As the United States abandons treatment, the employment situation improves, and inflation intensifies, the Fed is getting closer and closer to raising interest rates. Canada's monetary policy is usually MADE IN USA, so no matter how the epidemic develops, it is only a matter of time before Canada raises interest rates. There are different opinions on the overall trend of the economy in the post-epidemic period. On the last day of last year, Musk said that he believed there would be an economic recession from 2022 to 2023. This statement attracted various interpretations. Will there really be a recession? In the face of rising interest rates and changes in the economic environment in the future, how should real estate investors respond?
01 Salary earners have become the main force in Canadian real estate investment
Ontario started its rent control policy in 1975 and began to relax it in November 2018, which lasted 43 years. During this period, the enthusiasm of institutional investors to build rental apartments was greatly affected, and developers mainly built condominiums CONDO.After half a century of rent control, Ontario has formed a rental housing supply market dominated by family retail real estate investors.Properties built after November 2018 are not affected by the rent control policy, and landlords can decide the amount of rent increase based on market conditions. As a result, some institutional investors are eager to build rental apartments. Riocon, a well-known institutional investor, built a rental apartment building called Pivot next to my office at lightning speed. When it was completed, it coincided with the epidemic lockdown. There are two ways for institutional investors to withdraw funds from real estate development projects: 1. Selling the real estate to end buyers to cash out, for example, selling CONDO; 2. After it is completed and rented, sell it to real estate trust funds REITs for cash out. During the rent control period, most developers usually pre-sell the condominium before building it, apply for a construction loan from the bank based on the contract for the sale of the condominium, and transfer the property rights to the final buyer after completion.During the period from the sale of the off-the-plan property to the final handover of property rights, the buyer of the off-the-plan property acts as leverage for the developer., after the property rights are handed over, the developer cashes out to pay off the construction loan, pockets the profits, and continues to develop the next building. When building rental apartments, the cash-out method is different. Self-raised funds and loans are used for construction. After renting out to a certain level, the buildings are sold to REITs for cash. REITs sell funds to investors and hold the properties for a long time. During this process, if the occupancy rate is very low, institutional investors will be unable to cash out.Don’t fight to be the first when the water is flowing, but fight to be the first. In real estate investment, it is the rule not to be the first., Pivot’s scramble to be first has given other institutional investors a good lesson. In the future, real estate investors will still be dominated by retail investors, because most of the rental apartments built by institutional investors are located in city centers with convenient transportation, and the cash-out speed is slower than that of CONDOs built for sale. From the perspective of capital utilization efficiency, it is not feasible for institutional investors to develop large-scale rental apartment buildings.
The current housing prices in Greater Toronto have squeezed wealthy real estate investors out of the market. With housing prices 10 years ago, wealthy people who did not need a loan to buy a house could barely participate in real estate investment. However, with today's housing prices, real estate investment depends entirely on the ability to pay.
There is one group of real estate investors who are blue-collar real estate investors who are responsible for renovation and quick buying and selling; the other group are white-collar real estate investors who submit a mortgage application to the bank and then entrust a real estate agent to find a house and hold it for a long time.People often refer to blue-collar real estate investors as speculators because they are always in and out quickly. The method they use is to force the value of the house to appreciate. Their investment model is like a blind man breaking off the corn, and there will always be only one ear of corn under the creaking nest. This type of blue-collar real estate investors often suffer heavy losses when they encounter sudden changes in policies. 2017 is the worst year for this group of people. Since the outbreak of the epidemic, blue-collar investors still have a long memory and have not dared to act rashly, because they know best that they are unable to hold for a long time, and short-term trading costs are high and the risks are high, and the time since the last painful lesson is short, and some people's wounds have not yet healed. White-collar workers in real estate investment are usually not dry land eels and are not good at decoration, but they have abundant off-site cash flow and can hold properties for a long time even if there is negative cash flow. White-collar workers who invest in real estate usually go to the bank to apply for a mortgage to invest in a house, cash out the money, make a down payment, and then buy more. Since the outbreak of the epidemic, the sharp rise in housing prices has provided conditions for additional mortgages. Therefore, white-collar real estate investors have been the most active on the stage of real estate investment during the epidemic. White-collar real estate investors can hold properties for a long time. As the number of white-collar workers increases, the number of properties available for sale on the market decreases. Competition among buyers becomes more intense, so housing prices will continue to be pushed up.
Through the baptism of the epidemic, the excessive currency has promoted the indiscriminate rise in housing prices, low interest rates have been maintained for a long time, and the stress test threshold for mortgage borrowing capacity has been continuously raised. After the great wave, white-collar real estate investors have stood on the stage.CBit.White-collar real estate investors with T4 or T4A income are more sensitive to changes in interest rates and economic environment. They are worried about rising interest rates, economic recession, financial crisis, unemployment, and government regulatory policies on the real estate market.
02 The General Theory of Employment, Interest and Money in Canada
As of January 2022, Canada’s unemployment rate has almost returned to pre-epidemic levels. The unemployment rate before the outbreak was 5.7%, and now it is 5.9%. In other words, the proportion of people who are willing to work but cannot find a job is about the same as before the epidemic. The actual situation is better than the data, because many employers cannot find enough employees and job postings are everywhere. The job market is very hot, and a rare buyer's market has emerged. Employees' premium ability has increased. Some people have taken the initiative to quit low-paying jobs and apply for higher-paying jobs. The average salary level has increased by 2.7%. This is not easy in a country where immigrants are constantly pouring in. The job market is booming. Let us reflect on an issue: the direct payment of aid during the epidemic has inhibited economic recovery for a long time. It was not until the stoppage of payment on October 26 last year that the economic recovery was completely on the right track. The government will restart the funding model in 2022, but the economic review will be much stricter. It will not be easy for the party to get the money. Trudeau has done a good job of making up for it. Only by not distributing money randomly can we ensure the recovery of employment and production.Full employment, coupled with rising wages, will push the inflation rate to continue to rise. Therefore, the central bank must face cost-push inflationary pressures when considering raising interest rates.In the balance between whether to raise interest rates or not, the decline in unemployment rate and the increase in average wages are very important weights.
Irving Fisher believes that,Interest rates are determined by each person’s impatience and investment opportunities. However, in the modern economic world, since currency issuance is used as a macro-control tool, interest rates have become a means for the central bank to intervene in economic activities, and interest rates cannot reflect impatience and investment opportunities. Since Canada's economy is a subsidiary economy of the United States, Canada's interest rate policy is basically in sync with the Federal Reserve. The consequence of manipulated interest rates is that the allocation of funds is not based on the efficiency of the market economy, but on the basis of the set interest rates, allocating funds to economic activities with the greatest returns. The current situation is that interest rates have been artificially determined, and funds will flow to industries that attract the most funds and have the highest returns, such as real estate. When interest rates are artificially raised, the flow of funds may also change. It depends on how much the interest rates are raised. If after the interest rate is raised by 0.75%, the highest return on funds is still real estate, then housing prices will continue to be pushed up.If the Federal Reserve raises interest rates but the Bank of Canada does not follow suit, the Canadian dollar will depreciate and its purchasing power will decrease, causing imported inflation., this is a consequence that Canada cannot afford. Therefore, if the Federal Reserve raises interest rates in March this year, Canada is likely to set the timetable for raising interest rates at the end of January or February. It remains to be seen whether if the Bank of Canada raises interest rates, it will lead to an outflow of funds from real estate and lead to a fall in housing prices. This depends on whether the return on real estate investment after the interest rate increase is lower than that of other alternative investment opportunities. There is no absolutely accurate basis for saying that raising interest rates will lead to a decline in housing prices. For example, Canada began to raise interest rates in July 2017 and did not stop until the end of 2018. It took a year and a half. The central bank increased interest rates from 0.5% to 1.75% in one go. During this period, apartment prices in Canada have been rising, and non-apartment real estate prices have been sluggish.
We all know that whether it is a country or a family, wealth does not increase with the increase of currency, because currency is just a symbol. Adam Smith also repeatedly emphasized in "The Wealth of Nations" that gold is not wealth, but a symbol of wealth. On the contrary, if currency is wealth, the country can just print more currency. Therefore, when a country's currency issuance increases, we should be clearly aware that assets priced in currency will appreciate. Some people simply categorize economic activities into Adam Smith's free market theory and Keynes's government intervention theory, which obviously cannot explain today's economic policies.Since the subprime mortgage crisis, developed countries such as the United States, Europe and Canada have fully entered Milton Friedman's monetarism, that is, as long as there is an economic and social crisis, the economy will be regulated through currency issuance.After the outbreak of the epidemic, the Federal Reserve's response was to restart the large-scale quantitative easing QE policy. Fools all know that printing money cannot prevent the spread of the epidemic, but the money printing policy did save the world from the subprime mortgage crisis. This prescription has been written into the pharmacopoeia, so we have seen a significant increase in currency issuance since the outbreak. Currency is water, and it needs containers to hold it. Although Canada does not have as many additional currency issuances as the United States, Canada's containers are small and lacking in variety. The main container that can hold water is real estate, so housing inflation broke out in Canada, and housing prices skyrocketed. More money from the United States has flowed into the capital market, pushing up stock prices and housing prices. Canada began to stop QE on October 26 last year, that is, to stop additional currency issuance, but promised not to withdraw the additional currency that has been issued, and announced that it would consider raising interest rates. The United States has started tapering, that is, slowing down the pace of QE (excessive currency issuance), and has stated that it will raise interest rates at the same time as it tapers. Many people are worried that stopping the over-issuance of money will lead to a fall in housing prices. From the perspective of currency issuance alone, no, because it is difficult to recover. As long as the balance sheet is not reduced, the already inflated housing prices will not fall. Since the outbreak of the epidemic, in addition to issuing additional currency through QE, the central bank has also jointly launched a functional fiscal policy with the Ministry of Finance, namely MMT, to support the Ministry of Finance in overdrafting the central bank account for epidemic relief, purchasing vaccines, and direct payment of epidemic subsidies. Therefore, during the subprime mortgage crisis, QE did not cause inflation, but this time because MMT was added, inflation did occur. Since the outbreak of the epidemic, the Bank of Canada has issued an additional 400 billion Canadian dollars in currency through QE and more than 150 billion in additional currency through MMT. The two faucets, one for cold water and the other for hot water, have not only pushed up stock prices and housing prices, but also triggered inflation. There is another source of money supply that does not come from the central bank, but from the private sector, and that is mortgage funds. Due to rising house prices,Families who are able to borrow have applied for additional mortgages and cashed out their existing properties. Since the outbreak, the increase in mortgage loans has reached a high of 193 billion, which is twice the same period in the past. Affected by the epidemic, people's living requirements have increased, so most of the incremental funds from additional mortgages have been invested in real estate, further pushing up housing prices. Although QE has been stopped and government overdrafts have been reduced, the power of the private sector to obtain funds from housing rights has not been weakened because housing prices are still rising. At present, the increment of money has decreased, but the stock is already very large, and asset prices, especially housing prices, will remain high.
To sum up, the recovery of employment will attract first-time homebuyers to return to the home-buying market and compete with real estate investors; interest rates will slowly rise, but it will take some time to reach pre-epidemic levels; the rate of currency issuance will slow down, and the rate of asset appreciation will also slow down, but asset depreciation is unlikely. Working-class real estate investors need to pay attention to controlling household debt risks and paying attention to changes in some major economic indicators.
03 A guide to controlling risk for working-class real estate investors
Although I have repeatedly emphasized in my public account that the borrower’s debt management ability is actually the level of financial intelligence, and suggested accelerating the repayment of home loans, there are still many different voices saying that it is wrong, and there are indeed many families who are investing in real estate while carrying large home loans. Home loan is the largest source of negative cash flow. Once unemployed, household debt problems may cause a chain reaction, and even the capital chain will be broken, forcing the family to sell their house. Raising interest rates will only increase the debt burden.Therefore, on the eve of interest rate hikes, it is recommended that households with large home loan balances adjust their debt levels in a timely manner.First, check whether the home loan has a floating interest rate or a fixed interest rate. If it is a floating interest rate, ask the bank whether the monthly payment will increase when the interest rate increases. Some banks will require the borrower to increase the monthly payment when raising interest rates. Other banks do not have this requirement, but only automatically extend the borrower's amortization and keep the monthly payment unchanged. Secondly , evaluate whether you can afford the new monthly payment when the monthly payment increases. Third, if the monthly payment must increase after the interest rate rises, you can consider upgrading your home. The loan amount will remain unchanged, but the amortization will be extended back to 30 years, thereby reducing the monthly payment. It is recommended that when you add the mortgage, transfer to a bank that will not increase the monthly payment when floating interest rates increase. If your income does not support an additional mortgage now, you need to actively save and actively accelerate the repayment of your home loan when interest rates rise, thereby lowering your monthly payment.
It is not necessary to convert a floating interest rate to a fixed interest rate. If you are worried that you cannot bear the risk of an interest rate increase, you can consult your bank about what the monthly payment will be if you change to a fixed 5-year interest rate. Record the increased monthly payment figure, save this amount every month, and use this reserve to accelerate repayment when the floating interest rate increases.
If the investment property has a floating interest rate, and the lending bank does not require an increase in monthly payments when the interest rate rises, it is not recommended to take any action. If the loan bank requires a higher monthly payment and the negative cash flow is large, please refer to the measures for self-housing.
Some people are worried about an economic recession and are considering selling their current properties and buying them back when house prices drop. There are many people who have this idea. In the 13 years I have lived in Canada, there was only a short-lived drop in housing prices in the first half of 2009 due to the economic recession. At that time, no one dared to buy at the bottom because was worried about whether their income was stable. The decline in Ontario home prices from April 2017 to mid-2018 was not caused by the recession, but by fear. There are indicators of economic recession. It is not that Musk said that there will be an economic recession.After this indicator appears, monetary and fiscal policies will respond to eliminate the possibility of an economic recession. This indicator is the comparison of short-term bond yields and long-term bond yields.A clear sign of a recession is that short-term bond yields are higher than long-term bond yields, the current situation is that long-term bond yields are not only higher than short-term bond yields, but the gap is widening, which is a sign of a prosperous economy. In 2018, there was a short-term inversion of long-term and short-term bond yields, and the Federal Reserve immediately responded by stopping raising interest rates and shrinking its balance sheet, thus avoiding a recession.
There are still people who are obsessed with the Great Depression 90 years ago and are always afraid of a financial crisis and a Great Depression. A financial crisis means that the financial system stops working, leading to economic collapse and then depression. What happened 90 years ago has been accurately diagnosed: many states in the United States did not allow cross-state bank branches to be opened. The single banking system was relatively fragile, and there was no federal insurance system at the time. When a run occurred, the bank collapsed, so people hid their money under the mattress. As a result, those who wanted to borrow money could not borrow it, and those who hid the money could not spend it. As a result, money stopped flowing, and a financial crisis occurred. After the crisis, the biggest mistake the U.S. central bank made was tightening monetary policy, which led to the drying up of inter-bank liquidity. Banks went bankrupt one after another like an infectious disease, and depositors no longer dared to trust banks. Hoover and Franklin Roosevelt implemented the New Deal, where the government spent money on behalf of the people, implemented trade protection to beggar your neighbor, and restricted wages and prices to block market signals. As a result, a financial crisis turned into the Great Depression. However, Roosevelt became the hero who saved the United States. In fact, it was he who turned the financial crisis into the Great Depression. Bernanke has studied the Great Depression all his life, and finally applied his research results to the subprime mortgage crisis. When a financial crisis occurs, it is necessary to loosen currency instead of tightening it, and turn on the full power of the money printing machine to solve the problem. After Geithner became Secretary of the Treasury, he believed that the most vulnerable part of the U.S. financial industry was capital adequacy, so he conducted a stress test to require unqualified financial institutions to replenish capital, thus ending the subprime mortgage crisis. In order to avoid financial crises, banking regulatory authorities usually use deposit reserve ratios to regulate banks' liquidity, while the central bank supervises capital adequacy ratios. Before the outbreak, Canada's deposit reserve ratio was 2.25%. Bank regulatory authorities lowered the bank's deposit reserve ratio to 1% in March 2020 to prevent a financial crisis.In October 2021, the Canadian banking regulatory authorities raised the deposit reserve ratio to 2.5%, which is 0.25% higher than before the epidemic. This shows that Canadian commercial banks have successfully overcome the epidemic and are in danger of inflating their self-confidence. Whether there is a risk of financial crisis, you can pay attention to changes in bank reserve ratios. The capital adequacy ratio of Canadian commercial banks is very high. It is currently higher than before the outbreak. The banks are very worried about this and are desperately paying dividends to shareholders and repurchasing stocks. Some banks even have so much equity that they are useless and even go to the United States to acquire peers.
Some people talk about raising interest rates and shrinking balance sheets together, but these are two different things. Balance sheet reduction means that the central bank sells the bonds on its balance sheet in the capital market. In 2018, the United States tried to reduce its balance sheet. As a result, the capital market could not withstand the Fed's massive selling. Soon, long-term and short-term bond yields were inverted, causing stock and bond prices to plummet. Stock traders should still remember the bloodshed in the stock and bond markets in December 2018. The Fed has since stopped and hastily ended its balance sheet reduction. The United States and Canada stopped raising interest rates throughout 2019. Therefore, shrinking the balance sheet is not that easy. When the Bank of Canada announced the end of QE on October 26 last year, it promised to reinvest, that is, if the bonds in its balance sheet mature, the central bank will purchase the same amount of bonds in the market to ensure that the level of liquidity remains unchanged, that is, it will not shrink the balance sheet.
04 All short-sightedness has short-sightedness
Since the outbreak of Omicron, the United States and Canada have had huge differences in their epidemic prevention measures. The United States, with far more infections than Canada, has adopted an open epidemic prevention model, while Canadian provinces have announced varying degrees of blockades, and even want to declare an international state of emergency. The United States has one ICU ward for every 4,000 people, while Canada has one ICU for every 6,000 people. Canada has always arrogantly believed that its publicly funded medical system is better than that of the United States. However, in the face of the epidemic, it has to be judged. The Trudeau government spent a lot of money during the epidemic, but forgot to increase ICU wards. Although publicly funded medical care is under the Generalized System of Preferences, it is too inefficient compared with the market-oriented medical system in the United States. In the face of Omicron, all Canadians have to pay for this medical system that has no foresight. Judging from the epidemic prevention measures, Canada's economic recovery will lag behind the United States, but the Federal Reserve must keep up with the pace of raising interest rates, otherwise U.S. inflation will be imported into Canada. The short-sighted medical system will cause Canadians to suffer a lot when interest rates rise.
The Greater Toronto Builders Association confirms that 40,000 new homes can be delivered each year. New houses are the supply of the real estate market, while the transaction volume of second-hand houses is the exchange of hands between stocks. There are 40,000 new houses in the Greater Toronto Area every year, which is simply unable to accommodate new immigrants. However, officials never face reality and take measures to suppress demand when housing prices rise. For example, Ontario’s 420 policy in 2017 is to use non-residents to suppress demand. This short-sighted behavior will cover up the fact of insufficient supply for a long time, so over time, the housing crisis broke out in the epidemic. Facts have shown that the effects of administrative intervention in the real estate market are short-lived. This is exactly what politicians want, just to be elected, even if there is a flood after taking office. In Canada, Chinese people are more worried about administrative intervention in housing prices than other ethnic groups. This is mainly due to the influence of their country of origin. Many people's fears are far greater than the actual danger. However, Canadian-born natives believe that administrative intervention in the real estate market is an exclusive prescription for socialist countries. In Canada, it often appears in campaign promises but rarely is implemented.
The same is true for families. If the purpose of our investment is to balance our lifetime income, does it matter whether the central bank raises interest rates or not? Does it matter which month interest rates are raised? Does it matter how many times you add it? Starting in June 2004, Greenspan raised interest rates 17 times in 18 months, from 1% to 5.25%, directly bursting the real estate bubble. OSFI, the Canadian bank supervisory authority, is very conservative and cautious. When the actual floating mortgage loan interest rate is only 1.5%, it directly sets the stress test interest rate at 5.25% to prevent the consequences of Greenspan-style interest rate hikes in the future. For households that obtain loans after June 2021, if approved by a major bank, the borrowers will all pass this terrifying 5.25% stress test. Those who think that raising interest rates will cause some families to sell their properties are worrying too much about others. Banks issue loans, and stress tests are risk assessments. Banks cannot control people who hide their illnesses and avoid medical treatment. Families who obtain mortgage loans from banks must meet such stringent requirements. Families who are panicking all the time when they see interest rate hikes should ask themselves whether they have passed the bank's stress test. If so, just live a steady life and have nothing to worry about. The consequences of Greenspan-style interest rate hikes have been seen by the whole world, and this tragedy will not happen again in 100 years. People who regard investment as short-term speculation care about too many things and are so busy that they can scare themselves up at night after reading Musk's Twitter. Both Buffett and Munger have publicly stated many times that they don't care about central bank dynamics and macroeconomic policy changes. They are not bragging, they really don't care. So what if Greenspan raised interest rates 17 times? Didn't he just lower them back? Really good investors only care about their own circle of competence, within the scope of their abilities. When others are fearful, they will be greedy, and when others are greedy, they will be fearful. real estate investment,It is a typical investment based on ability. Luck does not play a role. Buying lottery tickets depends on luck, and people who buy lottery tickets are without exception blind to probability.
Conclusion:
Einstein said that life is like riding a bicycle. If you want to maintain balance, you must keep moving. The environment is changing, interest rates are changing, and we must adapt, otherwise we will fall. As long as you are alive, you are riding a bicycle and must constantly adapt to maintain balance.
Now that you have immigrated, let’s settle down and learn about capitalism. Complaining and anxiety do not solve the problem. My personal ability is limited and I can only help working-class families who have T4 or T4A income and are willing to work hard to pay off their housing debt; I cannot help people who use Canada as a place of residence and do not declare their overseas income in Canada; I cannot help people who have no working-class income and want to apply for a mortgage. Even so, as a knowledge worker, I still hope that my compatriots can learn more about capitalism in Canada and realize that immigration is worthwhile spiritually and financially as soon as possible. I know that many readers cannot understand the full text of this article, but it is good to remember some of the conclusions, in order to reduce the confusion of rumors and lies, so that each of us can live a more practical and far-sighted life.
Mortgage borrowing capacity calculation formula: