(Bloomberg) -- Canadian apartment stocks have underperformed their peers for the past seven months, and investors now face a new risk: Prime Minister Justin Trudeau’s attempt to cool the scorching cost of housing.
Trudeau struck a power-sharing agreement this week with a left-leaning opposition party to secure his government’s hold on power until 2025. To get the deal, the prime minister made a long list of promises, including one to crack down on the “financialization of the housing market” by 2023.
That may mean changing the tax treatment of real estate investment trusts that own apartments. Trudeau’s Liberal Party promised to review tax rules and to “curb excessive profits” of large owners of residential properties -- including REITs -- during last year’s election.
Residential REITs have lagged behind the broader sector since Sept. 9, gaining just 0.6%, while the S&P/TSX Capped REIT Index climbed 5.3%, according to a report by Scotiabank analyst Mario Saric on Wednesday.
Trudeau’s 2023 deadline leaves investors to “ponder the extent of the policy review,” Saric said in a note to clients. It suggests a long period of uncertainty for investors in apartment REITs. “Regulatory clarity surrounding operational and structural parameters is critical for owners, with the announcement potentially delaying the desired clarity,” Saric said.
Canadian Apartment Properties REIT, the largest publicly-traded apartment owner in Canada, is the worst-performing REIT since Trudeau made his election pledge on Aug. 24, tumbling almost 10%. It’s weighing on the S&P/TSX Real Estate Index, making it one of the worst-performing sectors in Canada this year, while the broader market has hit records in recent days.
Residential REITs have also lagged their U.S. counterparts since the Canadian election, with Canadian Apartment Properties and InterRent REIT losing 10.7% and 5%, respectively. Cash flow growth for some Canadian REITs is constrained by rent-control rules in provinces including Ontario.
Some of the weak performance can also be blamed on rising interest rates. “Investors are being fed news that interest rates are going up and that real estate is interest-rate sensitive, so this sector should underperform,” said Dennis Mitchell, chief executive and chief investment officer of Starlight Capital Ltd.
Still, Mitchell is optimistic on the sector. With rent growth expected to accelerate because of limited housing supply, REITs should post earnings that beat expectations and the stocks should outperform this year, he said.
“A lot of it is sentiment,” Mitchell said in an interview. “There will be a lot of volatility and choppiness that investors will be able to use to their advantage.”
©2022 Bloomberg L.P.
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