The Canadian Investor - Is Commercial Real Estate Really in Trouble ? - Part 1

Episode Date: July 13, 2023

In this first part of a two part special on commercial real estate (CRE), Simon and Dan talk about the different types of CRE. They look at both the US and Canadian markets and what potential challenges and opportunities lie ahead for different types of CRE. Symbols of stocks discussed:  Check out our portfolio by going to Jointci.com Our Website Canadian Investor Podcast Network Twitter: @cdn_investing Simon’s twitter: @Fiat_Iceberg Braden’s twitter: @BradoCapital You can listen to part 2 on the Canadian Real Estate Investor Podcast with the links below Part 2 - Apple Podcast Part 2 - Spotify Part 2 - TCI website Interested in becoming the next co-host of the Canadian Investor Podcast? Send us a 1 minute video at [e-mail] . 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 Braden Dennis and Simon Belanger. Welcome back to the Canadian Investor Podcast. I'm here today with a different co-host. I'm here with Dan Foch or Daniel Foch, obviously, from our Canadian Real Estate Investor Podcast. Dan, how are you doing? It's a pretty long time coming, this special episode. You want to let

them know who you are and what we'll be talking about? Absolutely. My name is Daniel Foch. I am one of two hosts of the Canadian Real Estate Investor Podcast, which is the real estate side quest, I suppose, of the Canadian Investor Podcast Network. podcast network. And on our show, we talk a lot about specifically direct investing in real estate, but also some other types of investing in real estate through GPLP structures and public markets and private markets. And today we're going to be exploring the impact of commercial real estate. There's been a lot of ominous headlines in the commercial real estate space, especially coming out of certain kind of ground zero spaces for this correction happening in the US. I think we're all pretty familiar with what's happening in the housing market in Canada. But I think the commercial

real estate space is one that's been very slow to evolve. And it's one that a lot of people aren't super in touch with because the data as we learn trying to make this episode is not exceptionally easy to find. So I guess we can give a quick overview of what we're going to talk about today and then I'll dive into sort of compartmentalizing what these different asset classes are. Yeah, exactly. And the goal here, we're trying something a little different. So we'll do the first part on, obviously, this podcast, the Canadian Real Estate Investor. And then for the second part, it'll be uploaded on the Canadian real estate investor. So if definitely if you hear this, you'll want to switch over when the second part comes over. And we'll go over a lot of different things. So we'll start off by

just going over and Dan will do a, I'm sure really good job at this because that's his, I guess, space of expertise is probably the best way to say it is we'll go over and define what is commercial real estate, because I think a lot of people tend to automatically associate that with office real estate. And unfortunately, it's a much broader space, right? Absolutely, yes. And I think it is one where the impact of different trends happening in the broad market, you know, things like e-commerce, work from home being obviously major themes in the post pandemic society have had really disproportionate impacts, positive and negative on different asset classes.

And so it's, you know, I call the real estate market right now very much a stock pickers market. It's one where if you're a betting man, you could make a bet on or against an asset class and be very successful over the next 10 to 20 years by comparison to somebody who bet on a different asset class. And so just quickly, the commercial real estate space encompasses a variety of property types. That's office buildings. So your offices, this is where you're hearing about a lot of office towers in your San Francisco

and LA markets, especially having defaults among big names like Blackstone and Brookfield, defaulting on debt and walking away from properties in certain cities in the US. defaulting on debt and walking away from properties in certain cities in the US. The major headwind, obviously, for the office world is return to work is a big question mark. And the renewal of a lot of these large leases for these office buildings is a proportionately large question mark based on how those reopen. Next on the list would be retail. So retail properties are used for selling goods. Consumers go to use them to buy produced goods, pretty simple. Shopping centers, malls, strip malls, and actually kind of pre-COVID, the future of the enclosed mall

was a big conversation. And it still is in the States because-commerce be becoming a big headwind for retail um and but and in canada it's especially interesting because enclosed malls are actually becoming almost the center point of these newer newly urbanized communities but in a lot of these kind of more flyover areas in the states um they're they're falling into these states of obsolescence almost. Um, the next pieces would be industrial and multi multifamily properties, both two exceptionally hot asset classes in Canada. So industrial is where they build stuff, um, manufacturing production storage, a lot of it's, um, food related and distribution related. Um, this can include warehouses, distribution centers, factories, industrial parks, and flex spaces. You see a lot of warehousing and a lot of

that is becoming increasingly popular with the theme of on-shoring. Industrial is like the second tightest or tightest asset class in Canada on a vacancy rate basis. We've seen like almost tripling of rents in the past five to 10 year period and vacancies below 1% in a lot of, in your major cities, Toronto, Montreal, Vancouver, below 2%, let's say multifamily is basically the same thing. So this is houses in Canada, um, or, or, uh, apartment buildings, um, complexes that are intended basically for residential use. The rent environment, the rent escalation environment is a little bit more limited by rent control, which is a big popular thing in Canada. We're a lot less landlord friendly than the US. But similarly, vacancy, according to CMHC, is below 1% of many major markets in Canada. And I would say around that

kind of two to 3% range in, in most, in most markets in Canada was really just a reflection of that, the housing crisis. Um, the, the other ones that I'm not going to, we're not probably not going to dive into too much for the purposes of this discussion or sort of your hospitality. So hotels, healthcare, mixed use, and then sort of special purpose stuff. And there's, but that sort of covers kind of the spectrum of commercial properties. Because again, I think a lot of people just say commercial real estate, and they think office, and it's probably painting the market right now, especially with an unfair brush, because it's a very small portion of the total universe of commercial property.

rush because it's a very small portion of the total universe of commercial property. Yeah. And that definitely seems to have been the focus. I feel like a lot of people are interchanging commercial real estate and office space. And we'll double click on that. We'll do a full section on office space so people can get a better understanding what's actually happening there. But before we get there, let's talk a little bit about that because we've been, I definitely have been getting some questions about what you quickly referred to for Brookfield walking away from a property, well, a pretty well-known property. So the Y Plaza in LA. So it's important, I think, for people to understand that a lot of the commercial real estate has non-recourse loans, which essentially are loans that are backed by

the property, but there's no recourse to the owners of the actual property. In the case I was mentioning, like a Brookfield. And have you heard, like, I know you're pretty well connected. Have you seen lenders trying to kind of change that non-recourse loan now as some of these, you know, these mortgages are coming due or some of that debt is coming due and if they're refinancing or lenders requiring that there is some kind of recourse just in case the properties go down in value? Yeah, I think you're definitely starting to see a bit more of a credit contraction happening in the US side than in Canada, although I would anticipate it'll likely happen in Canada as well.

Lenders are just becoming a lot more picky. And in the States, I mean, it's tough because they can't really engineer a recourse environment overnight. You can't just as a lender... There's so many different institutions and there's always somebody else willing to do a non-recourse facility on the same product. So it comes down to underwriting the product better. And so that means, we just did an episode on our show about debt service coverage ratio as an example. How capable, and that's used in financial analysis as well. How capable are these assets of servicing the loan and servicing the loan against an increasing interest rate environment if we're the lender? Because it's not that they don't have recourse, they just don't have a personal guarantee.

They can't chase that person down to shake them loose for the money forever, but they can take possession of the asset, which is the big difference in the US. In Canada, we only have foreclosure. That's called foreclosure. In Alberta, a couple of other provinces, but Alberta is where it's most common. Ontario has something called power of sale. So the lender actually executes the ability to

force somebody to sell a property. Whereas in Canada, or sorry, in the US, foreclosure means the lender actually takes possession of the property if the person's in default. And so you're starting to see, and we've seen this happen amongst lenders in Canada, even on development properties, a lot of lenders becoming operators or executors on developments. And I think that that's probably going to be a continued theme happening over the next several years in commercial real estate. And so the thought process is, can we underwrite the asset better to protect ourselves in a recourse scenario rather than you know trying to push for recourse because the people are just not going to do the deals if if lenders are saying we need to be able to to sue you or collect from you or we need a

personal guarantee yeah exactly and for people who might not be super familiar just so you and like a better understanding of what's happening here so So if you take Brookfield, for example, so they had defaulted on the loan that they had on the EY Plaza in LA. So essentially, they had a couple of options. They could try to renegotiate potentially better terms with the lender, or they can just decide to walk away from the property, essentially giving it back to the lender. Why it's not great when you're a lender in that situation is if a company is walking or

an individual is walking away from a property, it's most likely because it's not performing well. If it's not performing well, the value of the property is probably not doing quite well. So obviously it'll depend on the loan to value ratio and versus what the actual market value is of the property. But oftentimes this is what they'll do. And there's been other example, Blackstone did the same thing. They walked away from 1740 Broadway in Midtown Manhattan, which was definitely an older building in need of massive investment to modernize it. So it would have cost several hundred million dollars to kind of revamped it and make it almost in a class A type of property.

And you also had one that made headline, Columbia Property Trust defaulted on 1.7 billion of non-recourse debt, secured over seven properties back in February. I believe this was in the Washington DC area. So it just shows you that there are definitely some dominoes falling in the U.S., but in the grand scheme of things, it's still relatively, I would say, a non-issue at this point. It's on the radar of people, but it's still a drop in the bucket, if you ask me. What do you think? I would agree, and I think, you know, at the beginning of the logic behind somebody defaulting, I mean, in a lot of cases, another recourse mechanism is cross-collateralizing assets. And they haven't done this in some situations with some of these landlords because they're strong borrowers. So you mentioned at the beginning that they could be almost using this as an opportunity to renegotiate the terms.

And when I'm looking at landlords at the scale of a Blackstone or a Brookfield, I'm going to make the assumption that that's the likely outcome here. I mean, on the EY Plaza that you used as an example, it was a CMBS package. So basically like a syndicated loan originated by Morgan Stanley and Wells Fargo. So large financial institutions as well. But there are examples of similar deals where your Brookfields and Blackstones are similar in market cap to the lenders that are lending on these deals. And so they actually have the ability to bully or to negotiate.

And I think that by not paying the loan is potentially a strategy that really gets people to the table about, okay, let's be serious about repositioning this thing because we're in a market where this is something we're going to talk about a lot. The office asset is a big question mark, and we kind of need to work on solving this problem together. Yeah, exactly. And I mean, one thing to that, I know the lenders are not necessarily all banks, but let's just talk about banks for a second. They issue loans. They're not in the business of being landlords. So it's not a great thing for them to actually take possession of these properties and having to operate them. And I will go a bit later in detail, but there has been some regional banks

that have been selling off loans in the US at a loss. So commercial real estate loans. So far, the ones I've seen were about high 90s on the dollar. So I think there was 192 cents on the dollar, which is not too bad. But that's something that you might see a bit more as they're trying to shore up their balance sheet for the most part. And I came across, I know I had shared that with you, the Cohen and Stearns report that was published in late March. And this was definitely focused in the US, but I took some interesting tidbits out of it because we've heard, I know I've seen it, I don't know about you, but this $4.5 trillion figure on income producing properties in the US. And I think it's made headlines a few times.

Have you seen that too? Yeah. Yeah. I think that there's a lot of people use it as this fear-mongering kind of thing where it's like a lot of these are, I think there's like trillions of dollars worth of CRE loans that are supposed to turn over in the next five years. And so the idea like that or the headline that a lot of people are saying is like, oh, it's 2008, but for commercial real estate. And I'm like, I don't know if that's necessarily a good comparison, but. No, exactly. And like you mentioned, some commercial real estate is actually performing quite well. 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. forward slash host. That is Airbnb.ca forward slash host. So I'll just share a few stats and I'll show some graphics here for those who are seeing video as well. So the 25 largest US banks own about 13% of all commercial real estate debt and their exposure as a percentage of assets is actually quite low at 4%. Regional banks, which have obviously been in the

headlines since March, they are definitely a bit more at risk. They own 31.5% of all commercial real estate debt, and their exposure as a percentage of asset is around 20%. Office real estate is more at risk, but also represents only 17% of income producing property loans versus 44% for multifamily, for example. So multifamily is still a big, big, it's like close to half. So I think, you know, when you see that headline, like you just mentioned, I don't know, it doesn't, it's definitely misleading because when you think that almost half of that $4.5 trillion is in multifamily that has super low vacancy rates. I think it's hard to make the case or at least the fear mongering that's been happening. For sure. I think that when you hear the word commercial real estate, most people aren't

thinking half of that is apartment buildings. And so, everybody's thinking, oh, we're going to see a decimation of the office and retail environment when they hear commercial, all of this commercial real estate risk. The, you know, it's, I think it's kind of fascinating. The multi, I think for the multifamily risk, the big risk there is people overpaying in the past three years, five years. But during COVID, I think we saw this huge rent escalation. We saw these massive societal shifts in where people wanted to live, where people wanted to consume real estate. And that put a lot of pressure on the rental market in Canada and in the US.

And similarly, just as an inflationary environment, we saw rental rates grow substantially all over the world. And you're seeing lineups of people for apartments in different areas. in this space, but I don't think it's non-payment of rents. I just think people are probably a little bit too levered or will become levered as the valuations start to come down or too highly exposed. So as your valuation starts to come down on an asset, and let's say the asset's worth a million dollars today and you owe $800,000 on it. And now because cap rates are going up, and we'll talk about cap rates and how they value properties. If cap rates go up, that means the values of properties are coming down based on their yield. And this basically means that more and more people who own property will see their leverage point get higher. So if you owed $800,000 and now your property value drops from a million to $800,000, now you went from being at 80% loan to value to a hundred percent loan to value. And this creates a risk scenario for lenders. This creates a risk scenario for borrowers.

And, and that, that to me is probably the, the more risky situation in, in multifamily. I'm going to talk, I'm going to mention a tweet that I put in from that when we get to it, but in the Canadian space, because that's kind of where we're seeing a little bit of that non-recourse environment happening in Canada as well. Yeah, and that's a great point. And just to add on to what I was saying earlier from that Cohen report. So, they also mentioned one of the key point at 50, the average in terms of loan to value ratio is about 50 to 60%. So definitely, you know, there is some room, obviously, as a whole as an aggregate, like, like you just mentioned, you know, some examples may be, you know, much closer to 100%. But I from the aggregate,

it's not as bad as people were showing and you know they did mention they could see especially in office real estate up to a 20 downside for the valuation of those office towers so that's something else to keep in mind and what i'm showing here is essentially how the commercial real estate how it's represented in terms of percentage in the US. And like we mentioned, 44% is multifamily. After that, the second largest is office, but it's down to 16.7%. And then the last one, I guess there's other, after that, there's healthcare that's also relatively high at 9%. But it just goes to show that, you know, you have to be careful with the headlines that we see because the actual figures are, you know, they're definitely different. Yeah, for sure. I think that most people just don't have an idea of what the composition of multifamily assets are.

It is interesting though in Canada because I think that our composition might actually be a little bit less skewed towards multifamily because we haven't been building apartment buildings since like the 60s and 70s. Like purpose-built rentals, they don't really pencil out in Canada or in major urban markets in Canada. The policy environment hasn't been designed exceptionally well for it. And we build high-rise condo buildings to sell to condo investors. And we most recently did an episode on our show about how all of these investors are actually cash flow negative. The headlines say losing money in quotation marks, but that's unrealized whether or not they've actually lost money. It depends on how they exit. But our high-rise bill form environment in Canada depends on basically developers being able to have this infinite demand of investors willing to absorb assets at a cashflow negative

basis. That's what our purpose built rental environment looks like. So you have individual condo investors holding all of our purpose built rental stock, let's call it. And so you don't have built all of these tall buildings with hundreds of units in them. They quite simply aren't commercial real estate assets. They're individual real estate assets or they show up in the housing market. When you look at US data, it's a little bit different because you have, like you said, almost 50% in apartment buildings. In the Canadian environment, I would say it's a little bit less skewed. I think the ownership environment is more skewed to, and we know we're going to discuss this pensions and different, um, you know, different, different types of owners. Um, so you basically

have individual owners, your mom and pop landlords owning a lot of our housing stock. And then you have institutional owners owning most of our commercial real estate, um, and probably more well-capitalized institutional owners owning most of our commercial real estate and probably more well-capitalized institutional owners owning most of our commercial real estate in Canada. Because one of the big questions that we wanted to address on this was like, could this happen here? Yeah. Yeah, no, exactly. And I'll just mention a couple other things to build on what you were saying. So in the US, I had mentioned you are starting to see some banks selling off some of their commercial real estate exposure, but it's typically more office space, even construction loans. So a couple of weeks ago, PacWest sold loans to Kennedy Wilson. They sold

it, like I had referenced a bit earlier, at 9292 on the dollar. And what happened afterwards, Impact West has been in the news, not for great reason. So it's been one of those regional banks that has been definitely struggling in the aftermath of Silicon Valley Bank. While their stock actually popped 20% after the deal was announced. So it definitely opened the eyes of a lot of other regional banks that do have commercial real estate loans on their books to potentially sell some of those to increase their liquidity. I definitely saw a few that are starting to move from hold to maturity asset, these types of loans, to available for sale. So when the banks actually change that classification, it does show the intent of potentially selling that in the future. So that's something just to keep in mind. There has been some development in the U.S., but it's still relatively isolated.

So it's not very widespread just yet. here and before we go on to our or you give us a bit more context for the Canadian market here is that real estate has just not performed all that well in the public markets since last year. So if you go back to March of 2022 when central banks started their rate hike campaign very aggressively as we all know at this point commercial Commercial or real estate as a whole, but it's commercial real estate for REITs that are listed in the US is down 15% during that period of time. And we're actually looking at total returns here. So it's not great, whereas the S&P 500 is slightly breaking even. So definitely real estate as a whole class has struggle. And that includes data REITs, which have performed quite well during that period of time.

Definitely with some tailwinds from the AI space and all the hype going on right now. Yeah, absolutely. I think the other piece that you mentioned is that we're starting to see this shifting around in the commercial loan books to increase liquidity, to shore up liquidity a little bit. And so to me, very much selling off some of this debt, selling off some of these assets is almost preventative maintenance for a lot of these lending institutions to not see duration mismatches like what brought down Silicon Valley as an example, to not see overexposure to individual asset classes that brought down Signature Bank, for example, big multifamily lender. And so I think that the more actually that we are seeing things transacting in this kind of

$0.90 on the dollar range is every time that one of those moves and it takes some of that longer term credit product risk off of the books for some of these institutions, the less likely that we see some of these 50 cents on the dollar transactions down the road. And we need to see this moving around of things. That's the market kind of rebalancing itself and trying to get to a healthier place. So the question I think that is on a lot of people's minds and that you and I probably get asked a lot when we share these headlines and talk about these headlines on the show is could this happen in Canada? And if so, you know, what city would be our poster child for it? Like we're seeing in the States, California very much being, um, mentioned a lot, um, as a result of, you know, I think changes in migration patterns, differences in, um, you know,

political, uh, environments and, uh, businesses, you know, tax, uh, tax brackets, people, businesses wanting to move to different areas. Is there risk that something similar could happen in Canada? And if so, where? My general answer to the question would be no. I don't think that this could happen in Canada in commercial real estate. I think that there is headwinds for commercial real estate in Canada. That's the episode. That's all you need to know.

End of the show. But I think that there are places where we're going to see a lot of risk become realized. And the places where we've already seen risk realized, Calgary being a great example of a market that is massively oversupplied on the office side. They actually have, and one of the big questions we get when we see,

and people, all the geniuses on tiktok and twitter and and in my instagram comments when i talk about um these commercial buildings being vague or um defaulting or like oh like we just need to convert these all the housing units we need housing so are they the same ones that thought that the bank of canada would be cutting rates at this point yeah exactly exactly yeah it's just funny it's like oh yeah that's a great idea i didn't nobody thought of that one and it must be so easy to to do so why don't we just give you these you know these uh vacant commercial buildings and you can just do it right um i mean calgary right now is converting six million square feet of office into residential and calgary's commercial or their

office and market was like at like 20 over 20 vacancy for a period of time and that that was the vacancy was already bad um heading into covid and then covid obviously work from home and all the stuff just exacerbated their existing problems but i think Calgary is a great example of what you could expect to happen probably globally in downtown cores over the next decade, several decades, even as we get to hybrid workplace, work from home, et cetera. So your A-class or now they even have like this kind of triple A-class office is still doing exceptionally well, very tight, commanding high rental rates, well-located, high capex that the landlords are putting into these buildings, making them beautiful. And tenants are still there and they're creating spaces that they can convince people to come to the office five days a week. Yeah. do you want to explain the difference a little bit just

quickly between a and b yeah so i mean your your a would just be very centrally located high quality like you know the the finishes when you walk into some stuff where you you know the the canadian cities are shooting uh these new york style um or uh new york style television shows like Harvey Specter walking into, I think it's from suits, he's walking into First Canadian Place, I think it is, or Commerce Court in downtown Toronto. So these really, really nice office buildings that are gorgeous, that are great meeting places, great gathering places. And then you get to your B class, which is really just very utilitarian office space. Nothing exceptionally wrong with it. It just hasn't been updated as recently as a, um,

it's not as well located as your a office space. Um, and then you could, it's, it's kind of just a quality rating really. So a is better than B and then there is kind of your C. Um, and then there are fringe sort of like sexier office categories like allied has kind of given been given its own they would be an a class office space but they've been given their own or what they were a period of time called class i office space industrial converted office space all the brick and beam stuff that was really popular with tech companies but but yeah so i think your b offices are very much going to become conversion potential, adaptive reuse potential. The problem is, in order for them to get there, they need to be vacant,

and their valuations need to be so dismal that the economics make sense to convert them to something else to bring them to a new highest and best use, which in many cases is going to become housing. And to contextualize it, like Calgary is a great example. You need a market, an office market that is so bad that, you know, 20 plus percent vacancy that offices are trading at such cheap valuations that, you know, if you could, if you can buy an office building at a hundred bucks a square foot, then yeah, it's going to make sense for you to spend the three 50, 400, $500 per square foot that it's going to cost to convert. Cause it's not cheap to do this. The floor, just for context, from an engineer, purely engineering perspective, think about the

way an office building is laid out the size of it. Like they're like a one acre floor plate. They have all of their, um, bathrooms in the middle wrapped around the elevator column. And then they're the windows can't open them. And the windows are very far away from that, that plumbing. And so if you were going to try and fill it with units for people to live in, they would be either bowling alleys basically, or they would have bedrooms that wouldn't have enough natural light or whatever. And so there's, there's challenges. There's a lot of challenges to do that. And the way to solve those is to spend a lot of money. For the most part, Canadian office market hasn't got to the point where it makes sense to spend that money. So that's example kind of number one. And I think

it's kind of like that rate cutting. The rate cutting thing is a good, good example of people saying, Oh, rates are going to come down. It's like, be very careful what you wish for. Right. And, and be very careful what you wish for with these office buildings being converted to residential space. Your, your downtowns are going to be, they have to get very, very bad before they get better. If we're, if converting office to residential space is the, is the ultimate outcome of what's going to happen with the office market in the world. So that's probably one big theme that's worth thinking about. 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. The next thing that I think is interesting in Canada is, this is an example from apartment finance here on Twitter. It says multifamily cap rates got so low that because of

DSC or debt service coverage limits, buyers are only qualifying with 65% loan to value at CMHC. However, at 65% loan to value, CMHC waives personal guarantees. So they're creating a non-recourse loan. With cap rates, assumingly blowing out, CMHC lenders will be stuck with some non-recourse, low debt service coverage loans. And so this is fascinating from my perspective, because we saw this huge run up in multifamily valuations, CMHC really supporting that with their credit product right now in Canada. CMHC is Canada Mortgage and Housing Corporation, by the way, wholly funded by taxpayers. It's an insurance product that first-time homebuyers can use or any owner-occupier homebuyer can use, but their primary mandate is to create housing. And so they also lend to multifamily, or they actually, sorry, they don't lend to, they insure multifamily deals for other lenders to lend more safely on. So multifamily assets,

we're trading in like a three and a half to 5% cap rate range last year. Cap rate, by the way, is net operating income divided by purchase price, kind of like an EPS or something like that, like some sort of price ratio. It's a metric that basically determines the return that a property transacts at. And now they're trading in probably over the 5% range. I've even seen stuff selling in Toronto over 5%. And that's what he's talking about, these cap rates blowing out. So valuations are going up. And I think they're going to...

Or sorry, valuations are going down. Cap rates are going up. Okay. Yeah. Yeah. So I think there's a risk now that that'll continue to go up. The cap rates will continue to go up. The cap rates will continue to go up. Valuations will continue to come down.

That to me, that's kind of like the big risk exposure. I know I covered a lot there, but the risk exposure in the Canadian market. Yeah, I guess though, if the cap rates go up, I mean, I guess the upside for that is it becomes more and more attractive for new investors to come in because then investments

start making a lot more sense, right? If the credit environment allows it to, I suppose, right? We're still at a point where a cap rate in a 5% doesn't really transact exceptionally well with credit at 5.5% or 5% unless people are going at lower loan-to-value. And that kind of defeats the purpose of real estate in a lot of cases, because most people buy real estate for leverage. So if you look at major corrective periods, like typically the cap rate is trades about 400 to 500 basis points above the Canada 10 year bond yield. And right now it's at 268 basis points above. So to get back into that channel, either bond yields need to

revert, which probably will happen in the fullness of time or cap rates need to go up, which means prices for these assets need to come down. And I guess that the next question would be like, do we see any municipalities in Canada actually having the risk for this to happen specifically. I think most of the risk has been realized in the commercial real estate space in Calgary. Your question is, does this happen in a place like Toronto? Does this happen in a place like Vancouver or Montreal? From my perspective, I think that this very much depends on what happens with the reopening of the workplace. office space and why there might be like i have this almost like not a conspiratorial thought process but just this idea that like the the central bank is very incentivized to get people back to the workplace to or to to get unemployment up so that

employers are back in in a negotiating position to get people back to the office. Yeah. Yeah, let me, I think you have the wrong hat on. You need your tinfoil hat, not a baseball cap. Yeah, and no, you have a really interesting graphic too that you had in terms of the average national cap rates by market, which is pretty interesting because it varies pretty widely. Yeah, I would say, you know, like you can see i guess vancouver's at 160 basis points um above the bond yield which is 112 basis points below the 15-year average calgary's 316 above um which is 76 below their their 15-year average toronto's 231 basis points above

which is 108 basis points below their 15-year average and montreal is 246 basis points above the 10-year bond yield and so again it's just like the question becomes if we see reversion, if we see cap rate, um, reversion to those traditional channel channels or towards those 15 year averages. Cause I think to me, it doesn't matter how far above the 10 year bond yield they are. It matters how far above their, or sorry, below their 15 year average they are. And if they revert to even, even halfway towards their 15 year average, I think there could be a lot of pain on the valuation side in commercial real estate um to to be seen in most of those municipalities um and i i think you know we were going to get into next the i guess the the big canadian pension plans and their ownership of real estate.

Yeah. Mm-hmm. Yeah. So I had that. It's not easy to find that information. So it's not like you can Google it. It seems like there might be an incentive for them to have it a little bit hidden. Yeah, exactly.

So anyone interesting in finding that info, you'll literally have to go into the annual reports from the large pension funds. And I did four over here, four large Canadian pension funds. So I looked at the Canadian pension plan, QPP, the Quebec pension plan are two by far the two largest teachers, which is not that far behind. And I also looked at OMERS. So in terms of CPP, far behind. And I also looked at OMERS. So in terms of CPP, it's the largest. So it has $570 billion in total assets. And when I'm talking about the assets and all the figures here, this is just the latest information from their annual report. So depending on where it was taken, I know CPP is as of March 31st of this year. QPP with the Caisse des Placements des Depots du Québec is as of December of last year. So just keep that in mind. It may not be an exact same time screenshot, but it should give people a good idea. So CPP, 570 billion in assets and 9% of CPP assets were

in real estate, which is around $52 billion. It's not overly massive. However, if you start digging into the annual report, and you'll notice that in terms of asset class, they also have 13% in credit assets. So if you dig into those credit assets, you actually realize that 14% of that is actually in real estate. So their exposure is definitely higher than just at 9%. Maybe, you know, around 13 to 15% is a bit more accurate. And it's not all in Canada. So CPP has it spread out fairly well. Some of the other plans like I'll go over, they're definitely more concentrated in Canada in terms of real estate exposure. And all of them have very little exposure when it comes to REITs or the public markets.

Any comments on that one, Dan, before I go through the list? No, I just think the interesting part is when I look at some of these graphs, you see that they're invested in public and private equities as well. And that could be in some of your traded funds. So they could have more exposure to real estate than we're actually seeing. But yeah, I would agree. I think that relatively small exposure in the grand scheme of things. Yeah, exactly. And I'm just showing here for those on Patreon, just to give you an idea of what the graphs, what I was talking about. And yeah, that's, and I'll talk about the issue of, I like that you talk about private equity, because there is some valuation issues that do come into mind that definitely raise some eyebrows.

But I'll go over the Caisses des Pots de Placement du Québec, which manages QPP. They are also a massive pension fund with $402 billion in assets. So if you're a Quebec resident, instead of getting money from CPP when you retire, you get it from QPP. It's one of the things that the province of Quebec manages on their own. And I grew up in Quebec for most of my life, so up until I was 22. And we had this joke, this running joke that Quebec likes to do things differently. So it's always a little different in Quebec. But, you know, I do still have a lot of family there. I love Quebec.

So it was just kind of a little running joke that we used to have. But if you go to them as of December 31st, 2022, they had 12% of their assets in real estate. And that's what you'll start kind of see is I would say, I haven't looked at all the Canadian pension plans, obviously, all the various ones, there's tons of them out there. But I would say, you know, probably around 13 to 15% in terms of actual real estate exposure, whether there's also some indirect exposure, obviously, it could go up or not. But just by the research I did here, that seems to be the sweet spot. So QPP has $48 billion worth of real estate. And now the next one, teachers, obviously, they made headlines with, what was it, FTX, where they had invested in FTX a little bit. And I just wanted to touch on that quick because it's easy to see headlines and then think about the worst. And that was across, obviously,

all the major mainstream media out there. But the reality is for teachers, it was just peanuts. They have $247 billion in assets. So it was just a tiny, tiny portion of their assets that were impaired because of FTX. Teachers, I mean, they have $28.1 billion in real estate assets, which is around 12%. That's compared to $26.3 billion a year before or 11%. So it has increased. four or 11%. So it has increased. They also have a public equity portfolio, but that is a very small portion is allocated to REITs. That public equity portfolio is around 22 billion, less than 1% of that is in public REITs. Now, they make most of their real estate investment with something that probably your listeners definitely I'm sure aware of. So a company called Cadillac Fairview. So it's only owned by teachers.

They're a large real estate managers in Canada. They own different kinds of real estate, but they are quite famous in Canada for Canadian retail. So for those in Ottawa, you might be familiar with the Rideau Center. They own that. In Toronto, they own the Eaton Center. But in terms of all their investment, it's 43% Canadian retail, 22% Canadian office, 11% in the U.S., and then the rest of the world for the remaining types of investment. And they did have something pretty losses in their portfolio to rising interest rates for their real estate portfolio, which had a negative return last year of 3.5%. However, I think we'll

touch on that a little later where there seems to be a little bit of a disconnect between publicly traded real estate and private real estate. Anything you want to add before I touch on OMERS quick? No, I think, you know, like for most of our listeners, people who are working in the, you know, in your financial districts, you know, you see these names on office towers and, you know, the pension funds, it's not that they go out of their way to not disclose that they own these assets, but it is always interesting to know, okay, you see your Cadillac Fairviews, you see, you know, Oxford, which I think you're going to get into, you know, you see your Bentall Kennedy, or I guess Bentall Green Oak now, who is like a Sun Life, I think. So all of these different, you know, owners that you see, but if you start looking into to who owns all of these office towers, in a lot of cases, it always goes back to basically

a large financial institution, either a pension or a life co or insurance company. And just worth having that understanding and kind of like following that chain of title for people just to get an understanding for who does have the exposure to these assets. Yeah, exactly. And one thing about CF is that I don't know if it's across their portfolio. I don't know them in and out. But from the properties I've seen anecdotally, they seem to have pretty high quality assets because I talked about the Rideau Center in Ottawa. It has one of the lowest vacancy rates in terms of the big malls that we have here. I was fully renovated a bit before the pandemic. Super nice mall. have here was fully renovated a bit before the pandemic super nice mall they just lost Nordstrom which is not great but I know the Eaton Center is kind of in that same type of class so I definitely

have seen at least in Ottawa I don't know if it's like that in your area in the GTA but malls that are more like class A malls are they look in much better shape in terms of occupancy that you can just see when you go into those malls. So they have less open space for lease versus the kind of more class B or C malls. Yeah, absolutely. I think, you know, they're, if you look at the largest owners in Canadian real estate, it is mostly like you see here ontario teachers pension plan and these are some of the biggest in the world by the way like you go to european publication ipe real estate number three on that list is a case to do depot placement du quebec and then you got it was that okay yeah my friend that's good that's good my uh mine is a little bit better than nick's i think

um ontario teachers pension plan so that's Cadillac, Fairview, Canada Pension Plan, Investment Board, OMERS, Public Sector Pension Investment Board, BC Pension, etc, etc, etc. It goes all the way down. So it's all, and these are all people in the global leadership of real estate ownership. Yeah, exactly. And I think that's important to remember, right? Because we talk about Canada, we've talked about the US too. But as a rule, central banks around the world have been quite coordinated and raising interest rates. So I would say there is risk, you know, not only in Canada, I think you can probably make the case in Europe and other countries as well. I know they have geographical diversification. By the end of the day, if central banks are kind of in lockstep around the world,

it's going to mean a higher cost in terms of, you know, for getting loans on those property. And to touch quickly on Omers, so they have over 100 billion in assets and they own mostly through Oxford properties like you referenced, and they have 17% of their assets in real estate. So definitely the highest in terms of percentage, which would be around $21 billion if we just take as a percentage of the total assets. And what I was alluding to earlier was that there seems to really be a disconnect between publicly traded real estate and private real estate. be a disconnect between publicly traded real estate and private real estate. We had recorded a REIT episode. And I remember I had mentioned that where the NAH REIT, which is the US REIT Association for their 2023 projection, they had shown that REITs had performed poorly in the US in 2022 because of higher interest rates. You don't have to look very far for that. It's pretty

obvious. But they were saying that this discrepancy between REITs and private real estate was there was a gap of about 40 percent in valuation and unfortunately it hasn't changed that much from what I can see and I saw an article in the financial post that I read this week and it was quoting Carl Gomez who is the chief economist at CoStar and he was saying the exact same thing that I was saying earlier this year and late last year, is there's a disconnect between the total returns from office REITs and the private office real estate. He's mentioned that the data really shows that office REITs are down close to 50%. And I will show he's not wrong, especially in Canada and the U.S. as well.

Office REITs have been completely crushed. And to me, as talking about pension plans, it does make me wonder, like at some point, right, like pension plans, they could potentially take some pretty hefty losses in the future if they're forced to mark these property accurately and there's not a rebound in their value. Because I was talking about teachers earlier and they reduced the value of some of their properties, but it was just peanuts compared to what the market was showing. And there could be a couple of reasons for that. The first one is they're typically well capitalized, obviously their pension funds, their institutional investors. And the second one is they can always say,

well, there hasn't been many transaction in the private commercial real estate market or office real estate. So it's hard to actually know what the value is. And I'll just show here for our viewer what it looks like. And it's pretty, I mean, you look at Allied Property REITs slate and you have, what's, sorry, I had True North that are all kind of mostly office real estate in Canada. And they've been crushed since March of 2022 when rates started going up. Allied is down 42%. And I didn't actually take total returns here. I just wanted to show the actual value of the properties without counting in dividends. So Allied is down 42.6%. Slate is down 51.3%. And True North is down 55.5%. So I can guarantee you that institutions are not marking down their office real estate to that same extent. And that definitely can pose a risk going forward.

Yeah, I would completely agree. moving forward is how we start seeing the, the revaluation, the writing down, and then also the, um, the reconfiguration of these assets moving forward, which I think is kind of what we're going to talk about on, on, on my show next. Um, and part two of this episode, which is, you know, I'm, I'm really of the, of the philosophy that the big bet available in the real estate market right now is what happens to the office. And it's a very divided camp. I know some exceptionally smart people, fund managers, billionaires who are bullish on the return to work and think that it's... And they're buying these assets and they're eager and they're salivating to see these assets come up distressed. And then there's a bunch of people, you know, similar wealth, similar stature, similar intelligence that have the exact opposite thesis. And so I think we're going to explore that a little bit on, on part two of this,

on the Canadian real estate investor podcast. That's correct. No, I think we did pretty good in terms of splitting the time. So a couple of big monologues in there for sure. It was good. I'm proud of both of us actually. Yeah, exactly actually yeah exactly i mean uh before we switch over to the other show i i don't know about you but i probably put like 10 hours of research in all of this uh at least just looking through things and um i think people know me you know me pretty well too like i i hate not being prepared and doing research on stuff and we had a twitter space. And I think he asked me a question. I'm like, oh, I've not done my research. I don't want to throw like, you know, information

or just kind of wing it. So that's, but it's been so far, it's been really fun. I'm looking forward to part two on the Canadian Real Estate Investor Podcast. We'll make sure to let everyone know when they come out on Twitter with our Canadian investor Twitter handle. So, at CDN underscore investing.

I'm at Fiat underscore Iceberg. Dan, what's your handle again? Daniel underscore Foch. F-O-C-H. Yeah. Yeah. Exactly. And remember the pronunciation.

Don't try to say it differently. He wants it that way. Okay. See you over to say it differently. He wants it that way. Okay, see you over on that to your feed. 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.