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The federal government’s planned review of the tax treatment of real estate investment trusts (REITs) and other large corporate owners of residential real estate is unlikely to alleviate the issue of housing affordability in Canada, some industry observers say.

“[Housing] is really an issue of supply and demand,” said Armando Minicucci, a tax partner with Grant Thornton LLP in Toronto. “To go after one specific kind of taxpayer is kind of curious.”

“Targeting REITs or ‘large corporate players’ with new taxes or other regulation could ultimately achieve the opposite effect [than the government intends] by reducing new supply even further and increasing prices for housing in Canada,” according to a report written by equity income portfolio managers with Dynamic Funds following the federal budget.

The authors of the report said Canada’s housing affordability issues are due to too many regulatory roadblocks to building new housing, and insufficient coordination by different levels of government in making sure housing supply keeps up with population growth.

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However, Ricardo Tranjan, senior researcher with the Canadian Centre for Policy Alternatives in Ottawa, characterized the idea that supply alone is driving the dramatic increases in housing costs as a “fallacy.”

“There’s too much speculation in the market, there are too many people flipping houses and there are too many people using housing as a financial asset,” Tranjan said.

In the 2022 federal budget, the Liberal government put forward several proposed changes to rein in investor speculation, including introducing an anti-flipping rule for homes held for less than 12 months and a two-year ban on foreign buyers of residential property in Canada.

The government also said it would proceed with a review of “housing as an asset class to better understand the role of large corporate players in the market,” citing the concern that “concentration of ownership in residential housing” was leading to higher rents and house prices. The proposed review would “include the examination of a number of options and tools, including potential changes to the tax treatment of large corporate players that invest in residential real estate.”

While the government did not mention REITs specifically, they could still be part of the review. “The term ‘large corporate players’ used in the budget is a generic reference to large investors, regardless of their legal status,” a Department of Finance official said to Investment Executive.

Details on the review “will be released later this year, with potential early actions to be announced before the end of the year,” the government said in the budget.

The Liberals first fingered REITs in their 2021 election platform, arguing that “large corporate owners of residential properties such as [REITs] are amassing increasingly large portfolios of Canadian rental housing, making your rent more expensive.”

The government reiterated its intention to review, and possibly reform, the taxation of REITs in the Prime Minister’s mandate letters to the ministers of finance and housing issued in December. In the “supply and confidence” agreement signed with the New Democratic Party last month, the Liberals promised “to tackle the financialization of the housing market by the end of 2023.”

REITs allow investors to pool resources to invest in real estate, which can include portfolios of commercial, industrial, residential and other types of properties. REITs are not taxed on the income and gains generated in the trust, but instead flow these out to unitholders.

When part of the distribution from a REIT is a return of capital, it is not immediately taxable to the investor — though such a distribution will lower the adjusted cost base of the investment and increase the eventual capital gain (or reduce the capital loss) on the sale of the investment.

The government has not stated which aspects of the tax treatment of REITs it finds troubling.

According to Elliot Hughes, senior advisor with Ottawa-based Summa Strategies Canada Inc., the government’s review provides them with the scope to make “recommendations that might affect different parts of the market in different ways.”

“I would consider that all options are on the table,” said Hughes, who served as deputy director of tax policy under former finance minister Bill Morneau.

Tranjan believes the government will use the review to more clearly define policy goals. He characterized the proposed anti-flipping rule and a ban on foreign ownership as “low-hanging fruit.” Meanwhile, introducing a review of large corporate players was an acknowledgement from the government that it needs to take more substantive steps to tackle housing affordability, he said.

“REITs don’t build; they don’t add supply,” Tranjan said. Instead, “they purchase existing supply and they reposition it” through renovations and charge higher rents.

But the authors of the Dynamic Funds report argued that “residential REITs provide well-maintained housing at affordable rents” and improve an apartment building’s environmental footprint through needed upgrades. Some REITs even construct new housing, they wrote, and any tax on large corporate players “would likely incentivize capital to leave the sector.”

While the authors remain overweight on residential REITs, based on what they regard as strong underlying economic fundamentals, the government’s review will hang over the sector until it’s completed, they said.

Minicucci said he’s been telling clients concerned about the review to “sit tight,” adding “there’s really no pre-planning that we can do to deal with any anticipated changes.”

The authors of the Dynamic Funds report believe the government will ultimately focus on limiting the ability of large corporate landlords to perform “renovictions,” where tenants are evicted, renovations made and rent raised. Changing the tax treatment of REITs would be difficult and raise minimal revenue, they said: “REITs do not tend to earn a lot of accounting profits due to the depreciation tax shield provided by owning hard assets.”

Tranjan, too, said governments at all levels will probably focus on protecting renters.

“There is still the absence of vacancy controls and very flawed rental controls, in provinces where they even exist,” Tranjan said. Dealing with those issues requires “a different set of policies that will have to be complementary to any policy aim to curb financialization.”