The Canadian Investor - How Canadian Real Estate Performs in a Rising Rate Environment

Episode Date: July 14, 2022

In this special release of the Canadian Investor Podcast, we preview the new addition to the TCI Network, The Canadian Real Estate Investor Podcast with Dan Foch and Nick Hill! Nick & Dan analyze the last 3 recessions and the effects it had on Canadian housing Market  Inflation, Interest Rates, Home prices and sales volume, Cap Rates and the correlation between them all We finish off the episode by providing some insight on how to navigate through a rising rate environment Apple Podcast - The Canadian Real Estate Investor  Spotify - The Canadian Real Estate Investor  Check out our portfolio by going to Jointci.com Our Website Canadian Investor Podcast Twitter: @cdn_investing Simon’s twitter: @Fiat_Iceberg Braden’s twitter: @BradoCapital Sign up to Stratosphere for free 🚀 our platform for self-directed stock investing research. Register for EQ Bank, the seamless digital banking experience with better rates and no nonsense.See omnystudio.com/listener for privacy information.

Welcome back into the show. This is the Canadian Investor Podcast, made possible by our friends and show sponsor, EQ Bank, which helps Canadians make bank with high interest and no fees on everyday banking. We also love their savings and investment products like GICs, which offer some of the best rates on the market. I personally, and I know Simone as well, is using the GICs, which offer some of the best rates on the market. I personally, and I know Simone as well, is using the GICs on a regular basis to set money aside for personal income taxes in April of every year. Their GICs are perfect because the interest rate is guaranteed, and I know I won't be able to touch that money until I need it for tax time. Whether you're looking to set some money aside for a rainy day or a big purchase is

coming through the pipeline or simply want to lower the risk of your overall investment portfolio, EQ Bank's GICs are a great option. The best thing about EQ Bank is that it is so easy to use. You can open an account and buy a GIC online in minutes. Take advantage of some of the best rates on the market today at eqbank.ca forward slash GIC. Again, eqbank.ca forward slash GIC. This is the Canadian Investor, where you take control of your own portfolio and gain the confidence you need to succeed in the markets. Hosted by Brayden Dennis and Simon Belanger. The Canadian Investor Podcast. We have some exciting news. I'm Brayden Dennis, as always, joined by the wonderful Simon Belanger. Simon, hey, come on. simon belanger simone hey come on it's a good yeah big day for us today yeah yeah yeah today's big day it's a good day it's our foray into building out this podcast network which i think

is going to be a wonderful media business and a wonderful tool for people to keep being not only entertained and educated at the same time, which I think podcasts are so good for. You and I are both big podcast listeners ourselves, even though we also run a podcast. And so today we are introducing Daniel Foch and Nick Hill, who are going to co-host. Introducing, that wasn't a terrible drum roll. Drum roll, please. The Canadian Real Estate Investor. This podcast will be part of the network. And so you're going to see some familiar things between the shows in terms of formats. Our show comes out Mondays and Thursdays. Theirs is going to be Tuesdays and Fridays. And today, you get to hear from them. Yeah. Yeah. I think we've been talking to Dan

and Nick for, I think, at least over a month now, if not more. It's been in the works, just working with them. We think they can produce some great content. If some of you are on Twitter or Instagram, you might even be familiar with them. And especially seeing that there's some real estate news coming out every single month. We're seeing also a lot of changes on the macro side in terms of interest rates going up, how that's impacting real estate. We just saw some data from the Toronto Real Estate Board where where they saw 41% drop in the number of homes sold. And they also have seen a big drop in the average home price in Toronto in the past couple of months. And Dan has a lot of experience in that. So he'll be able to put a lot of context. And then Nick has

the experience even more on the mortgage side. So I think they'll be able to bring a fresh perspective. We've been getting a lot of requests from people to have more real estate guests on the podcast. I don't think we've really ever had any. So I think this is a perfect podcast for those of you who are just looking to learn more about real estate investing in general, whether you're looking to buy a house,

whether you're looking to start investing in income properties, for example, the various markets across Canada. It won't just be Toronto. It won't just be Vancouver. It'll be across the board. I've listened to some of Dan's Twitter spaces and you'll even have some Twitter spaces. Sometimes we'll get inputs from realtors across the country. So I think he brings a great perspective and so does Nick. It's going to be wonderful. They've won me as a listener myself listening to the episode that they've came out with already that you guys are going to hear. Let's just let them take the floor because at this point, I think you're going to really like the show. And then you will be able to go type in the Canadian real estate investor in your show notes and subscribe and be there.

And if you want to just keep listening to stock talk, then you got us. If you want to listen to both, you got us. If you want to listen more to building out a portfolio of real estate assets, wonderful option as well. Canadians love their real estate. And you know why it's important too, is there's nuance. We can provide nuance to the Canadian real estate market versus just like everything that's out there globally, right? And that kind of perspective is really important for Canadians. So without further delay, introducing the Canadian real estate investor that you can go subscribe to on your podcast player. And here they are.

Let's hear from Dan and Nick. Welcome to the Canadian real estate investor podcast. Feels good to say that. It does. It really does. My name is Daniel Foch. I am a real estate broker, investor, commentator, analyst. I don't even know. Pointer of charts on TikTok. Is that what it's called? I don't dance, I promise. Thank God. Got enough of those. I am Dan's co-host. My name is Nick Hill. I also refuse to dance on TikTok, but again, similar to Dan, I'm a mortgage agent. I am an investor and I just try to get involved in any and all things real estate. Yeah, and you're good at it, man.

I mean, you slid into my DMs two years ago and look at you. You're like every realtor's favorite share on social media and you always got – I mean, you got good takes, man, and you're a little bit more bullish. So the realtors like you. They all hate me. You know what? Infamy is also good. And I think half of my shares are just because I grew a mustache recently, which seems to help. But facial hair aside, let's dive into episode number one. Yeah, what are we talking about?

How Canadian real estate has historically performed in a rising rate environment. This was actually Simone from our friends at TCI. This was actually his idea to get us started because it seems like a pretty topical, relevant thing to discuss here, Dan. So why don't you get us started? I thought the market was going to be going on a bull run infinitely. Just kidding.

We're going to talk about three different iterations of, well, two of which are rising rate environments, so the 1980s and the 1990s, and both of which were pretty interesting times for Canadian real estate. We're going to talk about 2008, which wasn't a rising rate environment per se, but it was an exogenous shock and recession and really changed the real estate asset in the Canadian sense. It's a bit of an outlier in the way that the real estate asset performed. So we're going to look at inflation. We're going to look at rates. We're going to look at recession. We're going to look at how home

prices performed. Did they go down? How long did it take to go down? How far did they go down? How long did they take to recover? We're going to look at return metrics. So cap rates, which are basically similar to your price to earnings in equities. Basically, the net operating income divided by the purchase price of a property gives you a sort of rough rate of returns, a little napkin math metric that most people use. And it also sort of measures the broad market. So you could say Toronto's cap rate is, I don't know, it's probably in the twos right now, but Toronto's cap rate's a two. Then we're going to look at the recovery, right? So, okay, we got to the bottom, did real estate lag? Was it a little bit behind the recession? And then what did the recovery look like? So that you can look at all of this information and you can say,

okay, I think today's market is most like the 90s, or I think today's market is most like X, today's market is most like the 90s, or I think today's market is most like X, or I think that history doesn't repeat itself, but I understand that it often rhymes, right? Mark Twain said that. And so we want to get an understanding for, are there lessons to be learned from this history? And can we use those lessons to make better informed decisions in real estate investing today? Well said, Dan. Why don't you start us off with this great quote that you have here? Yeah, sure. So this is a little bit behind our why, right? And this comes from The Economist on their housing market charts page on their website, which is public. And it says that financial media focus most of their attention on stocks and bonds,

but the world's biggest asset class is actually residential property. With an estimated value of about $200 trillion, homes are collectively worth about three times as much as all publicly traded shares. So from my perspective, when people talk about real estate, especially on the investment side, not everyone wants to be talking about just houses, but on the commercial side, those are very much institutional assets. It's not often you get lay people who are investing in plazas or investing in apartment buildings. And so what you see on the retail side is a lot of young people, young millennials investing in real estate through houses. Maybe they're duplexing them, maybe they're triplexing them, et cetera, et cetera. So that's what we're

going to end up talking a lot about because that's the accessible, that's sort of the entry level for the Canadian investment in real estate. So give me an outline of what we're going to end up talking a lot about because that's the accessible, that's sort of the entry level for the Canadian investment in real estate. So give me an outline of what we're going to be doing today. For sure. So I think the good place to start is to kind of outline some of the basics here. We're just going to go over some historical interest rates, what prime rate is, the role that the Bank of Canada plays, a quick definition of recession, And then we're diving right into the 80s, baby. So let's rewind here and just go over for the listeners so we're all on the same page here. First things first, prime rib. Sorry, prime rib. Prime rib is delicious. Prime rib is delicious. Prime rate is not. It's currently sitting at 3.7%. Prime rate is the interest rate that banks and

lenders use to determine the interest rates for many types of loans and lines of credit, including credit cards, which we all have, HELOCs, which apparently a lot of Canadians have as well, variable rate mortgages, which are on the rise, car and auto loans. So a lot of us, if not all of us, are affected by prime rate in one way or another. Now, each bank or lender determines their own prime rate based off the BOC. You'll hear us talk about the BOC quite a bit. That is the Bank of Canada. And they have something called an overnight rate. So changes in the target overnight rate are usually followed by similar changes in prime rates. So if we look back at almost 100 years

on a chart here that you'll find in the show notes, the Bank of Canada overnight rate and the prime rate essentially follow one another quite closely within a few points. Now, the BOC usually raises interest rates when the economy is showing signs of inflation. It's literally their best and essentially only weapon to really fight inflation, which I'm sure everyone's heard is on the rise. And that is important to know here because inflation, rising interest rates, there's usually another word that is associated with those and kind of using the same sentence, and that is the R word recession. Quick definition of a recession here is when a nation's economy experiences negative gross GDP, rising levels of unemployment, failing retail sales and contracting measures of income and manufacturing for an extended period of time, that period of time

being two consecutive quarters. That is where we are right now, folks. We are seeing this. I actually just did a little post on Instagram about the crazy levels of unemployment, especially in certain sectors like construction that are really hurting us. Anyways, let's dive back into the recessions. There have been 11 of them since 1948 in Canada. That's about one every six years, but you cannot measure. You can't even really predict. Only a certain few top tier economists can predict when we're going to see a recession.

So we're not going to dive into all those. The ones we are going to look at are the last three, which we think really affected us. And that is 1981 to 82, 1990 to 1992, and the most recent 2008 to 2009. And as Dan said, we are going to be looking at the rates, the real estate prices, and that'll start to illustrate a lot of things for us. So- Yeah. And to be fair, there was one recession that did happen between 2008 and present day, which was in, I think, 2015, there was an oil price shock and it gave us two very slight

declines in GDP. But interesting to think about anyway, because oil price shock and present day are also two topics that are very frequently discussed. And actually, I think as just an interesting fun fact, eight of the past 11 downturns in the economy, I think since the modern metrics, I guess GDP and stock market indices were preceded by an oil price shock. So like a very steep increase in oil price. And I think all of them or 10 of the 11 were preceded by a gradual run up in oil prices. So cost of oil price, the cost push inflation causes all goods to accelerate in value. And we start to see the central banks gaming the system, trying to change that equation, make things a little bit more comfortable for everybody.

And it naturally forces a bit of a cyclical event. Historically, that's what it tells us. I mean, there's really no way to imply real cause or effect. But anyway, I digress. Let's talk about what we're going to be looking at in these specific cases. So when we look at a rising rate environment, we're going to look at what happened with the rates. We're going to look at when house prices peaked, what was the price at the top, what it was at the bottom, how long it took to get to the bottom, and then how long it took to get back to that original price. We're also going to loosely look at what was happening elsewhere, what was happening within interest rates, inflation, indexes, rents, and the real estate return metrics, which are a derivative of rent. So getting an understanding for where real estate is becoming a better investment during

that period of time. Pro tip, the answer is yes, because they were going down in price. But we want to get an understanding for how real estate as an asset class performed during those periods of time so that you can kind of plan or get an understanding to see if there is any planning to be done. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense. And with them, you can buy all North American ETFs, not just a few select ones, all commission free so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award winning customer service team with real people

that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service. Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit questrade.com for details. That is questrade.com. Here on the show, we talk about companies with strong two-sided networks make for the best products. I'm going to spend this coming February and March in an Airbnb in South Florida for a combination of work and vacation and realized, hey, my place could be a great Airbnb while I'm away. Since it's just going to be sitting empty, it could make some

extra income. But there are still so many people who don't even think about hosting on Airbnb or think it's a lot of work to get started. But now it is easier than ever with Airbnb's new co-host network. You can hire a local quality co-host to take care of your home and guests. It's a win-win since you make some extra money hosting on Airbnb, but can still focus on enjoying your time away. Find a co-host at airbnb.ca forward slash host. That is airbnb.ca forward slash host. So Nick, let's start off with the second best decade of Canadian real estate history. I appreciate that. I was born in 1989. I love the 80s.

I just got the tail end. You know what I don't love though is the inflation rate in 1981 was 12.47%. That's a little higher. Yeah, just a little higher than what everyone's freaking out about now. The inflation rate in 1982 was 10.77%. To be fair, though, if I might interrupt, I don't know if CPI is necessarily an honest representation of what inflation is today. I will say that, and then I will let you continue. Fair enough. This is all we've got to work off of, and that can be a whole other episode. We'll

dive into that later. I'm going to introduce a term called inflation psychology because I'm going to use it probably a couple of times throughout this. Gordon Thiessen, who was the Bank of Canada General during the next period of time that we're going to talk about, but he was the governor of the Bank of Canada and he mentioned that Canadians have a higher inflation psychology than Americans. And so what this means is that Canadians are more likely to spend money today, almost rushing to get it out of their pockets before it loses value in the anticipation that than Americans. And so what this means is that Canadians are more likely to spend money today, almost rushing to get it out of their pockets before it loses value in the anticipation that a good is going to go up in value. So as an example, you're going to go buy a stove, a durable good, right? And you're like, I'm going to go buy the stove today because I think that

it's going to be 50% more next year. Canadians have a historically higher inflation psychology. year. Canadians have a historically higher inflation psychology. So this is important because it makes the Bank of Canada's actions clear in a lot of cases. So when we look at interest rates along that inflation, they were used as a policy tool to try and reduce that inflation. The economy was running a little bit too hot. We did see an oil price shock during that period of time and a lot of costs are being pushed on the consumers. Rates tripled in a relatively short period of time and they were successful in capping inflation. Now on that run up, they did actually back off a little bit and it caused inflation to continue even hotter. And so the lesson I think that might have been learned there was that rates need to be used relatively swiftly. I would say

that they were a more gradual increase but a high magnitude increase. This is when you hear about boomers all talking about, oh, interest rates were 21% or whatever. 21% is the top. That was my boomer voice by the way. 21% was the top. So they went from about around 6%, I think, to 21. I think you have the exact numbers, but 6% to like 21% on the prime side. Obviously, if you imagine interest rates tripling, it's a huge magnitude in capital cost acceleration and household indebtedness. Sucks a lot of buying power to the economy. What does this do to house prices, Nick? Totally. I mean, we've seen the Bank of Canada follow suit as they have in the past and raise

the rates to fight the inflation we're seeing. However, if people only knew what the comparison between rates then and rates now were, I mean, if we look back at the average, the Bank of Canada average rate in those years between 1981 and 1982, the average rate was 15.69 and that caused the lenders to make their prime 17.55%. So I feel like I could probably find like 100% loan to value private mortgage for less money than that today. Literally, yeah. Don't do that, by the way.

This is not financial advice. It does put things into perspective. And we see that housing prices, they peaked in the first part of the recession. And I'm just going to quote something here from BC Business from the 80s. As the city prepared for Expo 86, the average Vancouver house price more than doubled from 86,000 in January 1980 to 177,000 in January 1981. But interest rates were also marching north and after the Bank of Canada rate hit 21% in August of 1981, the average house price plummeted to 110,000, et cetera, et cetera. But the panic would be short-lived by January 1989,

the house price had risen back to 220,000. So we see the same thing happening again and again, and we can analyze this further as we move along to the other recessions, but a steep run-up in home prices, the inevitable tipping point, Malcolm Gladwell referenced the inevitable tipping point, usually that is directly associated with interest rates, the house price plummet, the transaction volume plummet, and then the slow creep up of return. We always see the transaction volume come back before house prices recover. So tell me a little bit about what was happening with cap rates and a bit about the recovery and anything else you want to touch on that before we move to your favorite decade.

Yeah. So the 80s were interesting because it was an inflationary recession. So there was really monetary policy was a big theme, right? Because they had something to actually control for. It wasn't so much an exogenous shock that was exceptionally clear that was outside of the realm of control, or at least they thought it was within the scope of control. Real estate was very much thought of as an inflation hedge at that period of time. And a lot of that was because you were starting to get institutionalized real estate purchases.

The value of real estate in North America very much became this thing that was inaccessible for the layperson and institutions were buying the bigger properties, right? Individuals weren't owning plazas anymore. They weren't owning the office buildings, etc. And so people heard this inflation hedge investment thesis and they started to rush into property as inflation started to ramp up. This caused a high degree of speculation. And then in 79, there was this energy crisis that happened as a result of some global conflict. And there was a run up in oil prices that caused this inflationary environment. People continued flocking into real estate in anticipation that inflation was not going to get any better.

House prices ran up and interest rates had to be increased to cap inflation. And what we know about real estate is, especially when prices are going up, you as a buyer have to chase the market and you have to use credit to be able to pay that new market price because it's outside of what you a year ago were saving up to buy it cash as an example, which a lot of people were actually doing back then. And so once you build this credit dependence into the market, all of a sudden the market becomes sensitive to these changes in the interest rate. And so as interest rates went up, house prices, Nick, as you mentioned, they peaked, I think in Q3 of 1981. They troughed in Q4 of 1984. So this was a very quick, I know it doesn't sound that quick when

you think about it over the course of three years, but when we look at other major cyclical events in Canadian housing and in credit cycles, which if you've ever looked at or read or listened to Ray Dalio's How the Economic Machine Works on YouTube would be a great place to get an understanding for how credit cycles work. Three years later, after that 1981 peak, house prices were down as far as 50% to 60%. But on average across the country, let's say 30% to 50%. Canada is very microeconomic. Each city trades independently based on different values that they have, geography, employment markets, etc. We can get into that another time. It took until Q2 of 1987 to return to that peak value. And during this period of time, we saw an acceleration from the lower bound of being a 6% cap rate to the upper bound being an 8% cap rate.

The rate of return on real estate actually got far more compelling as those prices came down and rents sort of had to keep up with inflation. So the inflation hedge that was built into real estate ended up being pegged more to rents than to price. And again, it took until Q2 of 1987. And then you mentioned right after that, we got back into this speculation and 89, house prices peaked again. So let's talk about 89 and again, my favorite decade, the 90s. Wow, 89 to 91, those were some tumultuous times right there. So the 90s, specifically 1990 to 1992, let's start things off with interest rates again. So they're pretty bad. At 1990, we see the prime rate averaging 14.06 and the BOC's overnight rate averaging 12.75

for that year. However, two years later by 1992, those have changed and the prime rate had dropped to 7.47 and the overnight rate had dropped to an average of 6.53. So those rates eventually worked their way down to the high threes and low fours only to hit six and even eight at some points. However, it would average out at 4.93 over the next eight years, all the way up to the year 2000 Y2K. It was during the first years of this recession here that we saw a drop in both home prices and overall transaction volume. Again, sound familiar? It wasn't into the tail end of that recession that transaction volume picked back up and asset prices did continue to suffer. So again, we're already seeing these reoccurring trends. So Dan, why don't you tell us a bit about

what was happening with sale prices during this time? Yeah, for sure. A couple notes on the interest rate as well. So I talked about the magnitude of the increase in the last one that we saw tripling of the interest rate. And this is important in today's environment because we had such a small interest rate, so it's easy to replicate these magnitudes. Right. I just want to jump in there for a second and say all the clickbait out there that interest rates doubled and doubling again, well, it's pretty easy to double from 0.5 to 1, right? I mean doubling at 7.47% would be a whole different issue. Right. Yeah. And so the magnitude in this period of time was that interest rates about doubled. And one of the interesting

points to note about this is that the speed at which they doubled was much more significant than the speed at which they increased rates in the previous inflationary cycle. So in the 80s, when we talk about the early 80s, they were kind of gradual with their way up. They were really toying with this monetary policy tool. They backed it off a little bit and then inflation ramped up worse and they skyrocketed rates after that. So when you, again, return to that principle of inflationary psychology in Canadians, Gordon Thiessen, who was the Bank of Canada governor at this period of time, mentioned that this was something that he was concerned about, Canadians' propensity to spend money sooner rather than later. And again, there was this psychology that real estate was an

inflation hedge. And so, one of the things that was distinctly different was that they raised rates a lot faster than they did in the past. And the reason likely was because it does require swift action to cap inflation as I think that they learned. The challenge was that you're increasing the borrowing cost for an asset that in Q1 of 1989 peaked at $273,000-ish. And it dipped actually going into the summer a little bit. And then there was, if you look at one of these cyclical charts, what almost looks like a bull trap. And that was in Q4 of 1989. So Q1 and Q4 of 1989 had very similar prices and it was high. Then it took until 1996, so seven years of downturn for the values to bottom out. And that was down about 40% to 50%. Depending on the market, there are some areas where it was 89% to 94%, like the

Greater Toronto area, but most of Canada was actually 96% if you look at the HPI, House Price Index across the country. Now, the interesting part is from that bottom, it took until 2002 to get back to that valuation that was set in 1989. That is 13 years of recovery. And the more interesting part is if you actually use inflation-adjusted dollars to figure out how long it took, to figure out how long it took. It would have actually taken until 2012 to return to that valuation. So in 2002, they just returned to that $270,000 home price, but without adjusting for inflation. If you adjust it for inflation, it could have taken over 20 years to get back to those prices. So just a little piece of inflation on there, what was inflation during this time period? It actually wasn't horrible. It was now, again,

the benchmark for inflation where all the central banks want it. And this isn't just Canada. We've seen central banks all over the world try to battle inflation as it becomes more of a global issue. Inflation really needs to be in and around that 2% to 3%. So in 1990, it was at 4.8%. In 1991, it was at 5.6%. But it ended up decreasing down to 1.5% in 1992, and then 1.9% in 1993, rate below that target of that 2% to 3%. I think there was also a bit of an overcorrection during that period. I think around 95, we almost touched a deflationary period. So inflation actually went below zero for a short period of time, which you always hear people talk about,

oh, inflation is so bad and also deflation is so bad. So they're kind of like, you got to imagine the Bank of Canada or the central banks really threading this needle between keeping inflation in the low one to two range, but not putting it below zero. Because I don't know, everybody says that it's a bad thing. I'm not exactly sure why, honestly. So we'll have to research that one too. For sure. And I think the funny thing about inflation that we haven't really mentioned so far is that it's really tied to consumer confidence and consumer mentality. And I think with a lot of the things that have happened in the last two years and the differences in mentality that we've had to experience, those are direct contributing factors to why we've seen inflation on the rise. But anyways, yes.

Well, I think those are important if we're really trying to get granular in the analysis of Canadian real estate, right? So there's this sentiment that real estate is an inflation hedge, right? But the challenge is that we don't really actually have – you have evidence of that in non-cyclical periods of time. So if you're in a bull run, real estate will typically outperform inflation or at a minimum, it will produce at inflation. So it'll grow at inflation. Plus you get yield, plus you get principal pay down from tenants, et cetera. So there's some value in that respect. But the actual inflation element of real estate is built on how we value properties, right? So remembering I did a postgraduate certificate in valuation at UBC, or I actually

didn't finish it, but I didn't write the exit exam, but basically there's three different ways that people value property or appraisers value property. And one of them is replacement cost new or RCN. Basically what that means is what does it cost to rebuild that house? And then you apply depreciation to it. So if you say the economic life of a house is a hundred years, that house is 50 years old, you cut that value in half. Okay. That would tell you basically what it would cost to rebuild X house on any given day. Now, in today's economy, we are seeing construction costs rising and they're rising at insane rates, like 22% year over year. And that's like a very, very conservative estimate. So this sort of establishes your price floor. Like right now, it costs in the

creation costs, total creation costs, hard and soft costs for condominiums in the city of Toronto are like $900 to $1,000, right? So what- Per square foot. Per square foot, right? So what this means is that this sort of creates, you have to think about this as a, that's your incentive for developers or builders to put units into the market. So if values start coming down, supply starts to get constricted. They stop bringing units to market. And it sort of expedites how real estate gets to the equilibrium, especially when you think about a country like Canada, where we're bringing so many people in through immigration. So that's your demand side.

Your supply side is not... Real estate isn't a fast supply chain. It takes six years from planning to construction to occupancy for a condo building as an example. Maybe if you're really lucky on the detached side, so your ground-based housing product, you could get it done within one to two years. That would be like absolute fastest. So again, not a huge supply elasticity, not a responsive supply chain. So it gives you a little bit of an understanding as to why real estate is often considered a hedge against inflation. But as we've seen in these two downturns, the inflation hedge didn't outweigh the exposure that it had to interest rates. Well said. And I think that's a good segue

to move on to- Yeah, it is. Because this is an exogenous recession, right? This is a recession, not so much – doesn't have as much to do with inflation, interest rates, et cetera. Exactly. I mean, the inflation rate in 2008 was a very modest 2.3%. So again, still kind of within that 2% to 3% threshold that they want to see now. Again, we all have fond memories of the 2000s, LimeWire, MSN, Walkmans, Facebook, all that good stuff. I think it was Myspace even back then. Yeah, it might have. I was a big Myspace guy. I was a huge Myspace guy. Yeah, you would. You would.

Yeah, for sure. Anyone listening, go find Dan on Myspace. Yeah, sure do. Follow Dan on MySpace. Follow Dan on MySpace. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense. And with them, you can buy all North American ETFs, not just a few select ones, all commission free so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award-winning customer service team with real people that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service.

Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit Questrade.com for details. That is Questrade.com. Here on the show, we talk about companies with strong two-sided networks make for the best products. I'm going to spend this coming February and March in an Airbnb in South Florida for a combination of work and vacation and realized, hey, my place could be a great Airbnb while I'm away.

Since it's just going to be sitting empty, it could make some extra income. But there are still so many people who don't even think about hosting on Airbnb or think it's a lot of work to get started. But now it is easier than ever with Airbnb's new co-host network. You can hire a local quality co-host to take care of your home and guests. It's a win-win since you make some extra money hosting on Airbnb, but can still focus on enjoying your time away. Find a co-host at airbnb.ca forward slash host. That is airbnb.ca forward slash host. Okay. Let's just rifle off some quick stats here and then kind of get into, because there's not a ton to talk about.

This was a different recession. So we're going to go over just a few numbers here and then kind of explain why it was a different recession. And I think it's probably a good time to start presenting our overall findings and what that means for the listeners. overall findings and what that means for the listeners. So the prime rate at the start of 2008 to the end of 2009 averaged 3.56. So pretty similar to what we're seeing now. Yeah, I take it. Come on. It's not that bad. However, the overnight rate averaged 1.67 for most of 2000 and then spent most of 2009 at 0.25. Now that is cheap money. And this is sort of where we first got addicted to that cheap, cheap money. Well, I mean, it's hard not to, right? I mean, you're borrowing at nothing. What is that? That's crazy. In hindsight, it's always easy to make these statements,

but you let that go on for too long and mentality starts to change. You've got a whole group of new millennial buyers coming into the market or what's the age category just older than a millennial? Gen X, right? Gen X. They would have experienced all this as well. Then that goes back to that consumer mentality, right? If I'm used to 0.25 or even 3.56 as the standard for years, and then all of a sudden rate starts to double and triple and quadruple all the way up to one, two, three, four, I'm going to be shocked. Whereas a boomer is going to look back at this and say, that's still cheap money. Yeah. And I mean, that does come into that rate psychology, right? Like when you think about inflation psychology, the other side is interest rate

psychology. Because I mean, if you look at that peak that you're talking about in 1981, and you draw a line to today's interest rates, I mean, rates really have been steadily decreasing, say for a few small anomalies since 1981, right? Like, I mean, there was a couple of jumps up, but we're sort of on this downward trajectory. And 2008 was an exceptionally good reflection of that, right? We didn't have much room to move rates down. We were already at historic low rates. And then this exogenous systemic shock happened south of the border. We didn't have a huge house price run up in Canada prior to 2008. We weren't as addicted to speculation as the US. It's almost like we'd learned our lesson back then in the 90s. We saw what they were doing in the States. Everybody was levering up and buying houses and everybody's seen the big short. And if you haven't, you got

to watch it. And I'd actually recommend reading the book too. Canada did pretty well through the 08 recession compared to most other OECD countries, but we dropped rates. And this is the important distinction because there wasn't much room under that historical rate. So we're kind of toying with this idea of net negative interest rates where your borrowing cost is lower or is below zero after you factor for the rate of inflation. So today, inflation is at, let's say 7% and rates are at 5%. You're still borrowing at minus 2% in present day. And so this is sort of where we got into this NIRP, N-I-R-P, negative interest rate policy or net NIRP, which is interest minus inflation is a negative number. What happened was in the US,

house prices peaked and they started this steady downturn. They dropped until like the mid-20-teens, right? I think 2013, 2014 before they started their upward trajectory again. In Canada, our prices peaked in like Q3 of 2008 and they barely dipped like 10%, let's say, max in the micro, right? And you're talking, sorry, that's not transaction volume, that's sales price. Sales price, right, yeah. Sales price. House prices, they dipped. But then what happened was they started this rip that has, we're kind of just getting to the end of that, to be honest with you. The bull run that was-

Such a good time. It was a good time. The reality is this bull run really started in the 90s, right? It started in 94 when house prices bottomed out, or 96 when house prices bottomed out. They've just been on a steady uptrend since then with a couple of dips. In 2008, if you look at the chart, really just looks like a dip. It looks like 2017 in Toronto when the non-resident speculation tax dropped prices in the GTA by 20% or 30%. But then they just ripped right on through after that. And the important point is that interest rates started decreasing. It became compelling from a capital cost perspective for people to borrow money, lever up and buy some of that sweet, sweet Canadian real estate. So if we look again at rates, cap rates, so investment returns, this is where if

you look on the US side, cap rates soared in that correction because prices were coming down, banks were just rifling off properties to avoid bankruptcy. And rents were being... I mean, people still needed houses. So rents were relatively less impacted. But on the Canadian side, we kind of look at the national cap rate. The easiest way to establish what that spread would look like and kind of how it was performing at a given time in the market is in 2001, the national cap rate was, I think it was 9%, let's say, which is crazy to think about getting a nine cap. But I mean, you average that out across all the micros in Canada, right? It makes a little bit more sense. But it was 415 basis points above the 10-year bond yield. In 2009, during the GFC, it was 453 basis points above the bond yield. And

that was a cap rate of about 7% nationwide in Canada. So national cap rate. The source on this is Bank of Canada and Altus Group, by the way. Now, go to present day. So during that period of time, from about 2007 to 2009, you saw cap rate expansion. So investment yields were getting better. Prices were coming down, rents were staying stable or potentially going up. So yields were getting better on these real estate investments. You fast forward that same metric to present day and cap rates are at about 432 basis points above the Canadian 10-year bond yield. But both of those metrics are significantly lower than they were back then with a national cap rate today being around 5%.

So I'm just going to give a quick little run through on what happened with those cap rates from start to finish, just to summarize, and then I'll let you jump back in. 1980, the 80s was a slow and steady compression of cap rates. So investment yields are actually getting less compelling. Prices were going up because you're starting to see more institutions get into investment. But during that downturn, we did see a spike up in cap rates. In the 90s, cap rates were very much expanding, slow and steady, but that trend sort of got kicked off by that recession in the early 90s. Rolling over after the dot-com crisis, maybe people learned something about investing in tech.

Pets.com wasn't the compelling thing anymore. So they started getting into hard assets again, and those cap rates compressed faster than they had historically ever. And that was where this US obsession with real estate speculation came in. Everybody was getting into real estate. Sounds familiar, doesn't it? And so cap rates were getting, they dropped from something like 8% nationally to 5% cap right before that. So US nationwide was almost at a 5 cap heading into that final recession. They jumped back up to, let's say, 6.5% and then steady downtrend through the 2010s to present day from about, let's say, six and a half, and then steady downtrend through the 2010s to present day from about, let's say a six, five, seven-ish cap rate down to a 4%. So we're trading at historic low cap rates right now. Which is not a great thing. We want higher cap rates.

Well, I mean, you and I do certainly. And typically the style of investment that I advise people to pursue is seeking things that, I mean, look, your yield has to be high enough from my perspective. I'm not signing myself up when I'm investing in real estate. I'm not signing myself up for a savings vehicle, right? When we think about the way Canadians buy real estate, we often commit ourselves to a payment. We're not buying a house, we're buying a payment, right? And so Canadians historically not exceptionally good at saving money. Mortgages are a house, we're buying a payment, right? And so Canadians historically not exceptionally good at saving money. Mortgages are a great way for us to be forced to do that, right? And the cheaper that they are, the more principal we're paying down every month when we pay our bank as a thank you for letting us keep our house. If you're buying a two-cap in Toronto,

right? Or if you're buying a two-cap condo in Toronto with condo fees, you're burning money. And yeah, I mean, maybe you're getting two grand a month in equity paid by the rental income. But if you're paying a thousand bucks a month, then I mean, really what you're getting, you're basically getting 100% return on savings. That's before you think about your cash on cash return or any of the other metrics that you should be using to analyze real estate. Yeah. Wow. Really, really well said guys. Dan and I are going to do another episode unpacking a lot of what he just said from cap rates to IRR to all the different types of ways different investors analyze the properties, different metrics they use. Just to keep things rolling here, I'm just going to give a quick

closeout of the 2000s and just wanted to explain why Canada didn't get as effective as the States and then some countries globally. I'm going to kind of give us a little summary of the findings that we've gone over and then Dan and I are going to have a quick discussion summarizing if it is a good time to buy real estate in a rising rate environment. So- Not advice. Not financial advice. Not financial advice. You'll hear that at the end as well. So quick summarization as to why

Canada's housing market didn't plunge in the same way the American market did. Really the 2008 crisis was caused by the housing bubble unlike a lot of the other recessions which affected the housing bubble afterwards, this recession was actually caused by the housing bubble, unlike a lot of the other recessions which affected the housing bubble afterwards. This recession was actually caused by the housing bubble bursting in the states, which obviously had global effect with global financial systems. That was actually, in my opinion, just mortgage fraud on a mass scale. So Canada's got a lot more of a regulated banking system which prevented lenders from giving mortgages to people that blatantly could not afford to pay them. There was less scrutinization of mortgages in which mortgage debts are packaged together and sold as securities. So that was the whole, we don't need to get into

that. Well, I mean, it's worth maybe discussing because in Canada, we don't really sell mortgage backed securities at scale and there's really no like private for them. CMHC is the only one who's buying those MBSs off of banks in Canada, right? Exactly. It's less systemically – I mean, if banks were only lending in real estate, then it might be systemically risky for the government to be buying all of those MBSs, but that's not the thing. The other thing is that Canadian banks are exceptionally diversified and that's probably something you hear a lot about on TCI when those guys talk about why those are good businesses to purchase.

We have a legopolistic banking system. It's not like the states where they had 2,000 financial institutions. It's the same issue in the savings and loan crisis. They have a bunch of these 1,400 banks or something failed during that period of time because everybody's just trying to be competitive. And the way to do that is make ridiculously risky financial products for the average person who has no clue what they're borrowing. Capitalism, baby. Which always results in a race to the bottom.

Yeah. And fortunately, we haven't seen that in the Canadian market because the scope of our financial system is very elementary. And that's ultimately, it could be a saving grace in the current downturn. I think we might have some other challenges that we're going to be dealing with. But we got six charter banks, right? I mean, five plus one, let's say national kind of just sneaked in there. But these are banks that are regulated by the Bank Act in Canada. So they have to follow liquidity requirements, Basel III, etc. There's a lot of rules because they're considered globally significant. I mean, Canadian banks are some of the biggest banks in the world,

right? They have a huge presence in the States and globally in capital markets, et cetera. And so the world doesn't want to see them fail. And so in order to do that, they have to keep a very small exposure to any one thing. But in the context of this conversation, only a small portion of their book is lending money for residential mortgages or real estate, period. And the main takeaway from that is diversification is a good thing. Yeah, it is. It is. So let's just, I'm going to run through a couple high-level points, takeaways for our listeners here.

What do our findings show us? Canada has seen prime rates from 22.75 at its highs all the way to 2.25 at its lows. And then again, all the way to 0.25 on the overnight side. Historically, we're still looking at low interest rates. The Bank of Canada uses the rate to fight inflation, which we've seen happen cyclically every time. That decreases buying power, which initially drives both transaction volume and asset prices down, asset prices level out and take longer to recover, but transaction volume usually picks back up first.

So that begs the final question. How does Canadian real estate respond in a rising rate environment? Well, this is my take. It is reactionary to the consumer mentality and very dependent on the interest rate. So when inflation is high, rates go up to fight them. Canadian real estate sales and volume and price fall. They slowly recover as do all things with time. The only question is how much as we've seen each cycle is different, right? There's been 11 recessions. Each one has taken different times to recover. So in closing for me, I think a good real estate investment ideally shouldn't be this subjective to rate changes. If you're buying a personal residence to live in for years and years, obviously proceed

with caution, but rates and rate changes shouldn't be top of mind in the sense that don't be walking away from your forever home if the Bank of Canada raises 50 bips. And then from the investor standpoint, this is an investor podcast. After all, just make sure your numbers work. Leave room in those margins. Run your numbers at a few points higher. Stress test yourself. Dan, what are your final thoughts on this? Yeah, I think I have a similar outlook. It's worth looking at the patterns that have happened in these markets, especially the greater Toronto area, which today is June 28th and house prices are already down in the GTA in some markets more than 20%. Yet, the delta, the change that we've seen in borrowing power as a result of rate hikes is

around 10% to 15% depending on the borrower, what type of credit product they're using, etc. So, either the market is forward looking, which it could be, but also if you were waiting for prices to come down, the price reduction has outpaced the credit cost acceleration, right? So you have to think about buying real estate as an investment or as a house and the costs associated with it. If you're going to lose 100K to equity going down, right, that's downside risk, but you could also lose 100K to borrowing costs going up if you wait a little longer, depending on over the course of a mortgage term. And we should probably actually do a full episode analyzing the rate sensitivity and we can talk about trigger rates and stuff like that. But from my perspective, it's do the math on how much borrowing power you're going to lose to rate

hikes and whether or not the equity position that you're in and the equity risk, the forward looking equity risk is worth taking given where you stand with your own financial position on interest rates. Wow. Love it. Okay. We are going to stop it there. First episode in the books. My name is Nick Hill. You can find me online across all platforms at MyBuddyNick. If you are interested in working with me on the mortgage side of things, G&H Mortgage Group. Dan and I don't have a website or anything set up for this podcast yet because it's the first one. We will keep everyone posted as things get built out. Yeah. If you want to find me on social media, I mean, probably easiest just to Google me, Daniel Foch, F-O-C-H. I think Google will probably put up the

platform that you're most likely to click on, but I'm pretty much on everything. And if I'm not, like just tell me and I'll try and make content on that platform too. You know, if you want direct links, I host a Twitter space every week. It's a live event. We talk to a bunch of people across the real estate industry about whatever's going on. So those are really cool. And then dfoch.ca is a website that goes to all of my direct links. If you want to send me an email, schedule a call, et cetera. Dan, you're famous enough that you just have to type your name into Google. Well, I think- I'm probably third page at this point.

I think it's just because you got such a- Generic name? Yeah. I guess that's the word. I was searching my Rolodex for a diplomatic word and there just wasn't one. I appreciate it. Yeah, whatever, whatever. All right. Thanks, Dan. We'll see you soon, everybody. Thank you. Have a good one. For more great content from Dan and Nick, you can search Canadian Real Estate Investor on your favorite podcast player. For those of you listening on Spotify or Apple podcasts, you can also get a link to their feed in the description of this episode. Make sure that

you follow or subscribe and that you give them a five star review that will help even more people find the great content produced by Dan and Nick. The Canadian Investor Podcast should not be taken as investment or financial advice. Brayden and Simone may own securities or assets mentioned on this podcast. Always make sure to do your own research and due diligence before making investment or financial decisions.