The Biggest Risk In Canada's Economy Right Now

[00:00:00] Welcome to the Canadian Real Estate Investor, where hosts Daniel Foch and Nick Hill navigate the market and provide the tools and insights to build your real estate portfolio. Today we're going to be talking about condos and how they're having a bad time right now in certain Canadian markets.

[00:00:20] Yeah, not just any condos though. We're going to be talking about pre-construction investors and resale condos. We will touch on how they're the biggest challenge in Canada's real estate market according to one bank economist and from my perspective, maybe even the biggest headwind

[00:00:35] in Canada's economy at the moment. Yikes. Yeah, then we're going to compare the condo market to the detached market. And we'll hopefully have some time to compare a pre-construction deal to a resale condo

[00:00:49] to a detached investment and talk a little bit about the pros and cons of each. We will probably start by using the investment deal from a recent CIBC and Urbanation report.

[00:01:00] If you want to learn how to do math like what we're going to do in the show, check out realist.ca, which is our course and community. Okay, let's get into it. I'm going to read to you the opening line from that recent report, Dan, that you

[00:01:13] just mentioned by Sean Hildebrand from Urban Nation and Ben Tal from CIBC Economics. It reads, the Canadian housing market in general and the GTA market in particular are facing the most significant test since the 1991 recession. To quote the legendary Taylor Swift, don't say I didn't warn you.

[00:01:34] Can you sing that Dan? No, I will not. Are you a secret Swifty? It is not a secret that I am a Swifty. I'm an unashamedly massive fan of Taylor Swift's Red album and everything before it.

[00:01:47] And I'm sorry to anyone who has a problem with me saying this, but Taylor peaked at Red. Speaking of Red, Dan, that is exactly the color the pre-construction condo investor will be seeing on their balance sheets according to this report.

[00:02:02] Read a little bit more from the report for me. Would you Dan? The GTA housing market is currently a tale of two markets, the report says. The low rise market appears to be in reasonable shape with limited inventories and improved sentiment given the recent trajectory of mortgage rates.

[00:02:20] This is not the case in the condo market, however, which is clearly in a recessionary territory with conditions deteriorating to levels not seen in decades. What makes the situation even more challenging is the role of investors in the presale

[00:02:35] market, which have made up to 70% or more of buyers that play in that space. So the report says to understand where we are and where we are headed in the essential to get a clearer picture of the condo investment space at this moment in time.

[00:02:52] Combining data sets from Urbanation and TerraNet, they do exactly that. The following note updates previous studies they conducted on the topic, which gives us a sense of where we are now relative to the past.

[00:03:03] Now according to CIBC, the GTA condo market is in a state of economic lockdown. The math doesn't make economic sense, both from the demand side, which is represented by investors and from the supply side, which is represented by developers, which leaves the market at a standstill.

[00:03:26] Prices are too high for investors to buy relative to resale prices, rents and interest rates while developers can't lower prices due to high development costs. As a result, new condo sales, the primary driver of new home construction in Canada's

[00:03:41] largest market have dove off a cliff to their lowest levels since the late 1990s. And you can see on the chart that for those of you who follow along visually or I posted a lot of this on social media, on my Twitter, YouTube, et cetera, I think

[00:03:58] Instagram as well. Condo sales dropped from about 15,000 in 1987 to below 1,000 in 1990. I guess it's worth discussing what happened to Canada in the 1990s since I think even Ben Tal is now talking about it as a comparison. Yeah, and it's no surprise to you.

[00:04:16] Listen, if you've been a faithful listener to the podcast since episode one, you know that we drew this comparison over two years ago. People all called us crazy back then, but now the mainstream economist is catching up

[00:04:32] and mainstream economics is now catching up to what we have said. Now, Dan, you were born in 1991, just born. So why don't I start us off with a refresher of what happened then?

[00:04:44] Yeah, good idea because you were two years old at the time and paying a lot of attention to what was going on in the economy at that age. The no comment there. The 1990s recession had a notable impact on Canada's economy and the real estate market.

[00:05:00] So I'm going to go over a couple of the quick details, Dan, jump in here as well. Economic impacts. The first one would be the recession onset. The recession in Canada began in the early 1990s largely due to a combination of,

[00:05:14] probably sounds familiar, high interest rates, reduced consumer spending, fiscal austerity measures, implemented control, inflation and reduce national debt. Then what happened then? Following that, we started to see an increase in unemployment and what I would call high unemployment. They peaked over 11 percent in 1992.

[00:05:33] This high unemployment affected consumer confidence and spending power, further depressing economic activity. Canada's unemployment rate is currently at six point four percent for context. So we have a long way to go if we're going to get to double digits.

[00:05:46] Yeah, from there, government deficits and debt tail as old as time. The federal government and several provincial governments were running large deficits. This led to significant debt accumulation, prompting austerity measures, including spending cuts and tax increases, which further slowed economic growth. History really does rhyme.

[00:06:09] Yeah, that one definitely sounds a little familiar. And then finally, this one's going to sound familiar, too. Interest rates were a big economic impact. The Bank of Canada. Yeah, I know the Bank of Canada maintained high interest

[00:06:19] rates to combat inflation because in the 1980s things were basically ripping. The economy was super hot and there was high inflation. While this policy helped to stabilize prices, obviously, it also discouraged borrowing and investment, exacerbating the recession and especially

[00:06:34] impacting real estate, which had seen a huge boom in investment in the 1980s. So let's talk about the impact there, because that's what the show is about, the real estate market. Yeah, for sure. Well, unfortunately, real estate was crushed, heavily impacted by the recession, the Bank of Canada.

[00:06:52] Here's a list of some of the activities that they went through in the 1990s and some of the things they had to deal with. The first is the kind and house prices, then reduced sales and new construction, followed by bankruptcies, foreclosures, power of

[00:07:07] sales and overall economic financial strain for Canadians. Reduced demand for commercial real estate. We're seeing that one right now play out. And then the impacts were different across Canada. Of course, some bad, some not so bad. Again, that's the tale. So that's the story that happens everywhere, right?

[00:07:27] The good and the bad and the ugly. But what's important here is the recovery from this recession didn't start years later until 1995 or even some say 1996. So, Dan, can you dive into the list I just went over? Let's start with house prices. Yeah.

[00:07:44] So it started off with a decline in house prices and condos were actually the leading asset class that kind of were the first piece. Let's call it the straw that broke the camel's back. So you saw a big decline in condo market and that led into this

[00:07:57] economic downturn that was particularly pronounced in major cities like Toronto and Vancouver where real estate markets had been booming in the late 1980s. From there, reduced sales and new construction. A number of real estate transactions fell sharply. Many new construction projects were delayed or canceled and

[00:08:14] developers faced financial difficulties and the supply of new housing units decreased. And it's kind of crazy because I remember like right when we were running up to or right when we're at the peak and kind of things started to roll over, I was invited to join

[00:08:30] the brokerage I'm at now and they asked me to do a presentation to all of their realtors about sort of what was going to happen. And I literally said, I was like, go look at the 90s. Real estate transactions got cut in half and right after that

[00:08:42] they did it. I remember I was actually on BNN Bloomberg talking about how real estate transactions would drop like 40 to 50 to 60 percent in total dollar volume and I actually had like threats from people in the industry and blah, blah, blah, a bunch of stuff.

[00:08:55] And then it happened within a year. So it's kind of funny that reduction in economic activity led to things like foreclosures and financial strain like you mentioned. So many homeowners face financial strain due to job losses and high mortgage rates. We saw an increase in foreclosures, distressed

[00:09:11] property sales, power of sales and that further depressed property values. Yeah, the collapse of Olympia and York, Dan, I think would be a great example. I know we've toyed around with the idea of doing an episode on it just for context. They were a major international property

[00:09:28] development firm based here in Toronto, Ontario. The firm built major financial office complexes including Canary Wharf in London, another notable one, World Financial Centre in New York and if you know the Toronto Skyline, the big white building with BMO on the top known as First Canadian Place.

[00:09:48] They built that as well. So some noticeable, notable, sorry, big builds worldwide but they went bankrupt in the early 1990s. And today fast forward we've seen major projects like Mizrahi is the one in Toronto, one of the most notable projects in the country.

[00:10:06] So all those companies like State View and Van Dyke and more in the news but nothing to that Olympia and York magnitude yet let's say. Though there is a lot of speculation that real estate companies of that size and magnitude may be in trouble today in Canada.

[00:10:21] Yeah, now speaking of size, let's move over to what happened in commercial real estate back then. The commercial real estate sector was obviously also affected. Reduced demand for office and retail space led to higher vacancy rates and lower rental incomes. Well Dan, that one might be worse nowadays

[00:10:39] because guess what they didn't have back in the 90s? Good old pandemic. Didn't have Zoom either. Didn't have Zoom either, yeah so I think commercial 90s versus now might be in more trouble in some areas. Now that's a whole nother subject so we're not

[00:10:57] gonna get into that too much but. I know retail. What happened next Dan? I mean retail hasn't been as bad because we have so many people in Canada, so many people moving in and we can't increase our retail footprint but commercial definitely is a big question mark.

[00:11:08] And on that note, that's a kind of asset class by asset class variation. We also saw regional variations. So like certain recessions you saw Calgary do a lot better than Toronto and some recessions you saw Calgary do a lot worse than Toronto.

[00:11:20] The impact of recession varies by region and in the 90s those that were heavily reliant on manufacturing and resource industries experienced most severe economic and real estate downturns. So think about what industries have the most exposure today in Canada and maybe you can make

[00:11:35] some sort of investment decision for the recovery phase. And Nick, talk to me a bit about that recovery phase. Yeah well Dan it began in the mid 1990s. Again years after it had started and the damage had been done. But the Canadian economy began to recover.

[00:11:50] Lower interest rates, improved consumer confidence and government fiscal reforms all contributed to this recovery. The real estate market gradually stabilized. Prices and sales volumes improved over time. Yeah I think in episode one we talk about this quite a bit or episode two I guess it was

[00:12:09] because number one was the preview. But you know we kind of talked about the 80s downturn and the 90s downturn. 90s was a little bit longer. But we have a kind of faster flow of information now and I think we both sort of thought like okay

[00:12:21] this will probably hit the bottom maybe 25, 26. So like three years, four years after rather than five or six years after. Now there were a few key factors in that recovery that you're talking about. And these were fiscal reforms, monetary policy, trade agreements and technological advancements.

[00:12:37] So start me off on a little bit more of that policy side. Fiscal policy, love talking about fiscal policy. The Canadian government implemented significant fiscal reforms. This included, again this is back in the 90s, this included budget cuts, tax reforms. They did this to reduce the deficits

[00:12:57] and the debt levels that they had grown. And these measures helped to restore investor confidence and stabilize that economy. And that investor confidence and consumer confidence is so important when we're staring down the barrel or in a recession. Yeah 100%. And you know I mentioned a couple of things.

[00:13:16] Like I really feel, and you have to be very careful when you throw this word around, but I feel like the CMHC might have to provide some sort of credit product to almost bail out inventory units of builders to keep this whole machine moving

[00:13:29] without creating too much of a collapse. And we're gonna discuss a little bit more of why we think that is. But you know the alternative would be in 25 or 26 when we hit this big gap that could appear in the construction industry or maybe even later than that, 26, 27, whatever.

[00:13:43] It's either you fix it today or you fix it later with a bunch of infrastructure spending to try and keep all of those construction workers employed. And we'll get to kind of what could potentially happen there. First, monetary policy. The Bank of Canada gradually reduced interest rates

[00:13:55] as inflation got under control and this encouraged investment in consumer spending, right? For sure. There was also, Dan you mentioned trade agreements. This one probably rings a bell for a lot of people. The implementation of the North American Free Trade Agreement, commonly known as NAFTA in 1994.

[00:14:15] That also helped to boost Canadian exports, particularly to our friends south of the border in the US and that obviously helped with regrowing some parts of the economy. Yeah, and with a weak Canadian dollar it was almost a good thing because we were big in the manufacturing space.

[00:14:30] So it was actually good for the economy to have a weak Canadian dollar because the US people were buying tons of stuff from us because it was so cheap relative to their dollar. We don't really have that set up today. The trade agreements,

[00:14:38] I can't see any new trade agreement evolving and we also haven't really, we don't really have this huge manufacturing sector. Maybe the resources we could benefit from oil and other resources with a low Canadian dollar because the Canadian dollar is starting to fall

[00:14:52] as a result of monetary policy. The last piece is technological advancements and this is gonna be a big one from my perspective that we have potential to see play a huge role. The 1990s saw the IT sector, computers, honestly.

[00:15:05] Like these are, and right now I think we're seeing as big of a paradigm shift in technology where you're seeing AI and all of these new things. It wouldn't surprise me if technology started to play this role in the recovery of Canada's economy.

[00:15:19] Yeah, I mean that would be great to see. So wrapping this up, Dan, in summary the 1990s recession in Canada had a profound impact on the economy and in the real estate market and it led to significant declines in housing prices and of course declines in construction activity.

[00:15:39] Yeah, and that's my big fear with what we're facing today, right? The construction industry has 1.5 million workers according to the latest data from Statistics Canada's Labor Force Survey. So if we saw a reduction like the 1990s, it would really hurt today. Yeah, and we're gonna see 50,000 condos

[00:16:00] expected to complete in 2024. Half of that, 25,000 in 2025 and even less, 20,000 of them in 2026. So again, that's 50,000 this year, 25 next year and only 20,000 condo units in 2026 which means that a ton of supply is being added to the market today. But when you look forward into 27, 28,

[00:16:23] things really dry up because those closings are from condos that sold as pre-construction condos in 2019, 2020 or even 2021 when the market was hot. Yeah, and if you look at Urbanation's website, they say that the Greater Toronto Hamilton area, the GTHA, New Condominium Market reported

[00:16:42] 1,461 sales in Q1 of this year. That is the lowest quarterly sales since the global financial crisis back in Q1 of 2009, which reported 884 sales back then. Yeah, and if you exclude that very brief period in 2009, new condo sales haven't been this low since the late 1990s.

[00:17:05] So, and the population, think about it, per capita, the population would have been like 10 or 15% lower then, if not more. So sales were down 71% compared to the latest 10-year average for Q1 periods, which is about 5,000 sales, dropping 85% from the Q1 high of just under 10,000 sales. Wow.

[00:17:27] So in 2027 or 2028, there aren't going to be very many condos built because no one is buying those condos pre-construction today. Exactly, which means lower residential construction activity in 27, 28, 29, well as long as this lasts until the problem gets solved. And that's how you end up facing

[00:17:48] that five-year recovery timeline from the 1990s because all of this stuff lags. When the condo pipeline dries up, there's no new jobs for people who were building those condos. Yeah, it's a great point. I mean, I've already heard reports and whispers of GTA union trades

[00:18:04] having to move to other cities like a Sarnia or a suburb for example, for non-residential projects, even going to other provinces in some cases like Alberta or even BC because of this. And that kind of gets back to that difference by geography.

[00:18:19] It does seem to be most severe in the GTA and not so bad in other places. So I guess this is maybe the one time you wouldn't want to be at the center of the universe in downtown Canada here. Yeah, I mean, I guess it is very poetic

[00:18:32] for the rest of Canada to watch Ontario's economy burn to the ground. Ontario's unemployment rate is 7% now and I think GTAs is even higher than that. So you're probably listening to this and asking yourself, how do we get into this mess?

[00:18:47] Well, let's unpack that by returning to this report by CIBC and Urban Nation. I'm gonna pick a little quote out of here, Dan. The percentage of pre-construction condos that are pre-sold is at a more than 20 year low of less than 50% and that's on the second chart

[00:19:06] for those following along here. Without at least 70% pre-sales, projects cannot begin construction. A fact that is working to dramatically slow down the supply pipeline, this reality will result in a sharp pullback in completions and a stagnating housing stock in the coming years

[00:19:25] which is sure to make the affordability situation even worse. And this is one of those industries' dirty little secrets. It's a little known fact about Canada's condo market. In order for a project to get construction financing, it needs to have pre-sold about 70% of its units

[00:19:41] so they rely on investors to get projects done. Then a lender can become confident the project has enough buyers but that's not happening anymore. Yeah, there's this very dramatic looking chart in the report here, Dan. Basically, a reverse hockey stick graph

[00:19:57] or I could guess this is what people talk about when one of these lines is falling off of a cliff and that shows how basically from 2019 to 2022 over 70% of units sold, of units were sold which means a lot of condo projects were obviously viable in that market.

[00:20:15] But then basically as soon as interest rates started going up, that line started going down off of the cliff as you said or as Ben Tal said earlier in the report and it now sits at below 50% of units sold which is not enough for most developers

[00:20:30] to be able to get financing on their projects. So what happens? Well, the report explains that this really scary reality that this crash has created from a macro perspective the dramatic slowing in condo activity has really important implications. As a simple rule of thumb each construction crane

[00:20:50] represents about 500 jobs. There's a cool takeaway for you. Next time you see a crane you want to sound smart with anybody? Drop that line. Already the number of condo projects under construction in the greater Toronto area has been reduced by no less than 75 since 2022. That's impacting nearly 40,000 jobs

[00:21:10] and the official statistics already reflect that. As of June this year overall construction employment in Ontario fell by no less than 7.5% on a year over year basis with the exception of course of COVID recession but this is the weakest showing since the actual recession back in 2008.

[00:21:31] And construction costs which surged in recent years but are now stabilizing or even declining in some areas will offer temporary relief for developers but they don't think it's a trend that will last. They don't expect the Bank of Canada to halt its easing campaign anytime soon

[00:21:48] and anticipate the overnight rate to reach around 2.75% which we covered in another episode recently by the end of 2025. These factors along with reduced construction costs should help condo developers align prices with market demand also known as prices will have to come down in that regard.

[00:22:05] Another key factor you may have heard about this one, population growth. The federal government's efforts include a new cap on international students and a targeted decrease in temporary residence to 5% over the next three years. Now while this policy may not significantly reduce population growth in 2024,

[00:22:28] growth will likely slow in 2025 and 2026 and combined with higher condo completions this may ease pressure on the rental market but may hinder condo investment demand. So they go on to say that at least for now they doubt these forces will make it possible

[00:22:45] for developers to lower prices enough to attract investors back into the market. So this is obviously gonna be a kind of extended problem and they feel the elevated interest rates and ever increasing development charges which we've mentioned many times on the show

[00:22:59] mean new condo prices will remain sticky and there's these two different types of competition in economics, a corno competition, can't remember the other one but basically where one type of producer can reduce prices and the other type of producer when met with declining demand will reduce quantity.

[00:23:20] And so this we're obviously learning that developers can't reduce quantity. Or sorry, they can't reduce prices, they can only reduce quantity to meet the market demand. Now Dan before you were educating me there you did mention new condo prices. Well, new condo prices have actually dipped

[00:23:40] by only 5% from their high. Well resale condos prices have corrected about 12% and are at risk of a further decline given recent surge in listings which is again shown in this report here on the chart four. Buyer incentives offered by developers and rent growth of 30% from COVID lows

[00:24:04] help bridge some of the gap for investors but it's not enough. Quite simply new condo investment doesn't work at the current market average price of close to $1400 per square foot. Yeah and we're gonna do some math in a minute to kind of illustrate exactly why

[00:24:22] and we're gonna use only $1200 a square foot because that's kind of the average of a lot of these pre-construction units that sold a couple years ago that are supposed to be closing today and the resale market's at about $1000 a square foot downtown just for those who are aware.

[00:24:35] So for condo investment to get back into the game as they mentioned in the report, we need resale market prices and rents to pick up and the speed of that and interest rates dropping quite a bit. Right now the price gap between new and resale condos

[00:24:52] is at almost all time high of around 60% and which is like 20 percentage points above the usual dimension. On top of that, rental yields are just a bit higher than the record lows during COVID and basically lower than the risk free rate that you can get from government bonds

[00:25:10] which they show in chart five of this report. So basically, if you could, I guess on a condo you can get leverage so it's a little bit better but I imagine you could probably get leverage to buy bonds but it's like why would you buy a condo

[00:25:22] if you can just buy a bond? We're gonna compare it to other things, other types of real estate fortunately for you but that's kind of where they're showing. You could literally buy a bond and do better. That's not good. CIBC's report goes on to say that

[00:25:37] when it comes to new condo investments there are three big things that you need to keep an eye on. Price appreciation, rental cash flow and market confidence. Now, they make it clear they don't really want to make any wild predictions about these factors and where they're headed.

[00:25:56] Instead, they just wanna give you a clear picture of what's going on right now. So Dan, what is going on right now? So if we just look at rental investment flows in 2023, 34% of newly completed condos were used as rentals but this dropped to 25% in early 2024

[00:26:15] due to higher mortgage rates. Investment in the resale market also fell with units bought and then rented declining to 10% in 2023 and just 2% in early 2024. This was expected due to the challenges of buying and renting in the same market and basically a lot of people are actually gonna try

[00:26:33] and sell them rather than rent them out because the numbers don't work which we'll get to. Okay, so let's talk about that rental cash flow analysis so you know if you listen to the show. Dan and I are big cash flow guys.

[00:26:45] Well, let's see what these condos are doing. In 2023, nearly a quarter of new rental condos had no mortgage consistent with previous years. Of all condo rentals completed last year, 58% of them had a mortgage and were cash flow negative. Well, 18% had a mortgage and were cash flow positive.

[00:27:06] Oh man, that is not good. Focusing solely on leveraged investors for this analysis, 77% were cash flow negative in 2023. This is a significant increase from 2022 which was the first time the majority of investment units turned cash flow negative at 52%. So 52% which is already horrible jumped up over 20% to 77% in 2023.

[00:27:39] The first half results of this year 2024 show the situation's actually worsening with 81% of leverage so investors holding a mortgage, 81% of leveraged investors in cash flow negative positions. Oh man. What a mess. What a mess. Yeah, so CIBC's analysis further found that on average condo investors

[00:27:58] who closed on newly completed units in 2023 experienced a negative cash flow of about $600 per month. This is more than two and a half times the negative cash flow investors who closed in 2022. So basically the cash flow negative position is getting worse.

[00:28:13] And the percentage of people who are cash flow negative is getting worse. And you know what? Nobody's really weeping for these people and we're not trying to rub it in their faces or say that people should feel bad for them.

[00:28:23] What my concern is is when you have this many people and we're gonna kind of quantify the number of these people as well, those are all, like that's all money that isn't going to buying other stuff in the economy. And this is how you see these knock-on effects,

[00:28:36] the secondary effects of this contracting the economy. So in 2022, people were only $223 cash flow negative and it's a significant change from the days of positive cash flow in 2020 and 2021 when people, that's when people were buying these condos because it looked like a good investment

[00:28:53] and that's shown in chart nine in their report. Who would have thought the good old days were 2020 and 2021 at this point? Yeah. Okay, so let's pause there for a second, Dan. Let's pause and compare what we just went over

[00:29:07] to a detached or even a resale condo of the same valuation. So if someone bought a pre-con, I'm assuming they paid, let's say $1,200 per square foot, the resale market is about $1,000 per square foot right now. So if you wanna spend $650,000, let's say,

[00:29:26] which I think is around the average, let's do the math. You could buy the average Toronto pre-con condo for $650,000, divide that by 1200 bucks a foot, it gets you about 541 feet, which is probably a one plus den or a one bedroom, one bathroom.

[00:29:42] So give me the rents on that from Door Insight. Yeah, so according to our good friends, friends of the show over at doorinsight.com, make sure to go check them out, download their Google Chrome extension makes investing a hell of a lot easier.

[00:29:55] They also have great databases on a whole bunch of stuff but we're looking at their market rent database today. That unit for rent Dan that we're mentioning the median rent would be around $3,050 plus utilities or about $4.11 per square foot. So any 80% mortgage, 20% down would be 520,000

[00:30:18] which gives you a payment of about 3,050 a month which is basically the exact same as rent. Condo fees let's say on the lighter end would be about $350 a month. And of course you got your forgotten costs of taxes, maintenance and insurance.

[00:30:33] So let's say another $150 a month very generously and then we'll look at utilities. We'll leave those out assuming that the tenant may be nice enough to pay for those. So let's total up those costs now. 3,050 mortgage, $350 condo fee, 150 bucks for TMI equals roughly $3,550. Your rental income is $3,050.

[00:31:00] So you're losing $500 a month to own that condo and that's before considering things like commissions, land transfer tax, legals and the occasional thing that goes wrong operating that condo. Yeah and most people were happy to be in that cash flow negative position before

[00:31:19] because the condos were going up in value but that is not the case anymore and people aren't lining up to buy these condo units anymore and this is where we have arrived at this problem. Now you could buy a nearly identical condo

[00:31:35] in a comparable building in the resale market for $1,000 a square foot and the rents would basically be the same. You just pay around 550,000 for a 550 square foot unit instead of $650,000 and the rents wouldn't be that much better for that brand new unit.

[00:31:56] And the condo fees and the TMI would essentially be the same. So take me through the math here Dan. So since you're paying about 20% less, your 80% mortgage drops to $440,000 and the mortgage payment would drop by a comparable amount to $2,600 a month rather than $3,000 a month.

[00:32:15] We will just take the non-mortgage costs of $500 from the comparable building since they're gonna be very similar if maybe this building's one year old and the pre-con is brand new. Condo fees would be about the same, 350 a month, TMI 150 a month. Utilities we will leave out again

[00:32:31] because the tenant's paying them in this scenario. Your total costs are $2,600 mortgage, 350 condo fee, 150 TMI equals $3,100 monthly. Rental income is just over 3,000 per month at 3050. So you're losing about $50 a month to own the resale condo which is not bad but it's still not great

[00:32:50] and it's certainly not the type of investing that we advise people to do. So why would someone choose a pre-con over a resale? That's a very good question. Well, during the boom in 2020 and 2021, people were willing to pay over market value for a pre-con because they thought

[00:33:06] it will be worth $1,200 a square foot. They were paying by the time that they took possession so a few years out, right? When you buy a pre-con unit, you're giving a deposit and committing to take possession of the unit when it's built contractually.

[00:33:22] And the deposit itself is one of the reasons people bought pre-con as well. The deposits were spread out over a year or so so you could pay 5% on signing and then 5% after 30 days, 60 days, 90 days, et cetera. Some were even actually spread out over two years or more.

[00:33:37] Yeah, so that naturally attracted people who bought pre-con because they literally couldn't afford to buy a resale during that time. And unfortunately, now that they're built, it turns out a lot of those people can't afford the units today either. Well, they bought when rates were 2%

[00:33:53] and now rates are 5% so that definitely creates a problem as well. Yes it does and again, most people didn't care much about being cash flow negative because values were skyrocketing, right? But now that they're built in most cases, they're not worth what those people

[00:34:09] had hoped they would be. And that's the part I think Bental's analysis misses. Maybe deliberately because they're a bank who has exposure to this asset class, I imagine, but is the majority of these condos have negative equity, not just negative cash flow.

[00:34:25] So basically someone buys the unit for $1,200 per square foot, it's worth $1,000 a square foot today. That means they basically roughly lost about 20%. So yeah, if they're putting a 20% deposit in, they lost their entire deposit, not accounting for land transfer tax, legal fees, all the other fees on closing

[00:34:45] which can be 30 to $100,000. And those are sunk costs. So if you think about how many condo units are going to close in the next five years and it's something like 125,000 condo completions in the next five years, assume they're all the average price that we mentioned of 650K.

[00:35:00] They've lost 20% on average or $130,000 per unit across $125,000. Do you have your calculator out? Do you wanna run the numbers on that one or is it gonna scare people too much? No, but I am a genius that does this kind of math in my head.

[00:35:13] So don't worry, I knew the answer already. That is 16 billion, Dan, or 250 million in losses. And I guess that explains why. No, 16 billion comma 250 million. So 16.25 billion dollars in. Wow, 16.25 billion. Okay, maybe I'm not as good as math as I thought. There you go.

[00:35:31] So I guess this explains why we have record condos listed on the market in Toronto and record low purchases of condos at the same time. The market has lost confidence in this asset class. But I recently posted a chart on my Instagram

[00:35:43] that shows how investors are actually purchasing more real estate than they ever have in Canada. So if investors aren't buying condos, what are they buying? The answer I would say is low-rise real estate. And let's try to understand why they'd be doing that. Yes, love it.

[00:36:02] Okay, so let's take that same $550,000 that you could've spent on that resale condo which was the better option for condos. And let's say you're a very intelligent person. Can you go buy a Duplex somewhere else in Canada? Yeah, so Vernon, BC, I'm looking at a Duplex for 550,000

[00:36:20] at just shy of 7% cap rate which would be cash flow positive of $522 per month. So you could certainly put that $522, or that $550,000 to work better outside of GTA condos. Yeah, there's one in Hamilton I'm looking at right now. Liebel Duplex with separate hydrometers,

[00:36:38] six and a half cap rate, $700 in positive cash flow a month. Up down Duplex in London, Ontario. So it doesn't have to be outside of Ontario even. Six cap, 355 positive cash flow per month. Yeah, listen, they are literally everywhere. There's people doing crazy deals in Lethbridge, Alberta.

[00:36:55] I see one in St. Catharines right now. Quebec City, we're working on stuff in Moncton, Halifax, St. John's, Saskatoon, Edmonton, even up in the territories. Dan, we just helped a client buy a 10.6 cap in Winnipeg. You can find cash flowing deals all over the country for under $550,000.

[00:37:12] Just not Toronto condos. Okay, so let's get back to the report here, Dan. The report really does provide some sobering algebra on this. Okay, so well rents achieved on leases of newly completed condos rose 8% last year to a record high average of nearly $2,700 monthly.

[00:37:39] Ownership costs rose 21% to nearly $3,250 per month. Okay, right, so rent was 27, ownership 3250. This was due to a combination of higher price units reaching completion in a higher interest rate environment. Now since 2022, ownership costs have soared by nearly 60%, more than doubling the increase

[00:38:03] in rents over that same time period. And this is where it gets absolutely mind blowing. When examining the distribution of cash flow by dollar amount, the results showed that 30% of investors of new condos completed in 2023 were cash flow negative by over $1,000 per month.

[00:38:24] And this was more than double the 14% share in 2022. Man, like $1,000 a month is like you can, go get a Porsche or some kind of crazy car or like I mean to be losing $1,000 a month on. Yeah, that's my truck payment.

[00:38:40] Yeah, and you use that truck all the time as an actual, I'm not gonna trip you then. You are actually a truck guy that uses the truck, not just a truck for show guy but. Yeah, groceries are heavy man. Anyways, that is mind blowing and scary.

[00:38:58] So if it wasn't for the increased share of mortgages provided by the big five banks, rental cash flow likely would have been even worse. The big five banks held nearly three quarters of all investor mortgages that closed back in 2023 up from 55% share in 2022.

[00:39:18] Now, the big five generally offer better rates in financing terms for investors compared to other lenders which of course range from credit unions to trust companies to mix and private individuals. And if you are in the market for a mortgage, please reach out to Dan or myself.

[00:39:37] Wherever you are in the country, we can service people everywhere. You know, we place people with all those lenders. But anyways, negative cash flow positions on those loans provided the big five banks, they averaged $359 for newly completed units in 2023 versus negative cash flow of $918 on loans

[00:39:57] provided by other types of lenders. So a lot of bad news in there. Yeah, and they concluded also that the bigger the unit, the larger the negative cash flow position. So studio units, and this is why you see a lot of investors piling into studio units

[00:40:10] and builders wanna build more studio units because they rely on investors to fund their buildings. And so as many small units as they can get because they're cheaper, they can get more investors which means more projects. And those were basically cash flow neutral on average

[00:40:24] for condos completed in 2023 compared to negative cash flow averaging 500 for one bedroom units, 700 for two bedroom units and 866 for three bedroom units. So this provides some insight as to why investors favor smaller units, the report says, as the scarcity of rental options in the market for larger units

[00:40:44] or it's kind of created that scarcity. Only 3% of condos completed in 2023 that were held as rental investments were three bedroom units. So a lot of those bigger units probably absorbed by end users, families, et cetera. Yeah, and I mean, we've talked a lot

[00:41:00] about the damage that is doing to Canadian youth essentially building too small of places for younger people to start families. And Dan as landlords ourselves and guys that obviously like investing in real estate we've all heard the commodification of housing, right?

[00:41:19] And I don't think a lot of people understand what that is, but I think what we're describing right now is exactly that and it is really turned on us, right? Investors are only investing in smaller units. Builders only build smaller units

[00:41:35] that has a negative effect on human behavior and so on and so forth. And now we're at a point where all of these people have bought these units that they can't afford and that are losing between hundreds and thousands of dollars a month, which is just shocking.

[00:41:48] So final question for you, Dan, why would someone buy a condo? Yeah, so I guess on the pre-con side, like if they're newer, so you would assume, you know, you would hope there's less issues when you own something that's brand new. Doesn't appear that that's actually the case,

[00:42:03] but we can set that part aside. You know, if you own a condo, it's less maintenance. So condo corp does most of the maintenance. You know, you're really only responsible for the, you know, the finishes on the interior of the unit.

[00:42:15] And so, you know, you don't have to do snow removal, lawn care, et cetera. You're in an urban area, so your leasing cycle is definitely gonna be shorter. You know, there's definitely more demand in urban areas, regardless of which city you're in in Canada. Populations are growing quickly

[00:42:31] and they're growing exceptionally quickly in cities. So any city across the country would see more demand than a rural area. And you also see more rental in urban areas than rural areas. So you have more demand for rentals, right? A lower vacancy rate,

[00:42:45] which means your lease up is faster and a more stable, like, you know, yeah, you could be getting a 10 cap in Winnipeg, but it might take a longer time to lease. And I'm just not saying that that's actually the case, but, you know, in some rural area

[00:42:57] where you can get a 12 cap, it, you know, you might take three months to lease your suite up. So, you know, and there's a lot of people who own their houses or there's not a lot of people looking for rentals.

[00:43:06] And that kind of goes to the next point, which is, you know, investors believe in these urban areas, right? If you're bullish on Saskatoon or Toronto or whatever, you know, people are more likely to buy into like a city or then like some small town in some area,

[00:43:19] because it's kind of hard to really like get behind a geographic thesis for a small town because a lot of them just depend on these urban areas. You know, these bedroom communities, it's like, oh, it's because it's close to New York City

[00:43:31] or close to Toronto or whatever, right? Yeah. And the final piece would be, people think the value will go up. I think that's really the big reason is I think people believe in the scarcity and they try and get the cheapest, like kind of lowest entry thing

[00:43:44] that they can get for condos. Look, I've been bearish for a long time and I was wrong for a long time. And I think a lot of people were right that values were gonna go up and now they're wrong. But that was probably the other reason

[00:43:57] why a lot of people bought these condos. Yeah. I mean, I appreciate us ending this on a note where we're saying there are several positives about condos and listen, there are. I've spent most of my adult life living in condos in cities like Toronto and Vancouver.

[00:44:13] Yeah, I think you and I, like even when I've been talking about buying like a Saskatoon or some of these East Coast cities that I've been interested in just testing a thesis, I've literally just been like, hey, do you wanna just test it out

[00:44:23] on getting a condo in one of these markets before we actually build out a whole management program and find all of our. And so I'm not like, I get the asset class. It's just, it hasn't worked well in the past three years for Toronto.

[00:44:37] Yeah, and I think that was a kind of just a crazy combination of variables that variables and unfortunately greed by many parties involved that have kind of led us to this mess and we are far from over

[00:44:51] and far from, and the cleanup is gonna be big on this one. I mean, look, like I just said the last three years it didn't work. The 30 years before that it did. So basically since the 90s when we're talking about at the beginning of this report.

[00:45:05] So even if it's a bad investment class it takes 10 years to correct like what happened in the 90s still one or 10 of the last 40 years were bad. Right, so it's still like that's still only an investment that misses 25% of the time.

[00:45:20] If 75% of the time it works every time then you're good. What's that? Isn't that a line from. Some panther, sex panther cologne. Smells like pure gasoline. And on that note we will wrap it up. 75% of the time you should listen to us every time.

[00:45:38] Thank you so much for listening. Hope we didn't scare you too much in this episode. If you want any advice. Just blame it on Ben Tau. Yeah, exactly. If you want any advice on markets to invest in or you need a mortgage

[00:45:51] or you're looking at a certain asset across the country reach out Dan and I work with the best people in every market across the country. Find us at meetups across the country as well at meetups.ca and check out realest.ca too

[00:46:07] if you want to take your real estate investing journey to the next level. Thank you so much for listening as always. We really appreciate it. We'll talk to you soon. The Canadian Real Estate Investor podcast is for entertainment purposes only and it is not financial advice.

[00:46:23] Nick Hill is a mortgage agent with Premier Mortgage Centre and a partner in the G&H Mortgage Group. License number 10317. Agent license M21004037. Daniel Foch is a real estate broker licensed with Rare Real Estate, a member of the Canadian Real Estate Association, the Toronto Real Estate Board

[00:46:47] and the Ontario Real Estate Association.