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Thursday, May 5, 2011

2011 Canadian Election

By Michael Farrell (Vancouver)

Stephen Harper and the Conservative Party of Canada were elected into a majority government on May 2nd after serving for the past five years as a minority government. However, the bigger story may be the almost total obliteration of the Bloc Québécois (BQ), the federal party dedicated to promoting the sovereignty of the Province of Quebec which was reduced to four from 49 seats in the House of Commons. I can see two possible positives effects on Canadian real estate from this election.

After the Quebec Referendum of 1995, during which the Province of Quebec chose to remain part of Canada, many Canadians viewed the likelihood of Quebec pursuing separation again in the future as extremely low. However, some international investors did view the issue as a political and economic risk related to investing in Canadian real estate. I believe that the most recent election will likely render the BQ defunct as political party in Canadian politics and will remove the risk premium, perceived or real, international investors had associated with investing in Canada.

In the 2006 federal election, when the Conservatives won the first of two minority governments that led up to their latest victory, their election platform proposed a deferral of capital gains on the sale of assets when the proceeds are reinvested within 6 months. A structure that is similar, for real estate, to the 1031 Exchange in the United States. However, the election promise has not been fulfilled to date and one might speculate that the Conservatives will use their majority in the Canadian House of Commons to pass a law allowing for capital gains deferral for real estate in this country. I believe such a law would increase efficiency in the Canadian real estate market by reducing the tax burden on the industry and adding to the supply of product.

Currently corporations are taxed on gains from real estate assets either as revenue (and taxed at the corporate tax rate) for active real estate companies (eg developers) or as a capital gain. Regardless of the structure a corporation has employed, the overall result has been the over taxation of the real estate sector in Canada as measured by the OECD (OECD data, "Taxation of Corporate and Capital Income", 2005) and the Fraser Institute (Grubel, Herbert, The case for the elimination of capital gains taxes in Canada, Fraser Institute, pg. 34, 2001).

I believe the lack of a rollover provision has reduced the efficiency of the Canadian real estate market by restricting the supply to the market. The reason for this is that some Canadian cities, Vancouver included, have extremely fractured ownership. Many owners are families or individuals that are unwilling to sell due to a relatively large capital gains liability. As a result, properties are held for extended periods with little motivation for the owner to maximize return or pursue the highest and best use of the property. I believe individuals and corporations would be better off being able to sell their property and reinvest the proceeds in larger higher quality assets as market prices rise. In turn, this more regular turnover would provide greater supply to the market.

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