Tsunami of foreign capital could be headed toward Vancouver and Toronto real estate.

Tsunami of foreign capital could be headed toward Vancouver and Toronto real estate.

A recent change to China's Constitution could have far-reaching impacts on Canadian real estate and thwart the Canadian government’s efforts to cool the real estate market.

It was recently announced that the Chinese government has changed its constitution to allow the current President Xi Jinping to rule indefinitely. This change reverses an amendment to China's constitution made in 1982 which was intended to prevent a lifelong dictatorship similar to that of Mao Zedong.

There are many factors influencing real estate prices in Canada. In a past post we explored each of these and they are summarized in the diagram below.The changes to the Chinese constitution impact two of the key factors: foreign capital flowing into Canadian real estate and the effectiveness of taxes targeting speculation.


Key Factors Influencing Home Prices

It's known that foreign capital from all over the world has been flowing into Canadian real estate. It is unclear exactly how much foreign capital has being funneled towards homes in Canada due to the supply that they are absorbing, and the fact that some participants in the market are less budget-conscious.

According to Juwai.com, China’s largest international real estate portal, Canada is the fourth most popular destination for mainland Chinese real estate investment, behind #1 USA, #2 Australia, and #3 Hong Kong.

Why does president-for-life change anything?

Some theorize people are taking money out of their countries because they feel domestic investments are vulnerable to government appropriation, could devalue for some reason, or they may need to flee their country in the future and would like a nestegg somewhere safe.
Most governments in the West believed that since the 1980s China was moving towards greater freedom and democracy. They believed that by engaging in trade with China to help raise the standard of living, it would align the Chinese government with western values and democratic institutions. The recent change to the Chinese constitution represents a shift toward more autocratic rule.

The change also calls into question the degree to which mainland China will respect the legal traditions and democratic institutions in its Hong Kong territory and raises the possibility of capital flight from Hong Kong.

As long as some wealthy residents of China and Hong Kong believe that the recent change is a turn for the worse and puts the future of their children in question, there will be a strong incentive for them to move their families and money to safe havens.

Responding to capital flight, the Chinese government has instituted restrictions on capital outflows and specifically forbidden its citizens from investment in foreign real estate.These measures have been circumvented by determined individuals. Some have simply moved funds in briefcases of cash, while others have exploited crypto-currencies, or used “underground banks”. To better enforce the rules, the Chinese government has been collaborating with foreign governments including the Canadian one, and has hired over 400,000 civil servants in 2017 to help prevent illegal cash outflows. Whether someone is moving proceeds of crime or simply moving their life savings out of China, if they are breaking the Chinese laws for capital outflows they are money launderers.

Why will this money flow to real estate?

A Canadian lawyers association report succinctly summarized why Canadian real estate is the preferred vehicle for money laundering.

  1. Anonymity: Canadian land title offices do not hold information about beneficial owners of property, effectively granting them anonymity. So a property buyer can have someone or a Canadian company buy the property on their behalf and own the property while it is not registered in their name. The recent B.C. budget seeks to change this but it is unclear how long it will take to implement the change.
  2. Weaker Rules: Anti money laundering requirements for real estate professionals are more lax than for industries like banking and investment management and the industry is notoriously poor at fulfilling its duties under Canada’s anti money laundering laws.
  3. Weaker Enforcement: Enforcement of laws for real estate professionals is a weak deterrent. The penalty for a real estate professional found guilty of an infraction could be as little as a small fine or a temporary license suspension.

What can we expect in Canadian real estate?

Expect an increase in the flow of foreign money into Canadian real estate and other safe havens. Taxes targeted at foreign speculation likely won’t impact the demand for real estate because these investors are not seeking the best investment but a safe holding.  From the buyer’s perspective, it is better to pay high taxes than risk losing it all. In addition to capital from mainland China, we may expect an uptick in capital flowing from Hong Kong. This doesn’t guarantee higher home prices but it definitely puts upward pressure on them. The money is flowing into real estate because the real estate industry has weaker anti-money laundering controls than other investment vehicles.

Canada is not unique in being impacted by this capital flight to safety. Nations considered safe havens should consider developing a policy approach to helping people who are fleeing political uncertainty or oppression. Canada is a compassionate society and we need to figure out how to help these people bring legitimate money to their new homes while minimizing the negative impacts. Truthfully, an overabundance of supply may be the only realistic solution that is likely to have the desired effect.

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