Real Estate Finance in Canada: A Preamble
Dogan Tirtiroglu, Canadian Journal of Administrative Sciences
This issue of the Canadian Journal of Administrative Sciences (CJAS) comprises five papers on real estate finance in Canada. To my knowledge, this is the first time that an academic journal has devoted an entire issue to Canadian real estate matters. I extend my thanks to Professor Abolhassan Jalilvand, former editor of this journal, for encouraging me to undertake the guest editor's duties and privileges for this special issue; Professors Iraj Fooladi and Philip Rosson, the current editors, for their exemplary cooperation; the authors and referees for their contributions and invaluable feedback and comments, respectively; and the Institute of Mathematical Finance in Montreal for its financial contribution towards the publication of the special issue.
Each paper studies a different aspect of the Canadian real estate markets. Hence, the special issue offers a diverse picture; it is my hope that such diversity can stimulate further research. From my short editorial experience, it seems to me that real estate research with a Canadian focus needs a big boost. It lags considerably behind that in the United States. In fact, limited Canadian research output, published sparsely and mostly in the U.S. academic journals, was one of the main reasons behind my request to CJAS for this special issue. There is indeed a lot to do. I invite all interested parties (researchers, universities, research centres, and funding agencies) to put more of their intellectual efforts and resources into research on real estate matters in Canada. Real estate constitutes a good portion of the national wealth, is an engine of the macroeconomic activity, and is also the major component of most individuals' personal portfolio, so efforts to uncover knowledge pertaining to the Canadian real estate markets are not trivial.
A Synthesis of Papers in this Issue
The first paper, by Tsur Somerville, examines financing of development projects and aims to fill the research gap on mortgage lending between the residential market and the development projects. It focuses on two hypotheses that have implications for efficiency in the Canadian credit markets. The first is whether small-scale local lenders establish "relationship" lending with smaller borrowers (developers), smaller projects, and more atypical projects. Or, alternatively, do small local banks fill a market niche ignored by larger lenders due to their desire to achieve economies of scale by focusing on loans that are easily processed? The second considers whether capital flows efficiently from one region to another, given the risk and required return relationship.
One of the basic lessons drawn from the research on capital markets is that capital should flow to projects that offer a sufficient risk-adjusted expected return. However, this lesson does not state who may be supplying the capital where it is demanded. It is assumed that anyone with sufficient capital and a willingness to earn the risk-- adjusted expected return on the project would be a good candidate for supplying the capital. Somerville's evidence (and other evidence from especially the banking literature) on this issue suggests that large lenders shy away from lending to smaller projects or borrowers. So, this leads potentially to a gap in the supply of capital even though the borrower is willing to offer to the lender a properly risk-adjusted expected return on the project. Somerville's results show that this gap creates opportunities for small-scale lenders, such as credit unions, which probably have informational advantage in producing more and better information about the local market conditions and especially about the borrowers' risk profiles.
Somerville's second inquiry provides a response to developers in British Columbia (BC) who, according to the author, complained in the early 1990s that Central Canada-based lenders did not lend to viable projects in BC because Ontario and Quebec real estate markets were in poor shape. …