Balancing risk and reward

For yield-hungry investors, are there still options in real estate that don't involve loading on risk?

Balancing risk and reward
The home capital saga has brought alternative lending into the spotlight recently, creating anxiety that a full-scale housing correction could be on the horizon. Spectacular price growth in the GTA over the past year hasn’t eased that concern, but just how much of a risk is real estate for investors right now?

That depends on the size, the location and the type of investment, of course, and there are plenty of different options available when you’re talking about real estate investing.

Aside from buying land or property, investing in a mortgage investment corporation
[MIC] has become an increasingly attractive option for Canadians in search of yield. The bread and butter of these companies is providing mortgages that the banks deem too risky, so the Home Capital scandal has provided plenty of ammunition for alternative lending naysayers.

As a result, MICs that aren’t making headlines for the wrong reasons are quick to point out the safeguards that have been put in place to protect investors. Atrium Mortgage Investment Corporation, for instance, markets itself as “Canada’s premier non-bank lender,” which president and founder Robert Goodall attributes to its prudence when issuing loans.

“As a lender, you are really looking for a market that is steady,” he says. “There are certain areas of the GTA market that have seen price growth of more than 30% in the last 12 months, so we have been very careful lending in those areas. We look at what values were two to three years ago in assessing the safety of a new loan, and make sure that our loan exposure is well below those values.”

The approach has served the company well, and while Goodall is adopting a cautious approach to the current market, it hasn’t hindered the firm’s ability to generate returns.

“Since 2008, Atrium has consistently been in the 60% to 65% loan-to-value range, which means our developer clients have 35% to 40% equity on any project we are lending on,” he says. “We are over 8% annual dividend yield today, but more importantly, for 15 years, we have never been less than 8%.”

The prospect of a bubble forming in the GTA prompted the Ontario government to step in and apply the brakes in April. The measures introduced include new rent controls, as well as a 15% non-resident speculation tax, and already it appears the market has slowed somewhat. Opinion is divided on whether the government’s moves will ultimately prove a success, but Goodall is generally supportive of the new rules.

“Like every CEO of a bank here, I’m not displeased that this legislation is being brought in,” he says. “It will cool the market, no question. That’s good for the lender and ultimately good for the developer, because if values go up too quickly, they will correct at some point.”

However, Jeffrey Olin, president and CEO of portfolio manager Vision Capital Corporation, takes the opposite view. As manager of the Vision Opportunity funds, which focus on the real estate sector, Olin observes the industry at close quarters on a daily basis, and he has strong feelings on the government’s involvement, particularly when it comes to rent controls.

“To build an apartment building before the government changed the rules – if you paid market price for the land, had all the construction costs, paid the city’s egregious development charges, and if you got $3 per square foot in rent, and you did that on time and on budget, you would get a return of 5%,” he says.

That’s not a number that will inspire many developers to rush out and start constructing rental properties, and now that annual rent increases are capped at 2.5%, Olin believes even fewer apartments will be built. That certainly won’t help matters when it comes to Toronto’s supply shortfall, although it will likely benefit apartment REITs, he explains.

“We like apartments in the US and Canada,” Olin says. “In December, Vision made a regulatory filing that its funds owned 10% of Pure Multifamily REITs units, which are apartments in the Sun Belt, Dallas, Phoenix and Austin.”

Aside from apartment REITs, Olin and his team are also moving into the industrial space. The changing retail dynamic across North America means more companies are adopting the Amazon model, negating the need for storefronts but making warehouse space essential. It makes investing in industrial space much more attractive, Olin says.

“We own Prologis in the United States – a US$30 billion market cap and the largest logistics and industrial company in the world,” he says. “We own Pure Industrial REIT in Toronto, which is probably the only institutional-calibre, publicly traded entity for industrials in Canada. You can contemplate a 15% total return there.”