Is post-pandemic Canada set to for sky high inflation? And what does that mean for the economy, interest rates & the real estate market in our immediate future? Carlton Professor and BNN regular Ian Lee joins Adam and Matt to discuss the alarming number of forces that could upend the value of a dollar in Canada, set prices for all things higher, and lead to interest rates heading skyward. So what does all this mean for your real estate goals and portfolio if money is literally worth less and borrowing becomes significantly more expensive? Stay tuned to find out if cash is trash. The professor is in!
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Tell us about yourself.
I’ve been teaching at the Sprott School of Business at Carleton University for about 30 years. Before I became a professor, I worked in the finance world in banking as a lender. I leant millions in consumer loans, consolidation loans, mortgage loans and more. I worked in all aspects of credits and collections in Ottawa and Eastern Ontario and worked with developers as well, giving me real estate experience.
I started when I was 20 years old and was getting promoted once a year, which was very rapid in those days. I then got promoted to the head office in Toronto but told them going to Toronto would be a fate worse than death. I turned it down, but it meant my career was frozen. While I was working, I was doing my undergraduate degree part time. Once I graduated, I applied for a Masters and left the bank to do that full time.
I’m one of the many Canadians who doesn’t believe Toronto is the centre of the universe. I have my roots in Ottawa and never wanted to leave. I have family here, worked here, studied here and now teach here. When I got offered the promotion, I talked to friends who worked in Toronto and knew I wouldn’t be able to afford living downtown or dealing with the commute into the city. The cost of living would go up tremendously, even with the raise they were offering me.
Has the covid real estate boom surprised you?
At the beginning, I wasn’t sure where it was going to go but I knew it wasn’t going to go down. I’ve never witnessed a crash in real estate in Ottawa – a crash being a decline of 20%. I’ve seen flatlines when the market overshoots but never a crash. Historically in Canada, the market adjusts by going flatline, but a decline is very rare. I want to be clear that I’m talking historically, and not making a long term forecast.
I’ve argued that real estate values will go up in Canada because of population growth. If the absolute population is growing year over year, as Canada and the United States have done, real estate values will increase over time. That’s my theory.
If you have the opposite, like the depopulating we’re seeing in Japan right now, there will be empty houses. That happened in Detroit, from two million people in the 1950’s to now less than a half million. That will bring long term declines.
In Canada, we’re bringing in a million people every three years – that’s one new Ottawa every three years. That creates a demand for more housing year over year. Now the liberal government is talking about increasing that to about a million and a half people every three years. That will guarantee an absolute demand increase for housing.
The explosion in house prices has been socially engineered by three levels of government:
- First, the Bank of Canada has driven down interest rates and they have never been this low. They did this for macro economic policy reasons, but it induced people to go into the housing market.
- Second, provincial governments across Canada legislated or threatened to legislate rent controls, which told investors they would not make money in rental housing. Rent controls create rental shortgages, which motivates people to flip from renters to buyers.
- Thirdly, we have local governments imposing restrictions on growth. I’ve argued that “urban sprawl” is a code term for young people and immigrants who want to go to the suburbs for affordable housing. We’ve demonized it by calling it “urban sprawl.” Councillors know the population is increasing. And yet they are limiting development and growth on the edges of the city. I argued that this was structural racism; 70% of our immigrants are non-white and this is creating shortages for them. This is driving up land values and benefiting the people in the wealthiest postal codes.
Those of us in the wealthiest neighbourhoods are supporting policies that enrich ourselves at the expense of those who want to go to the suburbs for affordable housing.
On the recent news from the OSFI (Office of the Superintendent of Financial Institutions) to tighten the income needed to apply for a mortgage
I’m not aware of any study that has shown that a capital gains tax on principal residences will lead to an explosion in new housing to support the shortage. What OSFI did is far superior to a capital gains tax, but it won’t produce more housing. It will address the panic people have about the “housing crisis” but it’s a stopgap measure. The longer term solution needs to look at the restrictions councils are passing that benefit themselves and disadvantage young people and immigrants.
You’ve said that real estate markets in Canada are not having deep crashes but have had flatlines. Long term, what does that look like?
I want to be clear that I strongly support immigration. Our birth rate is declining and we need immigration to support our standard of living. That’s a consensus in Canada. So because of that, we must build more houses.
Will there be a correction going forward? It’s difficult to say.
For those who claim we’re on the edge of a crash, I find that dishonest. The gross wealth of households is $14 trillion. Our personal debt is $2 trillion. So our personal net worth is $12 trillion. The average net worth is $350,000 per person in Canada. If you’re worth far less, there’s older people who are worth way more.
45% of all homeowners are mortgage debt free. So when people talk about a housing crash, the bank can’t take back your house if you don’t owe them any money. 75% of Canadians own a home and almost half don’t owe the bank anything. We also have an enormous net worth.
So I’m not suggesting there’s no risk in the market. But it’s the same old, same old. Who is at risk? Young people starting out who borrow up to their eyeballs, like I did when I was starting out, and live in a big city. That is who is at risk. People who bought in the last 5-7 years with a huge mortgage in an expensive city are at risk.
We can’t aggregate just because there is a crisis in Vancouver or Toronto due to irresponsible city councillors who discriminate against our young people and our immigrants. But it’s not a problem all across Canada. There’s no crisis in the smaller cities or more rural parts of Canada. It’s a big city problem where councillors have acted irresponsibly to restrict supply, which has driven prices up and people further into debt.
Can we talk about inflation and interest rates? Are you worried?
I am worried. There are some very smart people at the Bank of Canada. Today, I don’t believe there’s a risk of inflation and I don’t believe interest rates are going to go up. But in 2-3 years from now, I think we might be facing some risks.
Milton Friedman of the University of Chicago, who won a Nobel Prize in Economics, said that when countries become deeply indebted they turn to the central bank to deliberately inflate the money supply to repay those debts.
More recently, Charles Goodhart, a former professor at the London School of Economics and advisor to the Bank of England, argued that the last 15-20 years of low interest rates is due in part to Boomers around the world being in their peak earning years and paying down their debts, generating savings. We also had the Soviet Union collapse and China join the world economy, which meant millions of people were willing to work for low wages.
Goodhart argues that this trend is now over. Boomers are going into retirement and will be spending their savings, leading to a shortage of workers and driving us into a global savings shortage. Governments will begin borrowing lots of money which will cause interest rates to go up and put pressure on inflation.
I don’t think the inflation will jump tomorrow morning and not while we’re in these covid times. But as we go forward in the next 2-5 years, I think we’ll see interest rates go up. I’ve told friends it’s fine to have a variable rate mortgage but when you see rates go up, lock in. I don’t think we’ll see hyper-inflation but even if we get up to 5% interest rates, that will be a huge increase for those with a big mortgage.
The Prime Minister and Minister of Finance said that interest rates would remain low as far as the eye could see; I beg to differ.
What does this mean for the housing markets?
When I was at the Bank of Montreal in the late 70’s/early 80’s, people were saying the market was going to crash when we hit 12% interest rates. People predicted doom and gloom. But in 1980 when interest rates hit 20%, the national mortgage delinquency rate went from 0.5% to 1%. That means 99% of people paid their mortgage on time.
People would tell me their parents were helping them make their payments. It was the Bank of Mom and Dad. I’ve been using that phrase since 1980. Real estate is a unique market. It’s the only investment market in the world you can sleep in.
I don’t want to say prices are not overvalued; they are mind boggling. But behind many young people who are in trouble is the Bank of Mom and Dad. 70% of Canadians own their homes and many of the older ones have a lot of equity in their homes. What messes up the ability to predict if a market will crash is that backing these people is their families.
I joke that Canadians are so emotionally attached to their houses, that they’ll rob a bank to get the money to pay the bank their mortgage. I’m being facetious but Canadians will do unbelievable things to make their mortgage payments.
The national mortgage delinquency rate in Canada for March 2021 is 0.2%. Only 0.2% of mortgages in Canada are delinquent after a year of covid. Massive mortgage failures are just not happening.
Not everyone has a Bank of Mom and Dad, so if you get into trouble with your mortgage, you sell your house. And you know that you’ll be able to because of the housing shortage. You’ll eliminate your mortgage and make a capital gain to boot.
Is real estate the safest place for Canadians to put their money?
We tend to look at real estate in isolation. We see high prices in real estate but we don’t ask about the alternative. When you look at an investment, you have to ask how well it’s doing relative to other asset classes. We also have to look at the fact that you can live in real estate, but you can’t live in your gold or bitcoin.
I’m not saying you can’t make money in the stock market. The risk for me, because I’m older and conservative, is too great. I’m not willing to put my money into another asset class. A lot of Canadians think like I do: If I’m going to put my money into anything, I’m going to put it into real estate because I can live in it, there’s a shortage of housing and demand is growing.
How do inflationary pressure and interest rate increases interact with the housing market?
Lumber prices have gone through the roof; in one year they went up 300%! They say it’s going to go back down post-covid but won’t go all the way back down. And that’s the same with other building materials, which is feeding into the price of houses.
So not only do we have the socially engineered shortages but now we have the commodity shortages and inflation in building supplies to add upward pressure on housing prices.
What will drive the market down and cause it to crash? Depopulation. But are we shrinking? No, we’re growing by a million people every three years. Immigration drives the population up. City councils restrict supply. Building resource costs are going up. And I don’t see a driver pushing any of these things down.