The Bank of Canada maintained a low policy interest rate between 0% and 2% from about 2010 to 2022. So, it’s only natural that Canadian real estate investors were caught off guard when the bank rapidly increased interest rates, hitting the recent high of 5% to counter the relatively high inflation.
Immediately, this squeezed the wallets of real estate property owners whose mortgages were under variable interest rates. Those who were under fixed interest rates were temporarily exempt from the higher rates until they had to renew their mortgages that are typically under a five-year term. To the horror of some real estate investors, they found their mortgage payments more than double in this turn of events. Unfortunately, it means that some real estate investors had to give up and sell their properties because their income wasn’t able to cover the monthly mortgage payments and their other costs of living.
For real estate investors looking to buy, higher interest rates might lead to less competition and a potential drop in real estate prices. However, it really depends on the markets you’re looking at. Hot cities of living will see more resilient property prices. It also depends on where interest rates will be going. Since July 12, the Bank of Canada has maintained the same policy interest rate as it continues to observe the situation. Based on the changes in inflation, the policy rate could be raised further if needed.
If investing in Canadian real estate directly is too big of an investment for you at the moment, you can consider investing passively in real estate through Canadian real estate investment trusts (REIT). Importantly, you can make as small or as big an investment as it makes sense for your financial situation and investment goals. Higher interest rates have generally driven Canadian REIT valuations lower, providing an interesting investment opportunity that could generate decent monthly income and the potential for nice price appreciation.
Dream Industrial REIT
Dream Industrial REIT (TSX:DIR.UN) is in the relatively defensive industrial real estate industry. It has actually held up quite well in a rising interest rate environment, with the stock actually up about 9% over the last 12 months. It is roughly 23% lower from its 2021 peak, though. If it returns to that level in the future, investors will witness upside of north of 33%. Meanwhile, it pays out a decent yield of close to 5.4%, which is paid out as monthly cash distributions.
The industrial REIT’s industrial real estate investments are primarily in Canada (61% of the portfolio value) and Europe (30%). Last month, it reported strong mark-to-market rent spreads of 30%. It was 47.7% in Canada, indicating a tight supply and strong demand scenario. In comparison, the mark-to-market potential of 7.9% in Europe was much milder.
Here’s a better gauge of the Canadian REIT’s price appreciation potential. At $13.02 per unit, the 12-month analyst consensus price target represents a discount of about 19% or near-term upside potential of 23%.
Canadian REITs are already diversified as they have a portfolio of properties that generate rental income. For further diversification, you can consider these top Canadian REIT ETFs.