Rental properties: a safe harbour amid interest rate uncertainty

Equiton's Apartment Fund benefits from a perfect storm of supply and demand while providing a steady alternative to continued volatility

Rental properties: a safe harbour amid interest rate uncertainty

As Canadians grapple with stubborn inflation and yet another interest rate hike, investors are turning to multi-residential properties for a stable income amid the uncertainty.

The uncertainty may last for a while. After recently raising its benchmark interest rate to 5%, the Bank of Canada said it’s open to yet more hikes, with inflation not expected to hit the bank’s target range of 2% until well into 2025.

“Where do you go if you want stable income in a volatile market that’s less sensitive to rising interest rates?” asks Geoff Lang, Senior Vice President at Equiton. “The attractive alternative is multi-residential housing.

“Our Apartment Fund performed really well in 2021 and 2022 despite a high inflationary environment, and we are well positioned for any volatility that lies ahead.”

Speaking with Wealth Professional in a recent interview, Lang rattled off a number of impressive statistics to illustrate the success of Equiton’s fund.

In 2022, the Fund generated a return of 15.22% for Class F DRIP investors. It has seen 86 months of positive returns since inception, while enjoying an occupancy rate of 97.8% across all of its buildings as of the first quarter this year.

The Fund’s success is markedly different from what many investors have seen in other assets recently.

A steady alternative

It’s been a difficult couple of years for Canadian investors as equities languished and bonds experienced one of their worst years on record in 2022.

However, investors in Equiton’s Apartment Fund saw attractive returns in both 2021 and 2022 as the market for rental properties remained robust.

The Fund’s investors have also benefited from the special tax treatment given to REITs, deferring the payment of taxes until they sell their REIT investment.

The tax-friendly Fund compares favourably to money market funds.

“On a money market fund, you're getting charged interest income,” Lang says. “But with us, the distributions are 100% return on capital (ROC) which means they are not taxable in the year that they are paid out but rather they reduce the adjusted cost base of the investment which in turn increases the capital gain when the REIT is sold.”

Equiton has also been shielded from the high cost of borrowing that has afflicted so many others thanks to its 10-year fixed mortgages with terms to maturity of 7.5 years.

Apart from tax advantages and some smart choices with their mortgages, Equiton is benefiting from a perfect storm of supply and demand in Canada today.

High demand, little supply

In the last 5 years, Canada has added 2.8 million new residents while building just 881,000 new housing units. And with another 1.5 million immigrants expected to arrive by 2025, the demand for new housing won’t be easing any time soon.

And it may get worse before it gets better. The Bank of Canada’s latest hike, which brings interest rates to their highest level since 2001, is putting increased pressure on both potential home buyers and home builders.

The rising cost of servicing a mortgage is pushing more potential buyers into the rental market, while home builders are finding it increasingly expensive to finance new housing projects.

“It’s raising borrowing costs for developers and construction companies, which depresses housing starts and reduces the supply of new homes,” Lang says. “With fewer houses being built, and more demand for rentals coming from immigration, it creates a perfect opportunity for investors in multi-residential properties.”

Trusted tenants and new buildings

Lang says Equiton has an occupancy rate of almost 98%, and the only reason why it isn’t 100% is because the empty units are those being turned over and renovated in order to generate even higher rents and returns.

“We look for a credit score of over 700 and they must have no more than 30% of their income going towards rent,” Lang adds. “High quality tenants are key to protecting the portfolio and thus protecting the end client.”

With such a high occupancy rate it’s no surprise that Equiton is continuously looking to add to their stock of buildings. A new development is underway in Ottawa that will add three apartment buildings by the first quarter of 2025.

Lang says building or buying new properties is an opportunity to add overall value to their portfolio.

“In 2022, we made seven different investments for $272 million of capital deployed,” he says, adding that they were able to obtain a number of properties at good discounts.

“Talk to commercial real estate agents about 2019 and 2020 and they will tell you about getting 15 to 20 bids per sale,” Lang says. “That fell to two or three bids in 2022 and we were able to scoop up a lot of property at attractive prices.

“We're constantly looking for properties across Canada. While BC has softened a bit, we still like Alberta and the GTA obviously is our home base. We’re always looking for underperforming and undervalued multi-residential properties and select new developments in Canada.”