Oliver Foote, Author at Oliver Foote

What is Hedging?

Hedging and Derivatives

Recently I have been taking some accounting courses and through some of the courses I’ve been learning about things that I think many people would find rather dull, but that I have found quite interesting. I’ve been learning about accounting for Agriculture, accounting for stock based compensation or other employee share based compensation (SAR, share appreciation rights). We also had a section talking about financial derivatives and what they might be used for. The goal of my discussion to today is to talk a little bit about hedging, what is it? Why do people care? Who is hedging good for? Is Hedging complicated? You get the gist. Hedging was not something I learned about directly, but it is something that I think carries a bit of a “mistical air” about it, so I wanted to try my best to explain how it works and get into the weeds of financial derivatives.

What Are Derivatives?

Let’s start out by talking about what a financial derivative is, what does that scary word mean. Well to someone who has done calculus, it means that x²=2x’. In the financial world a derivate is adding another layer onto the underlying asset, and generally that layer can be traded and has value on it’s own, without impacting the underlying asset. You can think of it like this, in a non-derivative transaction you almost always are trading some form of money for something else. It might be money for grain, gold for a donkey depending on your mood. A derivative is derived from an exchange like this. We might create a contract that on a future date we’ll buy something for a set price, we might also exchange interest rates on our loans, or provide an option for someone to buy or sell something. In these examples the contract for a future price, or the “option” to purchase something in the future has a value. Generally, the value of a derivative would be the difference between todays price and the price someone agreed to buy/sell at, plus a “premium” for the timeline risk. The longer the timeline the larger the premium. By creating these options to purchase, or contracts into the future, we have created something that has value on it’s own, without affecting the value that the underlying thing will ultimately get sold at, thus we have a financial derivative. These derivatives are frequently used to “hedge your bets” against price changes (lock in a good price today), or just to speculate on price changes.

The Forward Contract

As a good starter example take the forward contract. A forward contract is a contract between two parties, where they agree to purchase or sell something to the other party at a certain price on a certain date in the future. Basically, a forward contract locks in a price today regardless of the fluctuations of the market. This is frequently done on commodities (agriculture and oil, for example), which can be somewhat volatile price wise depending on supply and demand, prices at the gas pump change almost daily. In order to avoid these daily price changes, you are agreeing to a certain price now, and the other party takes on the risk of the price changes. The “seller” has the potential to earn a profit or loss on the contract based on the price they agreed to and the price at which they’d be able to normally sell the same goods on the open market. As the “buyer” of one of these contracts, the price of the asset no longer matters to you since you’ve already locked in your price and you can now account for it as an account payable with no variability. In essence, a forward contract is just a way to try and remove pricing uncertainty from the equation for one party. If it’s important to your business to know the input costs of raw materials because you’re trying to manufacture something at a certain price, a forward contract might be useful. If there’s an unpredictable world event (which seem to be happening more and more these days), you can reduce the risk of volatile pricing, at least for a while. This type of contract can be considered a “hedging” tool. In this case the goal is to reduce the risk of a price fluctuation. Generally, a forward contract is not sold once it is created, in which case it wouldn’t necessarily be a financial derivative since there’s no way to make money on the contract itself if you so desired. That’s where our next type of contract comes in.

The Futures Contract

An extension of the forward contract is a futures contract, which you may have heard of as a financial derivative. A futures contract is again giving the rights to someone to buy or sell a certain commodity in blocks of 1000. The difference between this type of contract and a forward contract is that the futures contract itself can be publicly traded on markets up until the date the contract needs to be fulfilled. Again, many firms might use this as a hedge depending on what they are selling or buying. However, this type of contract can also be open to speculators, as the value of the contract fluctuates with the market price of the underlying commodity. This contract can then be sold over and over again at various prices until its due date. The risk from the speculators point of view is that 1000 of something is a relatively large amount. If the pricing of the underlying commodity changes by $1, you can be up or down $1000 relatively quickly. Multiply this by the number of contracts you bought and the volatility of the price, you can risk quite a bit of money, while also potentially profiting quite a bit of money. Most speculators aren’t using futures contracts as a hedging mechanism. But there are large firms out there who want to buy “insurance” on the price of a certain commodity, and might use this as a tool to lock in a certain price, not worrying about the value of the contract in the interim. Bored yet?

The Option Contract

Our next financial derivative to take the stage is going to be the option contract. This one get’s very meta very fast. An options contract can be a hedge against stock that you own in a certain company, or a speculative tool. Each option contract represents 100 shares of stock. Suppose that you think Nvidia stock price is going to be much higher 1 year from today. You can purchase a “call” option contract that gives you the rights to purchase 100 shares of Nvidia stock at $100 per share 1 year from today. However, someone else will be taking the other side of the bet, and due to the popularity of Nvidia stock or sentiment of the likelihood of the entire market being higher next year than it is today. You’ll likely have to pay a hefty premium to obtain that option contract. As time goes on and market sentiment changes, the “premium” you paid will start to decay and the option contract itself will lose value the closer you get to the specified date. On the final date of the contract, the only value is the “intrinsic value” of the contract. Which is the price the shares are trading at on the open market minus the price written on the contract. If the stock price is lower than stated on your option contract, it would be a better deal to buy the shares on the market, so your option contract is worthless. If the stock price is higher than your option contract, you might be able to make up for the premium and earn a profit on top of it buy buying the shares at a cheaper price than you can purchase them on the open market right now. The higher the stock price, the better our option to purchase the shares “cheap”.

Put Options

You can also purchase a put option if you believe the stock price of a company will go down. The put option allows you to force the company to purchase your shares at a certain price. Let’s again use the Nvidia example. We buy a put option at $100, 1 year from now. At the expiry date, lets say that Nvidia is trading at $80. But we have the option to sell our shares at $100. So on expiry, we can make $20 per share by selling 100 of our shares using our option and repurchasing them at the lower price (or not). Without getting too much into the details, I do want to point out that speculating on single stocks is known to be a bad idea. If you’re reading this you are unlikely to be someone who found an arbitrage opportunity in the market, or who built a model on weather patterns in Idaho in order to figure out potato yields and trade on that information, which is what you have to do to get an edge in financial markets. So this is my PSA not to speculate. But options can be used as tools to avoid fluctuations in the financial markets themselves. You don’t even necessarily have to exercise the option. For the sake of argument, let’s say that something about Tesla future stock price is worrying, and you’re the proud owner of 100 Tesla shares. You decide to “spend” a bit of money on a put option contract in order to be able to sell your Tesla shares at a good price in the future. The year comes and goes and it turns out that you’re completely wrong and Tesla doubles in value and your put option is worthless. Well you should still rejoice because your Tesla shares a worth more than they were last year! What you’ve effectively done is spent a bit of money to prevent loss, which has resulted in reducing your overall gain. You’ve essentially reduced the volatility and the risk built into your shares, which is how options can be used as a hedging tool.

Interest Rate Swaps

Now we’re going to get into the really whacky and fun stuff. Interest rate swaps. Why might someone want to “swap” an interest rate? Take Company A that has a bank loan for $1,000,000 with a variable interest rate, currently sitting at 4%. Company B also has a $1,000,000 loan, but with a fixed rate of 5%. If Company A, who has a variable rate, believes that the central banks lending rate will go higher in the future, and Company B believes the opposite, they might want to swap their interest rates on half their loans. This would result in Company A and Company B having a blended rate, where $500,000 of the loan has a variable rate of 4% and the other $500,000 has a fixed rate of 5%. They can both save money on interest if the variable rate drops, and they’d both have part of their loan guaranteed at the fixed rate if the variable goes up. It’s a good way of reducing interest rate risk. You can also do many different variations. Maybe Company A wants 75% variable exposure and 25% fixed exposure. I think this is a pretty cool tool that I didn’t really realize you could use before a couple weeks ago. But it makes a ton of sense. I wonder if you might be able to do something like this on residential mortgages? Let me know if you have any intel.

Credit Default Swaps

As my final financial derivative, I want to talk about Credit Default Swaps. If you’ve read or watched The Big Short you probably have heard about these. As a brief explanation, if someone, or an entity has some debt, you can create a “credit swap” for the underlying obligation. As the purchaser of a CDS, you are hoping for the entity or person to default, or go bankrupt, or fail to pay their debt in some way. If the entity does completely go under, their debt is then auctioned off and the CDS purchaser would receive their payout. The rate which you pay for the privilege of owning a swap is around 1% to 5% of the value of the debt per year to the entity. The part that is somewhat hard to wrap your head around on these kinds of swaps, is that you are buying the debt of a bankrupt entity. I’m not entirely sure how one would use a credit default swap as a hedge, unless you wanted to hedge against a large credit crisis, which if you look at consumer borrowing rates right now, isn’t as unlikely as it was a few years ago. I would have to put this in the category of highly speculative and quite frankly, I’ve still got some reading to do on it. That’s about all I got for this week, just wanted to get some ideas on the page about derivatives and their potential uses, as well as hedging and risk reduction tools. As always thanks for reading.

Keep Investing,

-Oliver Foote

Ontario Housing Is Still Getting Worse, Can Anyone Fix It?

Election Night:

Tonight there is an election in Ontario (at the time of writing this I’m not sure who won, but polls are suggesting the PC’s will win). During the election campaigning the party leaders spoke on a lot of issues. I wanted to do a bit of a review and analysis of the different housing policies that each party is running on and talk about what the PCs have accomplished so far, targets they set and if they were realistic, and what things continue to stand in the way of housing getting built in the province that I think the next government should tackle or implement.

Ontario Has A Supply Problem:

As I spoke about in my last post. The fundamental problem with Ontario real estate is that we do not build enough. Simple supply and demand. Not enough supply for the demand that we have, in rentals and end user homes. The amount of factors that influence housing is quite long, again, see my previous post. But just to name a few major ones that have led to the situation we’re in: exclusionary zoning (i.e. only one housing type allowed per lot, very hard to change zoning), lack of investment in trades for over 30 years, high construction and development costs, uncontrolled migration (importantly, with no housing to meet the new demand, migration itself isn’t generally a negative thing), and lack of purpose built rentals.

Will Our Changes Bear Fruit:

There are about a dozen more factors but these are some of the bigger ones that are keeping prices high. Every level of government appears to be trying to do something about the issue. But are they actually seeing results? When might all of this “investment” actually bear fruit? Or are we all too entrenched in our old ways to make a meaningful change that would actually improve housing supply (read: potentially hurt housing values for incumbents). Sometimes you have to upset people to get things done. But equally, there are ways to make meaningful changes and change attitudes without upsetting too many people, it’s just much more challenging. But lets see what my small set of ideas can do to change perspectives.

The 2022 Housing Affordability Task Force:

There was a report published by the Ontario Housing Affordability Task Force in 2022 which very plainly and simply stated that our housing problem will NOT be solved by measures to “cool” the housing market. Cooling down measures include: higher interest rates (which the governments don’t directly control), more tax advantaged accounts, higher leverage down payments, tax rebates, mortgage stress tests, and other incentives. While these things might be nice, they do not deal with the heart of the problem; a lack of building.

The Core Issue, Building:

We are now well aware that the fundamental problem for real estate in Ontario is that we do not build enough housing, and have not built enough housing, for years on end. This means as our population grew, the number of new housing units did not grow at the same rate. It was especially bad in the last 15 years or so. If we can all agree that our fundamental problem is construction of new homes, the next logical step would be finding ways to make building new housing easier. This includes higher density housing in areas where people may not be used to higher density housing.

Make Building Easy Again:

How do we make building easier? The big elephant in the background, is zoning. Our provincial and municipal land planning legislation is set up in such a way that makes it nearly impossible for anything other than single-family homes or mega skyscrapers condos to be built. You even see this in “new” communities, which arguably have the freedom to start from scratch and design a better suburb or city. If you look to a city like Milton, north of Oakville, they are developing old farmland there like crazy! And they’re putting in… Single family homes, or at best 3 storey townhomes, maybe a few condo apartments here and there on Main st. It kind of drives me crazy to see that a BRAND NEW city is being built the SAME OLD way? Where are the thoughts to transit, or cyclists, or rental apartments next to the new university, or multiplexes on a “quiet residential street.” For some strange reason we have an aversion to building small to medium sized apartment buildings on the same lot that a single-family home would go and Milton does a great job proving how our past failures are continuing to show up in our attitudes and mentalities towards home building.

Builders Aren’t The Problem:

Many people might want to go and blame builders for lack of a variety of housing supply. NIMBYs in our province get upset when a builder proposes putting in a 15 storey condo building on the corner lot off the main road at the entrance of your “pristine” residential neighborhood. Another example I saw was a builder wanting to expand the senior care facility next door by adding more height to help add more beds to our over-extended healthcare system. “These builders! How dare they try to change anything about my neighborhood! Imagine the traffic this will cause!” Don’t blame the builders. The builders are doing exactly what any rational actor would do in their shoes. If the zoning laws say, “sorry, but in 98% of this neighborhood, we won’t allow you to buy up a few houses next to each other and then redevelop it into a 4 storey, 20 unit apartment building, adding 17 units of supply slowly increasing density with time to meet the needs of our growing city.” Builders will do what they are able to accomplish within the law, or they’ll do the math on fighting the law and figure that if they have to spend 5 years fighting for a patch of land to be re-zoned and permitted, the only option that makes financial sense at that point is the 15-20 storey re-development. Same thing goes for builders who subdivide and build single family homes on new farmland in a new city. It’s probably well within the law to do so. It’s an easy win for them. We have to make other types of new developments and re-developments easy wins for builders and seriously cut down the friction.

An Old Example of What We Did Right:

I recently moved to Toronto and live a few blocks away from a main artery road inside of a residential area. There is a little main street nearby with a few restaurants, businesses, and corner stores. My street, built in the 1930s, adjacent to this area of commerce and a 7 min walk to my nearest subway station, is exclusively 3-4 storey apartment buildings. If you go further into the neighborhood it is almost exclusively streets lined with large single-family homes. On the same lot, these apartment buildings house 20-30 families compared to 1. But, if you look to the City of Toronto zoning bylaws, it would be illegal to build more of these apartments today in the same region. Not because they’re unsafe, we have 2 fully functional staircases and a fire alarm system connected throughout the whole building. But because of zoning lot coverage regulations, parking regulations, and regulations that prevent “changing zoning” even where it would make a ton of sense (i.e. on streets adjacent to shops and restaurants). Case and point someone bought up 4-5 homes on an adjacent street and has been waiting years for the city to approve their project which is quite moderate as far as projects these days go. There is approximately 0.5 parking spots (1 spot that’s blocked during the work day) for all 20 units of my building in an arguably “very residential” area. As far as I can tell, no one seems to mind. The main street provides necessities, transit provides convenience, new bike lanes (just outside the residential area) make that mode of transportation much smoother and safer, and more people get to benefit from all these features.

A Better Model That Seems to Be Working:

If you’ve ever been to a suburb of Montreal (or Montreal itself), you’ll notice that they do a lot of what I’m preaching here. They build a large variety of different housing types in a residential neighborhood where in Ontario you’d only see single family homes. This provides a variety of options for people who want to live in that area and reduces pressures on housing supply. I also mentioned in my last post that the way the legislation is designed in Montreal allows builders to be flexible with what they build on a lot, depending on what makes most sense at that moment in time (or what they think will make sense when the project is complete). This flexibility within the law allows them to do a much better job at meeting demand, and yes it means that things will change. We can’t continue to be immovable rocks that aren’t open to a modicum of change. We almost need to completely tear down and rebuild the way that we plan our land uses and housing in Ontario. The layers and layers of rules and regulations that have been stacked on top of each other just aren’t working anymore. Some people will get freaked out at the idea of tearing down rules and laws and think it will result in anarchy, that may be true. But, I’m suggesting replacing our current laws with ones that are proven to work, such as those found in Quebec, which aren’t perfect, but seem to be working a bit better. This line from the executive summary of the Provincial Housing Task Force sums it up pretty well: “The way housing is approved and built was designed for a different era when the province was less constrained by space and had fewer people. But it no longer meets the needs of Ontarians.” Honestly, if you haven’t read it, go read it, it’s very “based” (as the kids these days say). https://files.ontario.ca/mmah-housing-affordability-task-force-report-en-2022-02-07-v2.pdf

More Homes Built Slower Act, 2022:

Now that I’ve outlined what I think needs to happen, opening up zoning bylaws, adding more variety of housing, making building easier in general. Let’s chat a bit about what changes the provincial government has made and how housing is going so far. In 2022 we saw Bill 23 the “More Homes Built Faster Act” which aimed to reduce red tape for housing construction. This was passed in direct response to the housing task force recommendations of building 1.5 million homes by 2031, we’ll get back to that in a moment. One key change was allowing up to 3 residential units on land zoned single family residential, without requiring a zoning change, this includes construction of laneway or garden suites (ADU’s). Sources vary on what the actual numbers are on this new law. But in Toronto, where there are about 420,000 lots that may qualify for an ADU. A grand total of 126 have been built since this change (according to ADUsearch.ca). Even if we assumed a generous pipeline of 1000 units per year in say 2-3 years once more people get wind of building laneway houses. This “update” will mostly likely work out to a rounding error.

Condo’s Aren’t the Solution:

So that didn’t work, what else was included? In Bill 23 for rental developments of 4 or more units development charges will be reduced by 15-25 depending on unit size. According to the CMHC, “Among Canada’s three largest cities, Montreal posted a 112% year-over-year increase in actual housing starts in January while Vancouver recorded a 37% increase, both driven by higher multi-unit starts. Starts in Toronto fell 41% from January 2024, driven by decreases in multi-unit starts.” Alright, so that’s not going to well either. Multi-family starts have been falling in Ontario, which is a problem since those tend to supply a lot of housing. Again, wonder what Montreal is doing? A 112% increase in housing starts?! More than double from last year? Can we get some of that over here? There is a really big WHY in the room. Why is Toronto slowing down while Montreal is doubling? What on earth are we still doing wrong? The answer mostly lies in the fact that investors aren’t finding condos an appealing investment anymore, and builders aren’t able to sell enough units, and we have NO OTHER OPTIONS as far as supply goes. Which again shows that we haven’t managed to legislate a housing type into existence that varies from either single family or 50 storey condo tower. We also haven’t provided the right type of funding, or development charge cuts for smaller apartment buildings or multiplexes.

Ontario Land Tribunal, More of the Same:

Another change in Bill 23 was trying to speed up the processes in the OLT. They wanted to, “expand the Tribunal’s authority to dismiss appeals without a hearing, notably on the basis that the party who brought a proceeding has contributed to undue delay or if the Tribunal is of the opinion that a party has failed to comply with a Tribunal order.” Basically, they want to stop NIMBYs from causing delay in the development process. Fundamentally, I think this should be a good change. There is proven data that NIMBYs delaying the development process contributes to mountains of cost that ultimately get passed on to the end renters or owners of the units, and also makes building less appealing overall due to this risk. This still doesn’t address the fundamental change that is needed in our zoning bylaws, say it with me, VARIETY OF HOUSING TYPES.

The Middle is Still Missing:

What this effectively has accomplished is speeding up these mega projects. To be fair to residents of existing areas, often these projects seem a bit unwieldy and unnecessary when there could be a lot of smaller projects in the area that achieve the same amount of housing in a more graduated and “gentle” way. Inevitably you will hear people complaining about “greedy builders” who want to ruin the neighborhoods, when it’s our own legislation that’s handcuffing us. Again, builders are simply acting rationally, within the laws they’ve been given. A side effect of introducing this “Missing Middle” housing into legislation would likely also enable a greater number of smaller builders to take on these projects. The barrier to construction is quite high for very-high density projects. They require special, often custom engineering, massive re-bar concrete beams, and other construction materials that are very hard and expensive to ship or have to be custom built on site. This increases complication which increases costs. I’ll give this OLT thing a 1/2 point since the idea behind it is generally positive, but the foundation upon which it’s built sucks. It is still a drop in the bucket since there are so many other delays that continue to plague building and it’s not really a “solution”, just a band-aid on an existing problem.

What are the Results Saying and What Are the Projections:

According to this table from Statistics Canada. Ontario housing starts have gone down every single year since the Provincial governments Housing Task Force report in 2022 and their proclamation to build 150,000 homes per year. I’m not going to turn a blind eye to the fact that the overall economic environment is pretty bad as far as construction costs and labour costs go. People’s appetite for investment with high interest rates is down, and a slew of other problems we are dealing with related to the economy. I also think it’s a bit unreasonable to use an above average year of 2021, with almost 100,000 starts, then project out and say “I think we can do 150,000.” Yeah, right, how exactly are you planning to do that overnight? We can’t expect changes to happen that quickly, but we also really can’t afford to go backwards. We’ve had 3 years since Bill 23 to see results. The data clearly shows that our changes have not been bold enough. We also can’t use the economy as an excuse when BOTH Vancouver and Montreal are improving. This data isn’t housing completions, this is simply “starts” which is getting shovels in the ground. We need more shovels in the ground and more people who are able to dig (read: trades workers). Ontario is still failing Ontarians. We need bolder changes.

Chart design: Oliver Foote
*technically housing starts, not new homes.
Data from Stats. Canada.

The Best Platform – Green Party?

I’m not going to get too much more into Ontario politics, but the one party that surprised me with their housing platform was the Green Party. Regardless of your political affiliation, I believe that good ideas are worth sharing. They are taking the approach of shooting for the stars on housing and aiming for 2 million new homes rather than 1.5 million. I think that is a good approach, because if we overshoot, we may still land on the moon.

They are also proposing a bunch of changes that coincidentally align with a lot of what I wrote about in this article. I like their bold thinking and we need more of this from all of the other parties to help solve our housing problems. So what are some things I like that they are proposing?

Allowing single family homes to be divided into multiple condo units
Pre-approved building designs for municipalities to instantly approve for construction
Plan for mixed housing types based on demographic and immigration projections

Allow fourplexes on existing lots, and sixplexes on existing lots in cities over 500,000 residents
Remove onerous zoning rules around floor space index, set backs, planes etc.
Pre-zone missing middle housing ranging from 6-11 stories on transit corridors and major streets in large urban areas with over 100,000 people

Increase financial and legal support for small builders of missing middle housing
End minimum parking requirements
Change planning laws to allow various buildings to be built on main streets, transit stations, corridors, etc.

Real Changes Are Needed:

I do really like the ideas listed above and I think if they were implemented it would be a serious improvement to our zoning laws and these changes could actually get housing moving again in the province. Whatever the results of the election are, I hope that who ever is running the ship makes some real impactful changes.

Conclusion:

This was a bit of a long one, but I felt with the provincial election happening tonight that I needed to write out some of my thoughts on housing. What the current government has accomplished related to housing with their time in office isn’t particularly impressive. I believe if they continue along this path they won’t ever be able to accomplish their ambitious targets. But focusing more on pure data and the change that is required, I just don’t they’ll accomplish their targets on their current trajectory, on this particular issue I can’t say they have my confidence. I also don’t know which government WOULD be able to accomplish these targets since our system is so deeply broken. Whoever wins, they’ll have to make some very unpopular decisions. I just hope that the unpopular decisions are backed by data and proven success from other provinces or countries, not focused on personal affiliations or gains. This problem is not personal, it’s needs to be a unifying crisis. Thanks for reading, as always.

Keep Investing,

-Oliver Foote

Why Are Rentals Affordable All of a Sudden?

As someone who likes to stay on top of what’s happening in Real Estate and the economy. I have noticed something happening that honestly, I’m not sure many people saw coming. Rental prices are dropping in major city centers across Canada, and have been on a slow but steady decline for a good 6-8 months. The main reason for this change simply has to do with a supply and demand problem (on many levels), and it’s all happening at the same time, right now.

Demand:

Let’s talk about demand first. Allow me to tell you a bit of a short story about recent events, namely something called COVID-19. The effects of the pandemic are beginning to show up in so many different aspects of society, and what I’m going to talk about here is another example of how generational of a shift was caused by COVID. Prior to COVID, people knew we had a bit of a housing shortage in Canada, in bigger cities multiple offers were common, but politicians were making some small policy changes to try and address some of the problems. Fair housing plan, first time home buyer tax rebates etc. But these were really drops in the bucket, and I don’t know that any politicians were earnest sitting down and thinking to themselves that there was a real problem here and that things needed to change. Enter the pandemic, low interest rates, followed up quickly by a completely crazy housing market. What COIVD did, was shine the worlds biggest spotlight on housing and made the entire country realize how bad housing could really get if we let things go too far. All of a sudden, every level of government is talking about housing, all of a sudden we’re talking about educating trades workers again and doing something to fill in these gaps in our economy that have been growing for decades leading to the problems that we are now experiencing.

Interest Rates:

So what did the various levels of government do in order to try and reduce this crazy demand in housing that was brought on by COVID? Many things. The Bank of Canada (not technically the government, although still a government entity?), increase interest rates by 4.75% over the course of 1 year, the fastest rate increases in history, which made housing extremely unaffordable at current market prices. Almost instantly, a ton of demand dried up because, financially, it became a horrible deal to purchase a home. Real estate prices move in the downward direction a lot slower than they move in the upward direction, which meant that while the cost of owning a home climbed in lockstep with rate increases, prices did not fall at the same pace. Even with these high interest rates reducing the pool of potential buyers significantly, there’s just so little supply, that some people who really need a home, were still buying homes. We didn’t see a huge flood of inventory (until about a year or two later), because most people who were already in their homes might not have to renew their mortgage for another 3-5 years and don’t need to sell. Rates were a big hit to demand, but everyone was finally beginning to realize the gravity of the situation, and the Bank of Canada made it pretty clear that the high rates would eventually come down once they dealt with inflation. So while the oven was still hot, governments began to put other policies into place.

Foreign Buyers Tax:

In some provinces, mainly the larger ones, foreign investor taxes were put into place in order to reduce speculation on the Canadian housing market as an investment vehicle. Canada is a very stable country, so if you have money from another country that is less stable, why not just park it in a piece of land located in Canada, and as a side benefit watch the investment grow. Makes perfect sense from an outsider point of view. But what this means is that local “middle class” people have to compete with the global rich, who may want to send their children to school in Canada or for whatever other reason have an interest in real estate. There have been arguments made about whether of not the percentage of foreign investment in Canada was actually making a dent at all in the cost of housing and what even counts as foreign investment. But on the whole, if the goal of this policy was to reduce demand, a 25-30% tax on foreign investment is one way to accomplish that.

Foreign Buyers Ban:

Following this policy, but at the federal level, we had a foreign buyer BAN for 2 years starting Jan 1, 2023. Which has been extended for an additional 2 years until Jan 1, 2027, and who knows, maybe it’ll be extended again. What this means is that if you weren’t a citizen, or don’t have Permanent Residency (PR) status in Canada, you CANNOT buy real estate here, at all. So even if you were willing to pay the provincial tax of 25-30%, with the hopes of getting a rebate (within 4 years) once you have your PR, you can’t do that anymore. Again, if the goal of the policy is to reduce demand for housing. This will have likely accomplished that. However, a potential side effect of this policy is driving up rent prices, because there may be a situation where you have a highly skilled worker who comes here and is making really good money or may have the means to purchase a home, but now they are forced to rent. Which means more demand for rental housing from people who are barred from buying, even if they plan to make Canada their home long term. I would consider this a more artificial and temporary reduction in demand, because these skilled workers will probably buy after getting PR.

Less Immigration:

Wow what a great transition, let’s talk a bit more about PR shall we. Quite recently, the government has been walking back the number of people that can apply for PR and officially immigrate to Canada. This has made the process of becoming a Canadian citizen a lot more competitive, and if you combine this “reduce immigration” policy with the previous policy which only allows citizens or PR holders to purchase homes, you will see a notable reduction in demand for buying housing. There will literally be fewer people who are legally able to purchase homes in the coming years. That’s not technically correct since we’ll be increasing the number of Canadian’s every year while still not building enough. The pace of new entrants will still be outpacing construction. But at least with these new policies things will get worse slower than before.

Fewer Students:

One final thing on the demand front deals with students and rental housing. Students make up quite significant portion of the rental market. Prior to, and just after the pandemic. The government was allowing pretty much anyone who would be accepted by a college or university, to come to Canada and study. Which in theory is an ok idea since we hope those people will stay, get a good job, and contribute positively to the productivity of our economy (not to mention spend money while they are here). But this unregulated environment led to some bad actors taking advantage of the situation. In some cases students were getting scammed by private “career colleges” which sold a promise of a Canadian education, and frequently didn’t deliver even the basics. It was a bad look on Canada, and brutal on students that took a huge risk spending international student tuition to get an education in Canada.

Aside About Higher Ed:

Additionally, at some point down the line, higher education institutions, including the prestigious ones. Began to cater their “services”, to the international student audience. Why? Because international students pay 2-4x the tuition rates of domestic students and universities have been dealing with consistent budget cuts from the provincial government over the course of decades (god forbid we help to pay to educate our future workforce). As an aside, I feel very strongly that higher education should be almost free in Canada for locals (which means more government funding). It’s ok if you disagree, but I would ask that you think about the implications on young people when education leads to debt, we are handicapping them before they even begin working. Additionally, if it’s too expensive, some people end up forgoing education altogether. More highly structured education after high school isn’t always the right answer. But, I think fundamentally we can all agree that continuing to get educated is a good thing and more funding for higher education is a great way to do that.

After years of cuts, universities felt the need to increase international student enrollment in order to make up for the difference, and the funnel was effectively endless. Obviously, this all came to a head and some people began to tell their MPs about these issues, namely scam colleges, and shortly after we see a cap on student visas. What does this means for housing? Likely there will be less rental demand in major metro areas where higher education institutions are located.

Supply:

Ok, I think that wraps up the demand side of the equation. Excuse me while I go and watch the 4 Nations Faceoff Canada vs. USA game (Canada lost, dang). Supply is up next, and this is where things get really fascinating.

Rents at 18 Month Low:

A report from Urbanation, who do really good research on housing in the Greater Toronto Area explained in October 2024 that average rents, especially in large cities across Canada have been dropping. An even more recent report by BNN said that rents across Canada have hit an 18 month low in January declining 4.4 percent to $2100. Rents are still 5.2% higher than 2 years earlier. But this is still a welcome sign for many renters. So what’s going on here?

Flood of New Supply:

We’re in a very interesting moment in time right now. As mentioned in the demand section, we’ve done a pretty good across the board job of slowing demand. At the same time, we have a flood of new condo completions hitting the market, actually a record amount for 2024, 29,800 in the GTA. In a normal year there might be 20,000 completions, which means we saw a 50% increase in inventory hitting the market. Approximately half of these new condos were listed for rent, since many owners are reading the writing on the wall and can see that they won’t be able to sell at a good price. In fact they may not even get the price they paid out of the condo. The pandemic also slowed and delayed condo completions, and 2024 just happened to be the year of reckoning where everything hit the market all at once. Additionally, purpose built rental completions were 5,537 in 2024, which is 86% above the 10 year average. In 2023 completions were 5,779 units.

What This Moment Tell Us:

When you combine the twofold pressures of ton’s of supply for sale, a smaller pool of buyers than usual, more nationalistic policies, higher interest rates than usual, and a “stable” housing market which is moving very slowly in the downward direction. Many new condos and purpose built rentals hitting the market. Leading new condo owners to attempt to rent out their units because they are unable to sell them right now. We have accidentally created an amazing case study that proves the point that politicians, and economists have been shouting from the rooftops. How do we make housing more affordable? We build more. Simple. This moment in time proves that if we build more, and build more variety, and have a constant flow of new housing coming onto the market, it will very likely relieve the pressures that we’ve been seeing on the housing market and make housing more affordable. On top of managing demand, filling gaps in our economy with tradespeople, and building a variety of housing (we don’t need to exclusively build detached low-rise or 60 storey high-rise). If apartments almost become a dime a dozen, a commodity, instead of something you need to be making six figures even to afford a rental. That will put a lot of downward pressure on prices and people will be less feral when trying to bid on a home or a rental.

Quebec is Doing It Better:

We have a case study in Canada that we can look to, Montreal and Quebec. In general, Quebec has not seen the same problems with cost of housing that we have. The pandemic did make things worse for them as well. But I was wondering why they don’t seem to be having as severe of a crisis as we do in Ontario and BC. I learned that a few reasons for their ability to managing housing costs a bit better is because they have fewer exclusionary zoning by-laws, aka. They build a larger variety of housing. The home construction market in Montreal is able to adapt much quicker to changes in demand, they also don’t exclusively rely on high-rise condo’s to solve their supply problems. They build a variety of housing types, like 3-4 storey apartment buildings. That are able to be built quicker and meet demand quicker. Our supply is very inelastic in Ontario, which the supply in Quebec and Montreal tends to be more elastic preventing prices from going to crazy. They also prove the point that the fundamental issue surrounding housing is a simply supply and demand issue. We do have to look into all the layers that cause a supply problem, or lead to unusually high demand. But if you boil it down, we need to build a whole lot more, become a lot more creative, and as 2024 proved, the problem can get better. Thanks for reading, hope you found this interesting.

Keep Investing,

-Oliver