Canadian Real Estate Trends: An interview with Bruce Joseph

February 7, 2023No Comments


Keith Richards: This is part of our series where I bring in special guests and I’m really excited about today’s guest. I’ve actually known Bruce Joseph, I guess something like 10 to 12 years at least, maybe longer. We met in a coffee shop in Barrie, Ontario and at the time we just started talking about what he does for a living versus what I do for a living. We’re both kinds of in the investment world and Bruce has a background in the investment world, but he’s moved into real estate and he’s been featured on BNN TV as well as a lot of common media sources that you’ll be familiar with, the Goldman Mail and various media sources, as an expert on real estate trends and developments.

I’m really excited about bringing Bruce in because I’m not an expert in that area and yet I’m fascinated with the issues within Canadian real estate. You’ve seen me blog a couple of times recently about the problem with Canadian real estate, but Bruce brings a unique perspective, both as a longtime mortgage broker, and he also is responsible for managing a secondary mortgage market. I think they’re called MICs. So Bruce’s perspective, I think, is going to be very interesting to this audience and I hope you get a lot out of it. I’ll welcome Bruce and I’ll just ask him to start off with Bruce, your perspective on what’s going on in Canadian real estate. Welcome, Bruce.

Bruce Joseph:

Well, thank you very much, Keith. When I typically get asked to opinion on real estate, it’s generally focused on the credit side because that’s where I’m active and that’s essentially mortgages. And what’s really fascinating, I think the most fascinating thing right now in the credit is a lot of investments into real estate has slowed due to rising interest. We’ve had, I believe, one of the most aggressive interest rate hikes since like the 1980’s, close to within a 12-month span, almost like 5% on mortgage rates. So obviously that’s had a bit of a substantial impact on prices and demand. We’ve seen some general markets drop by as much as 30%, but the overall national home price index is something like 13, which is, again, you have to go back to the 1970s to get these kind of numbers.

But what I think is really interesting is the kind of information that I have into the optics into the private sector. I mean, you can get a lot of data on banks and arrears and extended amortizations, but there’s virtually no optics into this very large portion of the market, which has grown extremely fast in the last couple of years enough that the regulators have taken a note of and quite a bit of Canadian investment capital it’s poured into. So that’s probably what I find most fascinating is what’s happening in that market and the impacts it’ll have in the general overall economy.

Keith Richards:

Yeah, you’re right. It’s interesting seeing the decline in Canadian real estate prices, which really were a long time coming. Let’s face it. You, no doubt, are just as in tune as I think most of us about how Canadian real estate versus world markets has really, what I like to call, hockey sticked. Everything was going up, but it’s really hockey sticks since the Covid crash and all that sort of stuff. So you and I were talking about a week or so ago before this interview when I first started talking about setting this interview up and one of the things that you brought up, and this is an area of massive interest, I think, to me and many people watching this, the market on the secondary mortgage market and what’s happening. You mentioned a firm, actually just in my town in Barrie, that is struggling right now having put the stake in the ground at exactly the wrong timing and now they’re struggling with how much they’re going to be able to sell their condos for and that kind of thing. So tell us about your view and what you’ve seen in the secondary mortgage market.

Bruce Joseph:

Right, so for a bit of context, I kind of break the market into three sort of areas. So you’ve got your prime side and that would make up your Canadian chartered banks, and that’s really interesting to follow and there’s a lot of data there. Then you’ve got your alternative banks, which are still banks, but they operate slightly with wider qualifying criteria and their interest rates are higher. Then you’ve got your basically, years ago they used to call it the shadow banking sector, I just hear it called the basically private sector, which is made up of wealthy private lending individuals and mortgage investment corps likely dominate that market. So what’s interesting about that is virtually all, not completely, but virtually all mortgage investment corps have essentially one year terms. They don’t do five year terms.

They’re all essentially one year terms that reset and when they reset, they reset quite higher. Now, it’s important to note they are the lender of last resort. When they decide not to fund, it’s very typical that nobody else is coming to fund those mortgages. They are generally focused specifically on the value of a property. So if you’re in a particular market where you’ve got a 30% drop in evaluation, there is a very high likelihood that those private lenders are not going to renew their mortgages. So we had a big runup last year at a certain point, actually around this point last year and now a lot of these mortgages are coming up for renewal near the end of this quarter and there’s been a significant erosion in equity. So I think the next couple of months are going to be really telling because the way I see that is that translates a portion of those mortgages on those books being put into for sales where there are no other lenders coming to the rescue and how that impacts prices is really going to be determined on the overall demand at that point in time.

 

It’s not saying it’s abysmal at this moment, but the sales volume numbers are still like really low even though they’ve uptick a little bit in the last few weeks from previous years.

Keith Richards:

So that’s interesting. I didn’t know that about the secondary or the non-primary, whatever you want to call them, lenders as generally having a one year rollover. Wow, talk about timing. The rates, what they’ve done in one year. So you can imagine, and I did see a statistic that we’re seeing a greater number of walkaways. I’m not sure Bruce, you’ll know the right term for it, but people that maybe did sign on to buy a subdivision or a condo property and are just walking away. Can you fill me in on that?

Bruce Joseph:

Yeah, I think that’s going to be a much bigger event later in the year. New construction coming online, new builds right now at this moment are still relatively low. But from what I understand, it looks like we’re going to have a very high, near the middle end of the year, number of new construction projects basically hitting the supply and that’s where we’re really going to see it’s definitely a problem. It’s a problem because when you go to close on these properties you have to be qualified through a bank at the current market valuation. It doesn’t matter what price you paid for it, they’re going to evaluate these prices. And you have to also take into consideration that you may have qualified for your mortgage at low twos percent, and now you might be in the mid fives and mid sixes. So I think that’s a big problem. To what scale is yet to be seen but that would likely turn into people walking away from their deposits and from there it can be really uncomfortable depending on which builder they’re dealing with.

Keith Richards:

Yeah, I’ve just posted another blog where I noted that in the US they are starting to see some pickup and I guess you were just saying there’s pickup happening just recently in Canada as well. Am I reading you correctly in that you are not a hundred percent convinced just yet that this recent pickup, especially in Canada, is the real McCoy? Are you skeptical? What is your outlook as far as say, the bullish versus bearish outlook on real estate over the next year or so?

Bruce Joseph:

Yeah, I’m very skeptical about it but I’m not convicted either way either. I’ve had some pretty strong convictions in the past based on some high level data and the market’s been irrationally I don’t even know what the right word is.

Keith Richards:

Irrationally exuberant.

Bruce Joseph :

Yeah but almost like irrationally resilient too. The resilience of it really surprises me. So I mean, the one sort of, if you want to call it a bull case but something that could maybe put a floor under, is some of the data I’ve seen and just some of the individuals that have amassed such an incredible amount of wealth in real estate over the years, there’s an argument that there’s a certain floor at which they will simply begin buying these properties. I can tell you, overlooking a brokerage, we do have clients that own 20 plus properties, and that’s not uncommon for most brokerages to have those type of clients. Investor related type buyers know how to acquire these properties and scale. It just could be like a wealth shift in that.

So there’s that factor, but the immigration numbers are really interesting. Part of the bull case is, I think we had something like 800 plus thousand total immigration last year, which was the highest number ever. Too high likely and I think we’re rolling over this year probably 500 plus. So there is something there. I’m just not totally convinced that’s going to be the metric. I don’t see any evidence that the market’s going to skyrocket. I’m just thinking of like what could cause it to have this nice sustainable floor. But on the bear side, there’s a lot of evidence that things look fairly uncomfortable. To me the most glaring piece of evidence that is the number of transactions on the transfer of ownership of a piece of real estate.

So that’s real estate agents, mortgage brokers, insurance companies, lawyers, et cetera. That number is really down. So last quarter we were looking at close to like 40% for the entire industry in transaction volume down and those are all dollars that go into some of the highest spenders in the Canadian population and that just has a really broad effect, so there’s that. I think that’s a big thing. It’s also important to note that real estate agents, mortgage brokers, et cetera, are some of the largest buyers and servicers of debt against real estate. So that’s something to keep in mind. It’s pretty concentrated there. I would say that’s really part of the barricade that it’s going to be very uncomfortable, but there’s also two other things. There’s a psychological effect of interest rates and like how people feel about buying anything.

I don’t know that buyer psychology is positive right now, given interest rates. It’s going to take a while for people to normalize to where we’re at. Just the sheer affordability of just getting a mortgage today versus 12 months ago is still really uncomfortable for people. I think that’s a major thing, but those two things alone are fairly massive, but I think throughout the year we’re going to see a little bit of a bump in distressed sales and probably something that most of us can’t recall. Like the last time we would’ve seen this would’ve been decades ago. If I had to guess, I would be fairly, not certain, but I would have a strong feeling that could affect buyer sentiment as well. I feel like that could have a real way of dragging down buyer sentiment. So I think the bear case is fairly strong and there’s a lot of data to support that.

 

Keith Richards:

Yeah, just as a quick aside, I may end up putting this data in a blog coming up. This has got nothing to do with real estate, but it maybe ties in, in a way. I just read a study of revenue and purchases and gross revenue coming in on the luxury end of the world versus the sort of mid-level, not the low level, purchasing end of the world. So, for example, I was talking to somebody this morning and they’re a scuba diver, they want to buy an underwater camera. Well, those sales are slowing down because people are squeezed for groceries, for gas, things like that. Their rent’s gone up, their mortgage has gone up because, of course, that interest rate hike, if they had to renew or if they were on a floater, they’re all, these costs have gone up. So maybe you don’t buy the camera that you wanted to buy. It was maybe only a $600, $700 whatever purchase, but it’s $700 you don’t want to spend right now.

Versus the high end, this graph showed the sales of Ferrari, Louis Vuitton, these kind of things, are doing really well. Ferrari has the same chip problem that all the car makers have, but there’s a lineup. I’m a Porsche guy and I like Porsche cars and I know that there’s certain Porsches you can’t get. It doesn’t matter how much money you got, you can’t get them. So there’s this lineup to get these high-end things and that probably translates out to the real estate market. There’s a certain level of people that will just, you know, they’re going to benefit by this because of their cashflow. When the timing is right, they’ll step in and interest rates or not, they’ll be able to buy a property cheap. Whereas maybe not so much the general population. So it’s food for thought. On that subject, I wanted to ask you, I wrote down my question, so that’s why I’m looking down. Private lending, we were talking about this a couple weeks ago when we spoke and it’s increased over the years and this is like across the board thing. Why is that?

Bruce Joseph:

That I can definitely comment on. Mostly the demand for private capital has steadily grown. So most borrowers, at least that I’m exposed to, you could put them into two categories. One would just be their distressed, lender of last resort. In my observation, that hasn’t been the largest percentage of borrowers that borrow at 7 and 8% interest rate ranges on private capital. They’re typically borrowers that are self-employed, that don’t qualify, that can make the argument that it makes more sense to pay these rates than to not acquire the real estate. There’s also quite a bit of speculators that will buy at those rates and hold mortgage at those rates. There’s two components. So one is who wants these mortgages and why is the demand higher on that?

But I think a lot of that just has to do with the rise in real estate prices. You could easily justify private rates last year when you’re getting that kind of expansion. Little harder right now. On the flip side, investors also really enjoyed, especially when we’re at 2%, but really enjoyed just a high fixed yield that came with mortgage investment corporate returns that seemed to be something that drove investment capital into MIC Funds all across the country. And I think, just to piggyback on that, is it’s just a really simple investment. It’s not difficult to get Canadians to want to buy real estate. It’s the thing here, right? So to invest in debt against real estate is not a far pitch either.

So I think that was like a natural transition for people who wanted to have less exposure in direct real estate and have something slightly more passive. I could see where the demand was really heavy and why it just exploded on both sides. That’s why it’s going to be really interesting now because some investors that invested in MIC’s took out levered investments. I spoke about this years ago saying in any particular corrective environment this would be a problem. If there was a MIC that was very levered, because once the spread goes negative they would have significant redemption issues and that blows up the model. I haven’t observed that yet, but when I’m thinking of problems in the MIC sector, it’s likely there these particular funds that are heavily levered.

Keith Richards:

Okay. Another question that maybe is appropriate for the readers because the readers are investors, we’re stock traders, we’re bond people. We’re buying normal securities as well as commodities and that kind of thing. So the question I have, a lot of people in my business, we may say, okay, real estate looks good or real estate looks bad and so you can buy REITs, real estate investment trusts, that might focus on residential, rental properties or commercial, and commercial rental properties. And there’s also the peripheral companies like Caterpillar and lumber and whatever that feed off of the whole real estate market. Even the banks. If you think real estate’s going to do well, you buy banks because of course they’re going sell more mortgages. So the question I have is, are you seeing any distinguishing trends that might separate, say commercial versus residential versus residential rental properties? Like those three areas? Are you seeing like a commercial property still doing just fine and are there any distinguishing features between them?

Bruce Joseph:

Yeah, I’ll opinion from a high level on this. I’m definitely not an expert on commercials. Our brokerage does fund those. What I’ve observed is industrial real estate seems to have been quite resilient. Certain types of commercial, not so much, like office space or retail specifically. Certain types of retail where you may have restaurants or clothing stores, et cetera and that’s understandable given the rise of Amazon and just the efficiencies of technology. Clearly residential has been struggling and certain pockets have been really struggling. I would say certain rural areas have. Some of the rural areas expanded so unbelievably during Covid, it made no sense, but the psychology of people was almost madness for a couple of months. We saw prices in some of the most rural areas of Ontario going for valuations which would never make sense again.

So I think, residential clearly, especially more in the condo market is where I’m sort of observing the biggest likely problems. But as far as commercial, I didn’t see the same runup, so it wouldn’t have seen the same erosion either. One thing I’m thinking about when we’re mentioning this is sometimes I think about what I want to focus on is where we might see, if we do, where would we see the crack? So often it’s going to be, okay, well what are the lenders of last resort doing? Are there problems there? I was speaking with a fantastic analyst about a week ago about that very question that overlooks sort of like much more higher macro level data, and he geared me towards, when you’re looking at banks, what you have to realize is that during the time of Covid, when we were doing mortgage deferrals, when you look at the particular percentage of principle repayment it was at an all-time low because we were deferring it. Because of the extended amortizations from 5% increase in interest rates, the principle repayment of Canadian mortgages right now is actually lower than it was during the Covid crisis.

That’s really fascinating. But from a more, let’s call it, positive way of looking at things, I don’t think we’re going to see any immediate erosion there. But one of the things the analyst mentioned is, there may be a lot of distress in just straight business loans which I would definitely have observed on the commercial side of our lending arm where you’ve got businesses just taking out unsecured loans, restaurants, retail stores, you name it. The sectors that are really struggling right now, there’s some obvious issues with that. So to conclude all that, I would say it’s, I’m seeing more problems in residential real estate where people were over levered last year and most of the commercial industries, depending on what they are, if they’re not in the obvious categories, seem to be quite resilient.

Keith Richards:

Yeah, that’s the impression I got was definitely the commercial side is okay, and actually, I just did a little bit of an exploration on different types of REITs, which is not precisely what you do, but you know what a REIT is, real estate investment trust, and there are different REITs you can buy for different sectors and that includes commercial versus residential and whatnot. And you’re right, yeah. You’ll notice that the ones that are more people orientated versus commercial-orientated are doing worse as far as they go and that brings up a question. So you were just mentioning that the individual homes, so somebody goes in and bought, say last March, like right around the peak March of 22, they bought this house that at one point just two or three years before was selling for 500, and at that point was selling for 800 or 900.

That’s how much these things, I saw anyways, jumped. And they bought at 800 or 900 and now it’s down to like 700 or something or even lower. So you were saying there’s some distress coming out of that sector, but what about with residential, there will be some investors that will buy maybe a small apartment or a residential condo type of situation that they plan on renting out. So are any of these people showing any distress or is the rental market, as far as residential people are concerned, are they still paying their rent and are the investors in those properties still doing okay from what you’ve seen or what do you see?

Bruce Joseph:

Yeah, I would say for the most part, but also depends. If you’re a new landlord that entered the market in February, March, April of 2022 and took out a variable rate mortgage, and I think, at the lows I believe it was close to like 60 plus percent of all bank originated mortgages at the all-time lows were variable rate mortgages. So if you were running your rental spread on those numbers, you would be completely distressed right now. It would be likely have to sell. A lot of the exposure I’ve had to buyers that own multiple properties have been accumulating real estate for multiple years. I don’t think brand new rental investors made up a significant portion of the market last year. At least for the ones that did, they’re going to have a problem.

Whereas if you own an apartment building or a couple detached properties in the last few years, unless you went really high on the leverage scale, on the equity takeout with a variable rate mortgage, they’re likely fine. What I am seeing though, is the quality of tenants for a lot of the big apartment buildings and large landlords that we work with seems to have been declining and that might be just because of the overall economy as a whole. But I have been hearing that that seems to be a consistent trend, that quality tenants that can pay are becoming harder to find.

Keith Richards:

Oh, sure. Yeah for so many reasons, inflation and that kind of thing. Wait till the recession starts affecting employment. I mean, it hasn’t yet, but it will eventually because if you’re producing less goods that means you need less employees to make those goods. It’s kind of funny how things work. I have one last question for you, Bruce, and this morphs into those surrounding industries that I was talking about that circle around real estate. One of the sectors that we follow really as a barometer of real estate, but investors are interested in this sector, is the builders. In the US we have DH Horton. What’s the other one that’s pretty big? There’s a few of them. I’ve blogged on them before. We don’t really have any publicly listed builders and developers in Canada, but there seems to be a trend that they are starting to see slowing, like less shovels in the ground, so to speak. What is your take on that and is that just temporary or any thoughts on that, like how they might be doing or their outlook over the next few years?

Bruce Joseph:

Yeah, I speak with some mid-size builders. The really large ones in Canada are mostly owned by private families with exceptional wealth, like generational wealth. There clearly is going be some challenges with like smaller levered builders that are relatively new to the game. But for a lot of the builders I’ve spoken with they recognize that a major pivot is occurring. Some of the builders are changing because one of their biggest challenges is costs. The inflation cost of building a house today is so much higher. Often what gets missed too is the quality of labor. For many multiple reasons getting quality labor today seems to be more cumbersome than it might have been a few years ago. So you match that with rising costs and an uncertain price tag.

A lot of uncertainty on if we build this in rising cost environment and we’re projecting selling this at rolling the dice and what the valuation’s going to be, you will tend to see, at least what I’ve observed is, some builders looking to get into smaller, more affordable projects so they can keep on rolling out inventory and ensure that the sales actually occur versus maybe building like multimillion dollar McMansions and subdivisions, which are no longer accessible to the general population like they were the last few years.

Keith Richards:

Yeah, to your point, I have two sons that are both truck drivers and the one son is involved in construction. So the construction son, he has all these different licenses. He can do cranes, he can do cement, he can do you name it. He is the guy in his company that if the boss wants to go pour some cement, he says, Bryce, just go to this spot and here’s the stone slinger, the cement truck, the crane. Whatever it is, my one son can get in that car or that truck and go do it and operate the crane or whatever it is. He’s been trained on everything. So he’s very in touch with the construction industry.

And he told me, and this is what you’re mentioning with the McMansions or let’s say custom homes. I have a custom home myself. I didn’t buy into a subdivision. I bought a piece of land and built the home on it. Many people do that. Well, my son said, look, it’s really hard to get, for example, cement right now. So he goes, the custom home guys, they’re in deep trouble because who’s going to get the cement, he person putting up 20 new houses or you in your little lot that you would like a basement for next week and he says, so these guys are always put on the back burner and literally custom homes are taking much, much longer now to get built because you’re always shoved to the back for a lot of these supplies. And like you said, tradesmen and stuff. It’s just hard to get good workers, like you said. So that’s an interesting point you bring up. And again, part of my reason for being interested in real estate is because of my kids. They’re involved. Well, listen, any finishing words from you on the state of Canadian real estate that you’d like to leave the viewers with?

Bruce Joseph:

Yeah, the greatest minds I’ve spoken to that really have their finger on the pulse of the longevity and where this is all going, very few people I know have a very strong conviction of any sort of even long-term projections throughout the year. We’re kind of all looking at the factors and kind of seeing where it goes. But it’s going to be really fascinating and interesting to watch. It’s going to be an exciting year in real estate.

Keith Richards:

That’s one word for it, isn’t it?

Bruce Joseph:

That’s the best word I can come up with.

Keith Richards:

That’s great. Bruce, thank you. I’ve talked to you in the past probably for a couple three years now about doing something with you like this because I wanted my people to hear from you. Your perspective is so different from the stuff they hear from me with all the technicals in the markets and whatnot. So this is really, I think, going to be a well-received conversation and I really appreciate you taking the time because I know you’re super busy. You’re always on the go. Every time I’ve tried to talk to you, I get your voicemail. So this has been a great opportunity and thank you so much.

Bruce Joseph:

My pleasure, Keith. Thank you for having me.

 

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