Based on Fisher Investments Canada’s research, the real estate sector has some specific supply and demand drivers that investors would benefit from understanding
Real estate receives broad coverage in financial publications that Fisher Investments Canada reviews. However, we think the sector is often misunderstood. Here is a primer to help shed light on the much-discussed sector’s reality.
Fisher Investments Canada knows that real estate has two primary components: residential real estate (RRE) and commercial real estate (CRE). As you may surmise, individual households comprise the majority of the residential market, for instance owning homes for personal use or purchasing rental investment properties.1 CRE market participants are mostly corporate owners and investment funds focused on income generation.2 CRE consists of five categories: offices (40 per cent), retail (20 per cent), residential CRE (15 per cent), logistics (13 per cent) and hotels and others (12 per cent).3 Note, residential CRE differs from the aforementioned RRE, as it includes multi-family properties, such as apartments.
From an equity market perspective, real estate is a relatively small sector – just 0.8 per cent of the Morgan Stanley Capital International European Economic and Monetary Union index (MSCI EMU), 2.5 per cent of the MSCI World Index and 2.5 per cent of America’s S&P 500.4 Its constituents are primarily real estate investment trusts (REITs), as well as real estate management and development firms.5 At a macroeconomic level, real estate’s contribution is also relatively small: As a percentage of gross domestic product (GDP), a government-produced measure of economic output, eurozone housing investment was only 5.9 per cent of the bloc’s 2022 output.6 Fisher Investments Canada sometimes sees commentators add consumer spending on furniture and appliances to this but, in our experience, doing so doesn’t increase the share materially and also risks overstating its impact, since some of that consumption isn’t related to housing.
Now, real estate often receives attention among financial commentators whom Fisher Investments Canada follows due to its connection to the financials sector – and specifically banks. For example, the RRE market comprises 33.5 per cent of European bank loans while CRE accounts for about 6 per cent.7 We have seen arguments that weakness in one sector could spill over into the other – for example, rising interest rates lead to higher borrowing costs, which can weigh on property sector valuations. Likewise, recent financial headlines that Fisher Investments Canada reviews have pointed out that, with office vacancies rising due to work-from-home trends, borrowers may struggle to service their debt, knocking banks with high exposure to CRE loans. While our research suggests these concerns are overstated, they illustrate how developments in real estate can impact sentiment in financials, and vice versa.
Based on our research, the real estate sector has some specific supply and demand drivers that investors benefit from understanding. On the supply side are existing properties and new construction, the latter of which Fisher Investments Canada has found to be sensitive to construction materials and labour costs. Meanwhile, social shifts and individual preferences can drive demand, in our view. For example, we think COVID-induced lockdowns partly underpinned residential price rises in the early 2020s, as many sought new homes better suited to remote work.8 Conversely, we think similar factors drove commercial office prices down in that span, as demand for office space plunged.9
Our research has found real estate to be particularly sensitive to interest rates, as borrowing costs can impact demand. According to one European Central Bank (ECB) estimate, a 1 per cent mortgage rate increase can drive a 5 per cent house price decline over two years.10 Fisher Investments Canada thinks 2022 illustrates this: In our view, rising mortgage rates priced out potential buyers, reducing demand.11 However, we also think this meant potential sellers held onto their relatively low, older rates, keeping supply tight by choosing not to sell. Furthermore, easing and tightening lending standards can affect borrower rates and mortgage availability, which further impact demand, in our view. We think regional specifics such as taxes, rental laws, potential zoning rules and other restrictions can impact both supply and demand. For example, Germany doesn’t tax capital gains on properties held for more than 10 years, which can disincentivize sales and keep a lid on supply.12 In the U.K., rental property investors have encountered higher taxes and new regulatory burdens, spurring many to sell and contributing to relatively higher housing supply, in our view.13
We think understanding real estate can benefit investors’ portfolio decision-making. First, tone down talk about real estate prices, which tend to lag equity markets, according to Fisher Investments Canada’s research. Then, for those interested in owning REITs, we think it is important to understand their sensitivity to interest rates. We have found property ownership costs increase as interest rates rise, which hampers REIT values. Thus, in our view, real estate may not be in favour in a rising rate environment. You also may wish to study surveys of banks called Senior Loan Officer Opinion Surveys that aim to assess both the supply and demand for credit. Another example is that, if you notice new construction slowing, Fisher Investments Canada thinks that may be a sign of relatively low supply ahead and, as a result, higher prices. Then, too, given banks’ real estate debt exposure (described above), we think that, if banks aren’t in favour, that may signal real estate isn’t, either.
We think real estate can be a beneficial addition to investor portfolios. Understanding this sector and its drivers can benefit portfolio decision-making, in Fisher Investments Canada’s view.
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates. This document constitutes the general views of Fisher Investments Canada and should not be regarded as personalised investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments Canada will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
Fisher Investments Management, LLC does business under this name in Ontario and Newfoundland & Labrador. In all other provinces, Fisher Asset Management, LLC does business as Fisher Investments Canada and as Fisher Investments.
1 “Real Estate Markets, Financial Stability and Macroprudential Policy,” Jan Hannes Lang, Markus Behn, Barbara Jarmulska, Marco Lo Duca, ECB, 10/10/2022.
3 “Crisis Radar Falls On Fault Lines In Europe’s Commercial Property,” Chiara Elisei, Dhara Ranasinghe, Reuters, 20/4/2023. Accessed via the Internet Archive.
4 FactSet, as of 27/4/2023.
6 Source: Eurostat, as of 8/5/2023. Dwelling investment as a percentage of eurozone GDP, 2022.
7 “EBA Thematic Note – Residential Real Estate Exposures of EU Banks: Risks and Mitigants,” European Banking Authority, 10/10/2022 and See note 3.
8 Source: Bank for International Settlements. Statement based on euro area residential property prices, quarterly, 31/3/2020 – 31/12/2022.
9 “Europe’s Offices Eye Same Fate As NYC If Values Drop, Rates Rise,” Susan Munden, Bloomberg, 6/4/2023. Accessed via the Internet Archive.
10 “The Impact of Rising Mortgage Rates on the Euro Area Housing Market,” Niccolò Battistini, Johannes Gareis, Moreno Roma, ECB, 22/9/2022.
11 “Euro Area Bank Interest Rate Statistics: January 2023,” ECB, 3/3/2023.
12 “What Is The Capital Gains Tax Rate In Germany?” Expat Tax, as of 11/5/2023.
13 “‘Lots Of Us Are Very Anxious’: Why Britain’s Buy-To-Let Landlords Are Selling,” Sarah Marsh, The Guardian, 24/2/2023.
Advertising feature produced by Fisher Investments Canada. The Globe’s editorial department was not involved.