resurgence of REITs in Canada - how policy changes could support growth

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Recent reports predicting the demise of real estate investment trusts (REITs) appear to have been wide of the mark, and there may in fact, be untapped pools of investor funding and operators capable of putting those resources to effective use. We believe this might be a good time to consider ways in which the REIT model could be expanded to provide additional benefits to the Canadian economy, while accelerating progress towards the goal of a more robust and rejuvenated infrastructure for the public and private sectors.

Facing headwinds, but holding their own

REITs own, operate or finance income-producing real estate assets. These investment vehicles not only make real estate investment more accessible to investors, but may also provide attractive yields and steady payouts. In many countries REITs enjoy certain tax advantages – for instance, in Canada they aren’t taxed on gains from property and rental incomes as long as they meet certain criteria in relation to distributions and hold only qualified properties.

Despite concerns that rising interest rates may narrow the payout gap between REITs and bonds, REITs have offered some of the highest returns across the stock market, supported by strong underlying markets and a national vacancy rate that ensures a stable demand for property. Stable yields have been buoyed by a steady flow of rent from long-term leases.

Expanding the field of opportunities

With the economy strong and interest rates rising, investors – both institutional and individual – are looking for stable opportunities outside of bonds. Currently, REITs allow these investors to tap into a small portion of the demand for real estate in this environment, but it’s possible that with an expanded policy framework, REITs could provide greater value to Canadian pensions and other investors, while helping government meet pressing infrastructure needs by injecting investment into underfunded areas.  

Under the existing policy framework, which restricts the types of properties REITs can hold, potential growth is limited. There are three key ways the government might simultaneously support the REIT industry and its efforts in increase private investment in infrastructure: expanding the pool of REIT qualified properties, loosening ancillary use policies, and allowing re-investment of capital gains. 

Infrastructure and REITs – a perfect match?

Existing policies allow REITs to own or operate commercial real estate, multi-residential housing and a certain level of senior assisted living developments. Expanding the types of properties REITs are allowed to hold could inject a new stream of funding to support public service needs in areas such as healthcare and social housing, while also meeting infrastructure requirements.

With government spending on healthcare already under pressure, private investment is needed to close the funding gap – and REITs could be an effective vehicle to channel that investment. With a supportive policy environment in place, healthcare REITs could help meet the growing demand for assisted living and long-term care facilities, and reduce the backlog of capital projects in provinces struggling to update or replace aging hospitals and other health facilities. In the UK for instance, REITs are working with the National Health Service and local authorities to build out a development pipeline of primary care centers.

Another area of increasing public sector demand – but limited public resources – is social housing. REITs could provide a financial lifeline to help alleviate the social housing challenges in Canada, by introducing private sector capital. For example, in the US the Housing Partnership Equity Trust invests in multi-family properties for low- and moderate-income residents and operates 53,000 affordable housing units across multiple states.

Healthcare and social housing are just two possibilities to marry infrastructure needs and REIT growth potential. These investment vehicles could also inject money into Canada’s aging federal prisons and provide investment in educational facilities. By assessing its current needs and where REITs can fit, the government has an opportunity to address critical spending gaps, support an industry with strong fundamentals – and subsequently grow the economy and create jobs.

Reconsidering ancillary use restrictions

Expanding the range of properties in which REITs could invest would be a positive step, but in order to maximize the benefits of this change, policies restricting “ancillary uses” of REIT properties should also be re-examined. Restrictions on ancillary uses limit the potential opportunities for growth – while also hindering the ability of developers to provide attractive amenities to tenants and surrounding communities. Loosening these restrictions could encourage REIT investment in areas such as social housing.

Making Canada competitive in the REIT space with re-investment options  

In the competition for global investment, REITs in jurisdictions that allow re-investment of capital gains can appear more attractive than the countries that don’t. In the US for instance, capital gains can be deferred through a like-kind exchange, meaning taxes aren’t paid as long as the owners invest the proceeds within a certain amount of time. Similar policies exist in Japan, Germany and Ireland. Capital gains taxes in Canada may inhibit REIT growth by preventing trusts from efficiently recycling capital, putting REITs here at a disadvantage. Introduction of a like-kind exchange – or a similar vehicle – might provide a lift to the industry and create growth opportunities.

Taking advantage of the REIT opportunity now and into the future

At Grant Thornton, we have extensive experience working with REITs, developers and investors to find a path to sustainable growth. While we believe a review of the policy framework for REITs could yield many benefits, we are always available to talk to you about your current or future opportunities in real estate.