As many of you have noticed from my recent social media updates, I’ve made a significant shift in my investment strategy: I’m no longer purchasing residential real estate in Canada. Instead, I’m focusing solely on commercial properties. This decision hasn’t been made lightly, and I’ve received numerous inquiries about the reasons behind this change. To provide clarity and share my perspective, I’ve decided to lay out my thoughts in this comprehensive blog post.

Potential Policy Changes: A Growing Concern for Landlords

The looming threat of increased regulation poses significant challenges for landlords, including:

  • Rent Caps and Moratoriums: Restrictions on rent increases, which limit the ability to keep up with market rates and rising maintenance costs.
  • Eviction Restrictions: Policies that make it harder to manage properties effectively, even in cases of non-payment or property damage.
  • Increased Penalties and Repair Obligations: Imposing financial burdens that can make profitability increasingly difficult.

These changes not only threaten landlords’ bottom lines but also erode their control over their investments.

The Political Risk in Canadian Residential Real Estate

I firmly believe that the greatest risk to residential real estate in Canada today is political. The widening divide between the “haves” and “have-nots,” coupled with the worsening housing shortage, is a direct result of restrictive government policies. Zoning regulations, soaring construction costs, and labor shortages have made building new homes increasingly difficult. The government’s ambitious housing targets are wildly out of step with the realities of supply and demand, especially given the record levels of immigration.

Rather than acknowledging their role in this manufactured housing crisis, policymakers are shifting blame onto landlords, portraying them as “greedy” and responsible for the shortage. This narrative resonates with a frustrated public and provides a convenient scapegoat, leading to popular but damaging policy measures such as rent caps, eviction bans, and additional regulatory burdens.

The Real Impact on Landlords

For landlords, these policies make the already challenging task of owning rental properties even more difficult. In provinces like Ontario, Manitoba, and British Columbia, landlords face extraordinary risks:

  • Tenants can move in, stop paying rent immediately, and stay for months—sometimes over a year—without consequence.
  • Eviction processes are drawn out, leaving landlords powerless, while some tenants even trash properties on their way out.

Effectively, landlords lose control of their own investments, bearing immense risk for minimal returns.

Residential Real Estate: Too Risky for Too Little Reward

The margins in residential real estate are razor-thin. Traditional investment rules, like aiming for $100 in monthly cash flow per unit, no longer make sense. Imagine entrusting someone with access to a $400,000 property, only to lose control the moment they move in. For such a slim margin, the risk isn’t justified.

Residential real estate simply doesn’t provide the cash flow necessary to build a sustainable business. Between tenant protections, increasing costs, and regulatory hurdles, landlords in Canada face an uphill battle. Without significant changes, it’s clear that the political environment will continue to drive small landlords out of the market, leaving the housing crisis even worse than it is today.

The Risks of Speculative Development and Political Influence in Residential Real Estate

Another growing concern is the potential for a correction to Canada’s aggressive immigration policies and its impact on housing demand. This could lead to an overbuilt market, especially as governments incentivize development through programs like CMHC’s MLI Select loans. While these programs may appear beneficial on the surface, they represent a significant risk.

The Dependency on Government-Backed Programs

Every Canadian real estate investor and their dog seems to be jumping into development, largely because it’s the only way to make the numbers work. However, reliance on a single lender or government-backed program creates a dangerous bottleneck. If these programs are altered or terminated by new policymakers, developers could be left stranded:

  • Uncertain Exit Strategies: Properties financed through programs like MLI Select may not appeal to conventional lenders or buyers once the program ends.
  • Political Control Over Assets: CMHC-backed financing grants the government significant control over your property. For instance, during COVID, when CMHC restricted equity takeouts, landlords lost financial flexibility. A similar scenario could unfold with development financing.

If favorable terms suddenly disappear, developers will be trapped with projects they can’t sell or refinance. This kind of exposure to political whim is too risky to justify.

The Challenges of Speculative Development

Speculating on development is inherently fraught with uncertainty. You’re betting that construction costs, labor availability, market demand, and financing conditions five to seven years from now will align favorably. However, recent years have demonstrated how unpredictable these variables can be:

  • Skyrocketing Costs: Construction and labor costs have tripled in some cases. Strikes and shortages further compound delays and expenses.
  • Unreliable Forecasting: Market conditions five years out are nearly impossible to predict with accuracy, making speculative development an enormous gamble.

The Reality of Residential Real Estate

Even when development succeeds, the income from residential real estate is too slim and inconsistent to support a sustainable business model:

  • Lumpy Cash Flow: Vacancies, tenant turnover, and unexpected costs like maintenance, utilities, taxes, and cleaning often wipe out margins.
  • High Operational Burden: The cash flow isn’t sufficient to cover outsourcing back-office tasks like bookkeeping, lease renewals, or maintenance, leaving landlords stretched thin.
  • Unscalable Model: Competing against well-capitalized institutional players makes it nearly impossible for small landlords to scale effectively.

Exceptional Returns

Commercial real estate delivers significantly better returns compared to residential:

  • Properties with in-place double-digit cap rates and 60% leverage can achieve over 20% cash-on-cash returns.
  • Commercial properties are often bought at a discount to replacement cost, unlike residential properties, which are based on comparable sales.
  • Value-add strategies, such as filling vacancies, can result in properties increasing from 10–20 cents on the dollar to full value, yielding 7–10x returns within a few years.

Shifting Perceptions: Landlords as Villains

Owning residential property was once celebrated as a personal and financial achievement—a way to provide housing while earning a modest return. Today, the narrative has shifted, and landlords are often portrayed as exploitative, facing growing societal and media scrutiny.

  • Public Sentiment: Simply identifying as a landlord now invites accusations of greed or exploitation, regardless of ethical practices or the quality of housing provided. While raising rents to market rates for corporate tenants like Walmart is praised, doing the same in residential real estate can get your face on the front page of CBC.

Media Scrutiny and Vilification of Landlords

  • Media Scrutiny: Adjusting residential rents to market levels can land small landlords in headlines, labeled as predatory, while institutional landlords rarely face the same level of criticism.
  • Vilification of Landlords: The broader narrative has turned landlords into villains, creating a social stigma that adds stress to property management and tenant interactions.
  • Tenant Relations: Managing tenants has become increasingly contentious due to rising tenant protections, which often leave landlords at a disadvantage. This dynamic can make day-to-day operations more challenging and less rewarding.

This shift in perception has added emotional and reputational risks to an already difficult sector, making residential property ownership far less appealing for small landlords. This hostility makes residential real estate not only financially unappealing but also emotionally draining. It’s not worth participating in an industry where you’re demonized for actions necessary to maintain your property and business.

Commercial Tenants: Committed and Value-Adding

Commercial tenants tend to be highly committed to their spaces, often investing significant capital into the properties they lease. For example:

  • Tenant Investments: Superstore, one of our tenants, recently invested $7 million in renovations. After such a substantial investment, it’s unlikely they’re leaving anytime soon.
  • Upgraded Properties: When a commercial tenant eventually leaves, the property is often in better condition due to the upgrades they’ve made. This contrasts with residential real estate, where tenant turnover almost always results in additional expenses for repairs and maintenance.

The value-added nature of commercial tenants is one of the most rewarding aspects of owning these properties.

Low Cash Flow and High Risk in Residential Real Estate

  • Minimal Returns: The once-standard objective of securing $100 per month in cash flow for each rental unit has become a distant dream. For properties requiring investments of $200,000 to $500,000, these narrow margins are not commensurate with the risk involved.
  • High Operating Costs: Unforeseen costs—maintenance, vacancies, rising interest rates, and tenant turnover—can significantly reduce or eliminate expected profits. These expenses often exceed small-scale investors’ budgets, leading to financial strain.
  • Scaling Challenges: Tight margins make expanding a residential portfolio daunting. There’s insufficient cash flow to support hiring dedicated staff for property management, bookkeeping, or maintenance, forcing landlords to handle these aspects personally. This not only limits growth but also increases the workload and stress.

Commercial Real Estate Scalability

  • Operational Efficiency: Higher cash flow enables hiring specialized staff, including property managers, leasing managers, asset managers, operating staff, accountants, and investor relations personnel.
  • Building a Real Business: Commercial real estate operations can be structured like a traditional business, with systems and staff managing day-to-day activities.

The Edge in Commercial Real Estate: Employees vs. Owners

In Canadian commercial real estate, a significant advantage comes from dealing with employees of large corporations rather than property owners or individual entrepreneurs:

  • Employee Disengagement: Employees handling deals often see their role as a 9-to-5 obligation. They may lack the motivation to fully understand or enhance the value of a property deal.
  • Missed Opportunities: Unlike owners, employees might overlook significant value-add opportunities. For example:
    • When acquiring a property from Loblaws, we identified a land lease set to expire. This lease, involving an intermediary, would revert full rent to us directly from Staples upon expiration in three years, adding $150,000 annually to our income. This overlooked detail increased the property’s value by over $3 million.
  • Lack of Personal Investment: Owners live and breathe their properties, understanding every detail and potential for growth. Employees, fulfilling their role, lack the same level of personal or financial stake in the outcome.

This dynamic provides a competitive advantage for engaged investors. Competing against employees means dealing with differing levels of effort, care, and commitment, allowing opportunities to emerge that might otherwise be missed. This disparity underscores a significant edge in the commercial real estate market.

Triple Net Leases (NNN)

Triple net leases (NNN) are a foundational component of many commercial real estate (CRE) investments. Under this lease structure, tenants are responsible not only for their base rent but also for covering the three primary operating expenses: property taxes, insurance, and maintenance.

Key Advantages of NNN Leases

  • Reduced Landlord Expenses: By shifting these financial responsibilities to the tenant, landlords minimize their out-of-pocket costs, making the investment less burdensome to manage.
  • Predictable Income Streams: With tenants handling operating expenses, landlords enjoy a clearer and more consistent cash flow, even in markets where costs are rising or fluctuating.
  • Hands-Off Management: The NNN structure lowers the operational demands on landlords, making these investments ideal for those seeking a more passive approach.

Tenant Quality and Stability in Commercial Real Estate

One of the significant advantages of commercial real estate is the caliber and stability of its tenants. Commercial properties often attract corporations, well-established businesses, government agencies, or publicly traded companies with AAA-rated credit, offering far greater financial reliability than individual residential tenants.

Why Commercial Tenants Offer Stability

  • Financial Backing: Commercial tenants typically have stronger financial backing, ensuring consistent rent payments and reducing the risk of non-payment.
  • Long-Term Occupancy: Leasing to a national chain retailer or a government office often translates to decades of stable occupancy, which is rarely achievable in residential real estate.
  • Lower Risk of Disruption: In contrast, residential leases often involve individuals or families whose circumstances, such as a breakup or job loss, can create unexpected financial strain for landlords.

The stability provided by corporate tenants in commercial properties offers landlords a much-needed layer of security and peace of mind.

Valuation Based on Income

Unlike residential properties, which are often valued based on comparable sales, commercial properties are primarily appraised by their income potential, specifically their Net Operating Income (NOI).

Advantages of Income-Based Valuation

  • Direct Control Over Asset Appreciation: By improving the NOI through better tenant management, cost reduction, or rent increases, investors can directly influence property valuation.
  • Operational Enhancements: Changes that increase efficiency or revenue have a direct and measurable impact on the property’s market value.
  • Flexibility: This income-based approach gives commercial property investors more control over the trajectory of their investments compared to residential properties.

This ability to actively increase property value through operational improvements makes commercial real estate an attractive option for investors seeking higher returns and greater control over their assets.

Business-Oriented Transactions in Commercial Real Estate

Unemotional Interactions

In the realm of commercial real estate, transactions are characterized by their straightforward nature, rooted deeply in contractual agreements. Disputes are typically managed through structured mediation or legal processes, devoid of the personal emotional entanglements often encountered in residential real estate. This focus on business logic over personal sentiment ensures that issues are resolved based on agreed terms rather than subjective feelings.

Flexibility in Lease Agreements

Commercial leases offer significant latitude for negotiation and creativity. Without the rigid framework of residential tenancy laws, landlords and tenants can craft agreements tailored to their specific needs:

  • Custom Clauses: Rent escalations based on business performance or options for lease extensions.
  • Tailored Maintenance Responsibilities: Assigning specific duties to either landlord or tenant to suit operational needs.

This flexibility makes commercial leases a strategic tool for business management.

Professional Tenants and Reduced Emotional Involvement

Engaging with commercial tenants is primarily a professional affair. These tenants approach leasing from a business perspective, focusing on financial metrics and strategic benefits rather than personal aspects of space usage. This business-first mindset minimizes emotional friction, leading to:

  • Predictable Relationships: Clearer, more professional interactions.
  • Contractual Dispute Resolution: Issues are resolved based on agreements rather than personal grievances.

Better Leverage and Financing Options

Commercial real estate often offers more favorable financing terms due to its income stability. Key benefits include:

  • Higher Loan-to-Value Ratios: Allowing investors to finance a larger portion of the property’s cost.
  • Institutional Lender Support: Recognizing the stability and potential of commercial investments, lenders often offer better terms, which can be crucial for scaling an investment portfolio.

Favorable Tax Benefits in Canadian Commercial Real Estate

Commercial real estate investments provide substantial tax advantages that can significantly enhance an investor’s bottom line:

Depreciation

Investors can offset a large portion of their rental income by claiming depreciation, reducing taxable income and improving cash flow.

Active Income Conversion

Unlike residential real estate, commercial properties often generate enough margin to justify employing staff. By maintaining at least 5.5 employees on payroll, rental income can be reclassified from passive income to active income, which is taxed at a lower corporate tax rate.

Taxation Overview for CCPCs

Active Business Income (ABI)

  • Small Business Deduction (SBD): CCPCs enjoy a reduced tax rate on the first $500,000 of active income.
    • Federal tax: 9%.
    • Provincial rates vary (e.g., 0% in Manitoba).
  • Above the SBD Limit: Income exceeding $500,000 is taxed at the general corporate rate.
    • Federally: 15%.
    • Combined rates: 25–31% depending on the province.

Passive Income

  • Higher Tax Rates: Passive income (e.g., interest, rentals, dividends) is taxed federally at 38.67%. Combined rates can approach or exceed 50%.
  • Impact on SBD Eligibility: Passive income above $50,000 annually reduces the SBD limit by $5 for every $1 of passive income above this threshold. At $150,000, the SBD is fully phased out, taxing active income at the general corporate rate.

Summary of Tax Advantages

  • Active business income benefits from reduced rates, particularly within the SBD threshold.
  • Depreciation and active income conversion provide opportunities to lower taxable income.
  • Strategic planning can mitigate the impact of passive income thresholds on SBD eligibility, ensuring tax efficiency.

Less Exposure to Government Intervention

While residential real estate faces heightened regulatory scrutiny—such as rent controls and tenant rights legislation—commercial properties generally encounter fewer direct governmental regulations. This lower regulatory risk creates:

  • Predictable Operating Environment: Allows for better strategic business planning and reduced exposure to policy changes.
  • Operational Freedom: Greater flexibility in lease structuring and property management compared to residential markets.

Diverse Asset Classes in CRE

The variety within commercial real estate enables investors to diversify their portfolios across multiple sectors, including:

  • Office: Impacted by remote work trends but maintaining demand for high-quality, well-located properties.
  • Retail: Strategic locations continue to thrive despite challenges in broader retail markets.
  • Industrial: The e-commerce surge has bolstered demand for logistics and warehouse facilities.
  • Healthcare: A stable sector driven by demographic trends and consistent service needs.

This diversification allows investors to align with market trends and tailor risk profiles.

Despite challenges like the rise of remote work, CRE demonstrates adaptability and resilience:

  • Industrial Growth: Fueled by the e-commerce boom and supply chain realignments.
  • Selective Office Demand: Premium, well-located office spaces continue to attract interest.
  • Retail Adaptation: High-performing retail locations remain strong in urban centers.

Understanding and capitalizing on these trends offers investors the opportunity for substantial returns.

The Scarcity of Prime Commercial Land in Canada

Urban Land Constraints

  • Limited Availability: Urban centers are largely built out, making sizable plots for new development increasingly scarce.
  • Regulatory Hurdles: Acquiring and developing land involves significant cost implications and delays due to regulatory complexities.

High Cost of Construction

  • Rising Expenses: Labor and material costs, combined with regulatory compliance, make new construction projects economically challenging.
  • Imbalanced Economics: In many cases, the cost of developing new commercial spaces exceeds the value of existing properties, limiting new supply.

Growth Wave in CRE

With limited supply and steady demand for quality commercial spaces, especially in strategic locations, the market is set for long-term growth:

  • Appreciation Potential: Existing CRE properties are positioned for significant value increases as the market adjusts to supply constraints.
  • Sustained Demand: Businesses’ ongoing need for urban commercial spaces will drive demand in key sectors.

Deploying Larger Sums of Capital in CRE

Commercial real estate offers unique opportunities for deploying large sums of capital efficiently:

  • High-Value Properties: Investments often involve millions or tens of millions of dollars, suitable for large-scale investors.
  • Single Transaction Efficiency: For instance, purchasing a $5 million commercial property, such as a 200,000 sq ft office complex or a regional shopping mall, allows for broad income diversification through multiple tenants and long-term leases.
  • Scalable Investments: The ability to deploy significant capital in fewer transactions simplifies management while enhancing income stability.

This scale and efficiency make CRE an ideal avenue for institutional and high-net-worth investors looking for substantial capital deployment and long-term income generation.

Acknowledging the Risks in Commercial Real Estate

While commercial real estate offers many advantages, it’s not without its challenges.

Risks: Vacancy and Large Capital Expenditures (CapEx)

  • Vacancy: Losing a major tenant, such as Walmart or Safeway, can leave a property vacant for years. Re-leasing large spaces (e.g., 88,000 sq. ft.) is particularly challenging since only a limited number of tenants in the country can occupy such properties. Splitting the space for smaller tenants may require significant investment.
  • Large CapEx: Major repairs, such as replacing the roof of a strip mall, can cost between $1.5 and $2 million. Without sufficient reserves, these expenses could bankrupt an investor.

Disciplined Operations Mitigate Risks

Success in commercial real estate requires:

  • Strategic Property Selection: Focus on prime locations with strong tenant demand.
  • Substantial Liquid Reserves: Maintain financial buffers to manage unexpected vacancies or major expenses.
  • Thorough Due Diligence: Careful analysis and disciplined property management are essential to minimize exposure to risks.

In Summary

My pivot to commercial real estate is driven by a combination of factors: political risks in the residential sector, financial considerations, and a desire for a more stable and scalable investment model. Commercial real estate offers the opportunity to build a true business, with better returns and more control over the investment.

Investing always involves risks, but with careful planning, due diligence, and strategic management, I believe commercial real estate presents a more promising path forward in the current Canadian market.

Thank you for taking the time to read about my journey and the reasons behind my decision. I hope this provides clarity and perhaps even sparks some thoughts for those considering their own investment strategies. As always, I’m open to discussions and would love to hear your perspectives.