Article
How Canada’s Capital Gains Tax Hike Could Impact Real Estate Investment
April 22, 2024 4 Minute Read
Would your investment decisions change if your tax burden increased by 33%?
The federal government announced in the 2024 budget that as of June 25 businesses and private investors will be required to pay tax on two-thirds of their capital-gains earnings, up from one half, when they sell assets such as office buildings and shopping plazas.
What impact will this tax hike have on CRE?
“Increasing taxes during a time of falling productivity is an interesting decision to make,” says CBRE Canada President and CEO Jon Ramscar. “The Canadian commercial real estate sector has strong underlying growth fundamentals, but any government policy can have unintended consequences. We are now left wondering if this tax increase undermines Canada’s competitiveness more than it is able to deliver the proposed broader benefits.”
What might be bad for entrepreneurialism and competitiveness in general may not be immediately detrimental to the investment appeal of Canadian commercial real estate, adds CBRE Chairman Paul Morassutti. “But adding any additional cost or friction to real estate sales at this point only makes tough conditions tougher and gives buyers a reason to delay decisions longer.”
Tech Drain
A greater concern is that frustrated Canadian innovators and tech companies could reduce investment or move to the U.S. where the tax climate is more accommodating. Tech companies and tech groups within non-tech companies had helped mitigate the impacts of the pandemic and remote work on the Canadian office sector.
“If tech activity and demand is dampened due to entrepreneurs looking to the U.S. instead of Canada, this would reduce demand, for office leasing in particular, and draw out the sector’s recovery timeline,” Morassutti says. “The bottom line is that this budget taxes capital at a time when we desperately need more capital investment in the country and it will hinder productivity per capita rather than helping it.”
Reexamining Pricing
All asset classes compete for dollars and therefore adjustments in tax rates will force total-return buyers (those buying based on the cumulative return on investment, including any capital gains) to reexamine pricing, notes CBRE Research Director Marc Meehan.
According to the OECD, Canada has the highest total effective tax on distributed corporate profits in the G7 group of industrialized countries, with an overall combined personal and corporate tax rate of 55.2%. “Tax may not deter buyers from coming to Canada but it impacts valuations based on the total return calculations,” Meehan says.
No Avoiding It
With the capital gains tax changes just around the corner, investors who are in the midst of selling properties won’t be able to avoid its impacts, save for those transactions that are already firm, in the due diligence stage and waiting to close.
There is the potential for some investors to delay select strategic portfolio dispositions and estate decisions in hopes of a change of government and policy in 2025.
For those groups currently considering asset dispositions, Meehan notes that most of them are doing so to spin off assets that don’t align with their long-term portfolio strategies. “You need gains to trigger the capital gains tax. So the increase shouldn’t alter too many decisions for those realigning their portfolios.”
On top of that, he says, groups considering asset dispositions are still chiefly focused on the interest rate environment and the potential for interest rate cuts to help improve values.
Canada Remains Attractive
The tax changes could diminish the attractiveness of investing in Canada, by lowering the return for every dollar invested.
But it should be stressed that the Canadian commercial real estate sector has fared quite well with its fundamentals in recent years and continues to look appealing on the global stage.
Vacancy rates across all asset classes are low relative to competing countries. Canada’s growth outlook remains strong: the country is poised to lead the G7 in population, employment and GDP growth over the next five years, all of which translate into demand for commercial real estate – places to live, shop and work.
Canada also has a conservative amount of new commercial space being built, helping to improve the outlook for existing assets. And the country offers a stable operating environment, with an accessible banking system, cities with high livability scores, and a highly educated and lower-cost labour force.
“In terms of where investment dollars go within Canada, real estate is treated the same by this tax hike as every other investible asset class, including stocks, bonds, infrastructure and private equity,” Morassutti says.
“It’s the decisions for investors outside Canada that become more challenging immediately following an announcement like this.”
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