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The Time to Buy REITs; Canada Lowers Qualifying Mortgage Rate?

Jon Brown Jon Brown, Stockhouse
0 Comments| May 26, 2020

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It could soon be easier for first-time homeowners in Canada to “pass the stress test”.

The spread of the COVID-19 coronavirus has had an undeniable effect on the Canadian economy, but a possible proposed move by Canada’s central bank to drop its qualifying mortgage rate could offer some support.

Should the Bank of Canada drop the rate a few basis points, it could open up borrowing and stimulate the real estate market, as lending can support both the lenders and banks, themselves. What effect this would have on banks and real estate at large remains to be seen, but it appears that real estate investment trusts (REITs) would stand to gain a boost from such news once the Bank makes an announcement.

The breakdown:

On top of the standard mortgage rate that homeowners pay, banks also add a “stress test” to test their finances in preparation for hardship. If the base rate is 3%, the potential homeowner would need to be able to make sure that they could pay the test rate, in this case, 5.04%, to prove they would not go bankrupt.

This drop is not a decline in mortgage rates, just their test rates, though it could be viewed as an indication of where things may be headed. In any event, it will likely be easier to get a mortgage than it has been in the past, but payments aren’t going to change and people will still need to qualify for more than they would be paying.

What does this mean for the industry?

If this leads to a rise in people defaulting on their mortgages, the REIT market would likely fall, but if this means that real estate spending increases as people take advantage of lower test rates, then we could see stocks go higher.

A decent starting point for a “litmus test” on the state of REITs is an assessment of how the top three Exchange Traded Funds (ETFs) are performing. These REIT ETFs can offer a simplified and less expensive means to gain exposure to a diversified set of real estate holding portfolios. One thing they all have in common is that they are steadily gaining ground from the infamous crash of March 2020:

(iShares S&P/TSX Capped REIT Index ETF stock chart - March 2020 - May 2020.)

iShares S&P/TSX Capped REIT Index ETF (TSX: XRE) – One of the leaders in the real estate industry that tracks the S&P/TSX Capped REIT Index and provides exposure to roughly 16 REITs.

(BMO Equal Weight REITs Index ETF stock chart March 2020 - May 2020.)

BMO Equal Weight REITs Index ETF (TSX: ZRE) – This ETF has holdings in 23 REITs and utilizes an equal-weight strategy and attempts to reduce risks tied to individual securities.

(Vanguard FTSE Canadian Capped REIT Index ETF stock chart March 2020 - May 2020.)

Vanguard FTSE Canadian Capped REIT Index ETF (TSX: VRE) – With assets tied to 18 REITs, this ETF focuses on small, mid and large-cap Canadian real estate companies at a lower cost.

Looking ahead:

Should the Bank of Canada cut its test rate for mortgages, that news would more than likely be well received among REIT stocks, but could a move like that mean short term gains for long term losses down the road if we see defaults increase over the next decade? Let us know your thoughts in the comments below.

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