Episode 59: Safe as Houses? | Canadian Banks & Real Estate

There are few things that Canadians hold in as much esteem as their banking institutions. We Canadians are pretty fortunate to have a banking system that is robust and regulated, but are those handful of publicly traded institutions the best place to invest your hard earned money? What about Real Estate? We're tackling the big questions today on Barenaked Money.

What is Barenaked Money?

The naked truth about all things finance, from a Canadian perspective. This podcast is created and delivered by Verecan Capital Management Inc.

Verecan Capital Management Inc. is registered as a Portfolio Manager in all provinces in Canada, except Manitoba.

Announcer
You're about to get lucky with the Barenaked Money podcast, the show that gives you the naked truth about personal finance, with your hosts, Josh Sheluk and Colin White, portfolio managers with WLWP Wealth Planners/iA Private Wealth.
Colin White
Welcome to the next edition of Barenaked Money. Josh and Colin coming at you. We're going to attack a couple of sacred temples for people this podcast, I think, Josh. We're going to maybe be controversial a little bit and call out some weaknesses that we've seen in a couple of things that everybody believes in.
Is that elusive enough, Josh?
Josh Sheluk
I think so. I'm just really impressed that you took notes for this one, Colin. I'm blown away. Our audience is going to be blown away as well, because hey, when you take notes, good stuff happens, I think.
Colin White
Well, this is when I really get wound up about something. I go off and I get my poop in a row, as they say.
Let's jump into our first topic, Josh. For the edification of the audience, we have not shared the notes we've made, so you're going to see live how the cookie gets made.
The first conversation Josh and I had was regarding the state of the Canadian real estate market, and the plunge that it has gone through in the last number of months. I use the word plunge with air quotes, because again, that's just some of the commentary. But there has been a bit of a pullback in the Canadian real estate market. As always, it's nuanced, and there's a number of different ways to look at it.
Where do you want to start eating this elephant from, Josh?
Josh Sheluk
Well, I'm just happy I managed to buy right at the top. That's exactly what I think you want to do most of the time, right?
Colin White
Well, I think we all need to record the fact that Josh is a leading indicator of the cycles of the real estate market, because if it happened once, that means it'll happen every time, because that's how we decide who the smart people are. Right, Josh?
Josh Sheluk
That's right. That's right. Does this make me smart or dumb? I'm not sure.
Colin White
You're a leading indicator. Let's just leave it at that.
Josh Sheluk
Sure, sure.
Yeah. Where do we start? Well, I always get frustrated with the headlines in the real estate space, because for me, they always say, "Sales down 25%." Then you click on the article, and they say, "Yeah, the volume of sales are down 25%. Prices are down 2%." Does this frustrate you as much as it frustrates me?
Colin White
Well, I don't know that I get frustrated by it, because I've reached the point in my life that I never believe a headline, because I know they've picked the biggest number and the most extreme way of framing a conversation. So I don't get surprised by it maybe. I'm expecting, when I click on it, there's going to be more to it. I learned quite a bit actually, going through this exercise, as to the number of different ways that you can portray what's gone on over the last little while.
But we should preface this with, and again, to give perspective on all of this, people hold the feeling that real estate's always a good investment, and it's never a bad investment, and nothing bad ever happens. Our position isn't that it's a terrible investment. It's just ... It has a bit of hair on it. We're going to, I guess, quantify some of that hair over the next little bit.
So I don't get as frustrated as you do, Josh, but I know you. You kept going. When you were frustrated by the first number, you went looking for the second number. Did you find any more numbers?
Josh Sheluk
Well, yeah. I think in different ... It's always hard, real estate, right? Because it's such a varied asset. My house in Mississauga is going to be very different than your condo in Halifax. So sometimes when you see the broad stroke numbers, real estate up, real estate down, it could be very, very different for different markets across the country.
I saw some numbers, different markets. Some are down single digits. Some are down double digits. Some are even down 15+ percent. So I think that's at a point where it's becoming noticeable for people, from a peak to down 15%.
Colin White
But it's also a reminder that the real estate market is not as efficient as other capital markets. We talk about price discovery in capital markets. What are the mechanisms where a price gets set? When you're dealing with a share in a company, that's not regionally different. The real estate market does have some very significant regional differences to it.
We often speak in averages. Josh, you have a favorite expression about averages involving stoves and fridges that our listeners must know. Averages aren't always instructive.
But you're right. I think there are some regions that have been affected more or less than this. But have you seen anything as to the actual dollar value of decreasing in prices, or have you seen more volume numbers?
Josh Sheluk
Well, I've seen ... Those percentage numbers that I'm talking about are the declines in price terms. I haven't seen too much in terms of dollars, but prices, yeah, you're down, from what I've seen across most markets, somewhere between 5 and 20%.
Colin White
Yeah, no. There's a couple deep ones that ... BMO put out piece. They were talking about the inventory of homes for sale. Basically, they expressed it in if no more houses got listed, how long would the inventory last. At the peak last February, they were down to 1.7 months, which is a very, very short, very, very limited number of homes out there compared to the volume of sales that we're going through.
But that's crept up now to 3.4. So it's doubled. The inventory of available houses would take double the time to sell now than it would've earlier, which is an indication of, again, slowing transactions could lead to lower prices and might be on a leading indicator of lower prices.
There's also something else they track, sales to new listings ratio. It hit 75 at the peak. That was number of sales to new listings at any point in time, which is a very high number. In parts of Ontario, that's fallen to 40%, which is back to a number that hasn't been seen since 2008 or 2009. So again, by some of these activity measures, the markets have fairly dramatically retreated.
Now, the supposition is that prices will eventually fall. People can ask whatever they want for their house. They can stick to that price as long as they want. But at some point, if they really want to sell their house, and this goes back to how motivated they are, the prices are going to have to come down if we're going to see transactions.
To your point, Josh, I've seen some of those numbers too on the average sale price dropping, so that the deals are being done at lower prices now. The average price of sales dropped 190,000 in Canada. But I think that with increased inventory and reduced number of transactions happening, I think that the pressure is now on the sellers to maybe sharpen their pencil or lower their expectations a bit.
Josh Sheluk
Yeah. What we're really talking about is supply and demand. At one point, supply was really tight and demand was exceptionally high. That seems to have flip flopped on its head now, whereas today, your supply is growing a little bit and demand has definitely waned a little bit.
I think part of that's got to be interest rates. Interest rates have come up quite a bit. So the cost of carrying a house now is, I'll say, significantly higher than it was just six months ago. That's definitely factoring in.
Now Colin, one of the headlines that I've seen, and the real data points that I've seen, is that the expectation from some out there is that the real estate market will drop by up to 25% Canada wide, so some markets more than that, by the end of next year. Now, I don't know how they came up with these numbers, but how valid do you think this is?
Colin White
Well, any prediction of the future is kind of silly. Is Vladimir Putin going to hit something else with a missile in the next 12 months? But I think what you're quoting is the Desjardins number that was put out there. They were basically projecting off of April, May and June saw drops of 4% per month in the average price out of a home sale. That's, with rounding, it's about 15% in three months that they've seen it.
Wawa, that's another source, said that the average price in February, 2022, the peak was the average price for a sale in Canada was 8 16, and it's fallen by $190,000 off of that. So it's a 23% drop from the peak in February of the selling prices that are being transacted right now.
Again, when they do projections saying, "Hey, this stuff's going to continue the future," I'm not so sure of that, but we could be establishing a bottom here. I don't think that's necessarily ... The point of bringing up this conversation is to figure out that, "Hey, this is going to keep going," because back in February, if we had polled everybody, it was going to go straight up from there. So I think a little bit of this is just piling on, it's going in the new direction, therefore that's project it forward in that direction.
Josh Sheluk
Yeah, sure. Let me ask you a different question. Let's say, in a lot of markets, their real estate's down, based on average sale price, 10 to 15%. Have you had any of your clients come in recently saying that they have to sell their house?
Colin White
No. No. Again, unfortunately, it tends to be one of the larger financial decisions we make, so it is quite fraught. It is on many people's minds. I've bumped into people that are saying that, "I need to wait for it to drop further before [inaudible 00:09:52]" There's people like that.
But again, these people are trying to time something, in my opinion, that's not timeable. To me, the decision to sell your house is more of a personal planning decision, a personal lifestyle decision, and those kind of things. Yeah, around the margins, if you were 50/50 on doing something, people were maybe more likely to sell before than they are now, for sure.
But the other interesting thing that I read on this was that somebody was positing that maybe we don't have a housing shortage, we just had a bunch of people speculating on housing.
Josh Sheluk
Yeah. Well, you're preaching to the choir on that one. I think we've gone through the different issues with the demand/supply thing before.
I think you probably do have somewhat of a housing shortage, but I also think that when interest rates are 0%, and you can get a five year fixed mortgage under 2%, well, that speculative activity and that demand for housing is really incentivized to go out there and buy property. That's what you had. I think that that was probably a much more significant effect on the prices of houses than anything supply wise.
Colin White
Well, yeah. If any percentage of this has been driven by speculation, those people are being squeezed, because their objective for owning a home is different than somebody who's living in it. So there's going to be some uncomfortable people at that end of the market, for sure, and perhaps for the foreseeable future. I've got clients through this whole boom that have actually been trapped in properties that they couldn't get their money back out of, which is one of those regional risks in real estate that can happen.
Again, I think that it's important to go back to 30,000 feet again and say the point bringing this up is real estate's not a slam dunk. It has periods of time where it significantly has issues, either with return or with liquidity, and thinking of the future for the next little bit, is quite murky.
And it's an inefficient market. The numbers are dramatically different by region across Canada. Just because a region's winning at one point in time doesn't mean it's always going to win, because again, there's things outside of the normal supply and demand that can affect regional availability or regional demand for housing. You've got unrealistic players in the market who are going to ask way too much for their property. They're going to persist longer than they would typically persist in other asset classes.
So again, by region, and even though the averages are dropping, by region, it could drop a lot more or a lot less, or be more liquid or less liquid. So if this has been driven by speculation, then the speculators are having happen to them what happens to speculators. They're getting crunched a little bit for a while.
Josh Sheluk
Yeah. The reason I asked that question before, about people running out to sell their real estate now, is because I feel like it's a little bit different than what we deal with stocks. Where stocks were down 10, 15, 20% earlier this year, people were running out to sell their stocks. If I told somebody that their house was down 15% in value this year, they may not even understand or know that. Their response would probably be, "Well, it went up 30% last year. It's not surprising to see 15% drop in the value of the real estate."
I don't know why people think so differently about real estate than they do with stocks or bonds, for example. But I have to think it has something to do with the fact that they're getting slapped in the face on a daily basis with what their stocks are priced at. That same phenomenon doesn't happen with their house.
Colin White
Well, that's [inaudible 00:13:35] That's absolutely true. When they get their tax assessment this year, it's not going to be 15% lower. You can look at your account every day, you can look at your account in the middle of the day, and watch the valuation. So yeah, there's a way different expectation, for sure.
But you raise a good point. The only other mitigating factor there is a house is not just an investment. You live in them. We buy houses to live in. The whole idea that this is somehow an investment thing, I think has taken a disproportionate amount of the conversation.
That's because some people tell stories about getting rich off of it. Everybody thinks that's the way to get rich. It's a widely held belief, which is why we're recording this podcast, to point out it doesn't always work out well, easily, or in every location.
Josh Sheluk
Yeah. It seems like it's been really a frustrating couple years for buyers, because on the one hand, the prices were too high and going up, up, up, up, and they had to stick their neck out to buy something. Now, prices are coming down, and they're getting all giddy. But then they look at their interest rates on the mortgage potentially, and they're like, "Oh. Well, I'm not in any better position now." I feel for those people, because it's just been that type of couple years. It's been very frustrating.
Colin White
Josh, you are those people. That's why you feel for those people. It's very clear exactly where you are in the whole groups of people think.
Josh Sheluk
We know that. But I went in eyes wide open, knowing that I was going to buy at the top.
Colin White
Yeah. No. Flip back to previous podcasts and us making comments on how that's just fine. I'll send you on a treasure hunt, because that podcast is out there.
Do you want to move on to the second sacred cow?
Josh Sheluk
Well yeah. There's a natural progression from real estate to banks. Banks, you call it a sacred cow, because every Canadian loves their banks. Their bank stocks, they're precious to them. Banks never go down in value, just like real estate. Neither of these things ever go down in value. There's never anything that could happen bad to a Canadian bank, because they've always increased their dividends, and over longish periods of time, they've always made money. So why wouldn't I just put 100% of my portfolio into Canadian banks?
Colin White
Well, and I'd like to annotate that a little bit. It's a love/hate relationship. You love and trust holding the shares in the bank, but you hate the service you're getting from the bank.
Josh Sheluk
That sounds wrong, doesn't it? You're investing in a business because you think it's awesome, but you actually hate that business.
Colin White
Well, there's a correlation there, because if they treat it everybody fairly, they'd be less profitable, and they'd be less interesting to own as a business.
Josh Sheluk
Yeah. I was talking to a client this morning. She said, "Yeah. I'm reading about these banks. It seems like they're having a really hard time, but then I read, and they're making $1.6 billion in profit this quarter. That doesn't seem too bad." I say, "No. It's actually not too bad. It's pretty good. They're going to make somewhere between five and $10 billion in profits this year, most likely for most of them." She said, "Yeah. They probably only get that way because they're picking on the little guy, people like you and me." It's like, "Yeah. That's probably true."
Colin White
Yep. No, absolutely. We should thank them. If they tried to do a really good job, there'd be less room in the world for people like us. So they've given us room to grow. I appreciate that.
I pulled up the numbers as of today, which is August the 26th, taking a look at the Canadian banks year to date. There's an ETF that tracks the Canadian banks, ZEB, which has an equal weight of the major Canadian banks in it. It's tracking down 11.5% year to date.
On its own, that's down. Everything else is down as well. But the overall Canadian market is only down about 5% year to date. So that is a little interesting. Now again, the Canadian market is not all that broad as far as number of categories go, but typically, Canadian banks are not one of the weaker components of the index.
Again, not calling them bad businesses, they're still going to make a few billion dollars, but to say, "Hey. They're always the best place to be, and you can invest there and forget about everything else and be okay," is probably a little optimistic.
That's largely based on expectations now for the Canadian economy, because all of the banks, when they release their most recent earnings numbers, are increasing loan loss provisions and things of that nature, which again, are economically sensitive things.
I don't know, Josh. Have you seen any other evidence, anecdotal or otherwise, as to what kind of shape the banks are in right now?
Josh Sheluk
Well, I've been reading those quarterly reports, just like you have. It seems like they're doing okay. Yes, the loan loss provisions are off, but they're coming off of a very low point as well, because during COVID, surprise, surprise, everyone thought that loan losses were going to go way up, but because of the handouts from the government, they actually came way down, did the opposite. So yeah, they're increasing, but they're increasing from an exceptionally low level.
Just to play devil's advocate against the argument here a little bit, they also are seeing higher interest rates. Net interest margins is what they typically call that on the loans. Higher interest rates, kind of a good thing for them, because they can charge more on the money that they're lending out.
So it's a bit of a mixed bag right now, I think, for them. But I think, to your point, they've gone down more than the broad market this year. So the fact that these things are safer than average at all times, it might be a bit of a misconception.
Colin White
Yeah, no. Again, it's kind of funny. I feel we're walking a little bit of a fine line. My perception is that the general opinion of these things is like, "Oh my god. They're amazing. They're never bad. You should always hold them." Our opinion is like, "They're good, but you can't just bet on that and only that, and expect to have the best possible outcome." At times like this, it's just worth noting that the overall market is doing considerably better.
I think the other thing that's playing into the banks is, again, with the market sell off, I think some of their trading revenues might be a little bit more challenged. There's such a conglomeration of so many different types of businesses that it's sometimes difficult to completely attribute where the success or failures are coming from.
Josh Sheluk
Yeah. Well, the wealth management revenues seem to be down for most of them, because as markets go down, wealth management revenue goes down. And their trading revenue, as you said ... Capital markets, so less companies doing IPOs and things like that, then they're going to generate less commission income, for lack of a better word, from that as well. So there's a number of headwinds that they're facing right now, I think.
One of the things you've talked about, especially in the past, is price for perfection. Because so many people are interested in owning Canadian banks, that means that they're priced relatively high for what they are. If there's any missteps or headwinds along the way that people aren't expecting, then there could be more price volatility around that due to those factors. So it's something to keep in mind.
Here's a question for you again, Colin. Canadian banks, global banks, are we so much better than the rest of the world at banking?
Colin White
Really, really? You want to make sure that this podcast gets banned in our own country?
Josh Sheluk
Well, we-
Colin White
Let's just say that the Canadian banks enjoy a friendly relationship with the regulators in their home jurisdiction that allow them advantages that they don't get other places in the world, which I think is one of the reasons you see them trying to branch outside of Canada and not do so well.
Again, it's one of those things. You like to have a stable monetary system. I think for all of the slings and arrows maybe we throw at the banks, the fact that they're so widely regarded is a positive thing. It's very, very positive to the country.
There's certainly a non-monetary payoff to having that kind of belief in the monetary system. Other countries experience runs on banks and issues like that. That's something that's completely unCanadian. So yeah, I think that they have a little bit of a favorable relationship here, but I also think we all benefit from that favorable relationship.
Oh my god. I think I'm actually defending them. Wow. [inaudible 00:22:06] went full circle.
Josh Sheluk
Well, I'm going to push back. I'm going to defend them as well, because you said that they haven't done that well outside of Canada. But I think Scotia generates more than 50% of the revenue outside of Canada. TD, more than 50% of their branches are outside of Canada. RBC, BMO, CIBC, they've all made a pretty good imprint on the US market especially. So I think they have had success outside of Canada.
I guess my point is more that there's been some very large, very well established global banks that have hit some very big trouble along the way. To think that Canadian banks are immune from that I think is naive. Although to your point, there are definitely some protections in place that perhaps make them a little bit stronger and more resilient than some of their global peers.
Colin White
Let me ask the question I know is burning amongst all of our listeners at this exact moment, Josh. The banks are down. Isn't this a great time to load up?
Josh Sheluk
They're down 10%, which I don't think is that material in the grand scheme of things. I don't think something being down is necessarily a good reason to buy it, or not to buy it for that matter. The fact that they're down, I don't think that means anything to you at this point, I guess is the point. Certainly if we thought they were a little bit overvalued before, probably need to see a bit more of a correction than 10% for us to really think it's a pound the table buy or something like that.
But I guess, by the way, we do have some Canadian bank exposure for pretty much all of our clients. It's almost impossible not to, as a Canadian investor. We're certainly comfortable having some Canadian bank exposure. It's just we don't want 57% of our portfolios to be in Canadian banks, because that's probably a little bit irrational.
Colin White
Yeah. The other point, when people ask me that question, I say, "Do you think that Canadian banks are the only good businesses that are down right now?"
Josh Sheluk
Sure.
Colin White
Whenever you're making a decision, it's never about, "Hey, is this a good investment?" No, no. "Is this the best possible place to allocate capital right now?" That's the question. Having a narrow view on one industry doesn't get you to the strongest answer. You got to look at the whole playing field.
Because we've done that in the past. We've taken a look at Canadian banks versus US banks versus European banks. It's all the same sector, so it has some of the same variables to them. You should be looking at the much broader picture when you're making those decisions, rather than, "Hey. This is one thing that's good. I know this one thing, and I like this one thing. This one thing [inaudible 00:24:43] this one thing in my thing. I'm going to keep that one thing." That kind of all in one direction is how you make bigger mistakes.
Josh Sheluk
Yeah. If you really like pizza, and pizza's on sale, you don't want to buy pizza every day, because you might not like pizza so much anymore.
Colin White
Diminishing marginal returns I believe is how they framed that in my Economics 101 class in university so many years ago.
Josh Sheluk
Yeah, there you go.
Colin White
I think currently we would describe it more as a concentration issue, but diminishing marginal returns also applies.
Josh Sheluk
Yeah. Potato. Potato.
Wrapping up, maybe Colin and I have debunked some of the commonly held beliefs out there. Maybe we've made a couple other people dig their heels in a little bit stronger than they have ever in the past. Maybe we have some people writing us an email right now that says, "I've owned Canadian banks for 30 years. They've never gone down. I've owned real estate for 30 years. They've never gone down."
We're here to keep debating this topic, and to keep providing evidence on both sides of the spectrum. I guess I would say, just because it's never happened doesn't mean it never can happen.
Colin White
Well, you're right, Josh. We may be just in the wind, but that seems to be our specialty, tilting at windmills. Again, for the record, we don't think these are terrible investments. They're just not as good as y'all think.
Announcer
This information has been prepared by White LeBlanc Wealth Planners, who is a portfolio manager for iA Private Wealth. Opinions expressed in this podcast are those of the portfolio manager only and do not necessarily reflect those of iA Private Wealth Inc.
iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.
Colin White
We've noticed something. It seems there are a lot of people who would rather try to figure out their lives with an online calculator than air your finances to a human. Stop doing that. You need to talk to someone who can help direct you, tell you where to start with what you've got to make the biggest impact on your future. You can't figure that out at DoIHaveEnoughCash.com, but you can figure it out by chatting with us. Call us. It'll be okay. You'll see.
Announcer
The content of this presentation, including facts, views, opinions, recommendations, descriptions of or references to products or securities, is not to be used or construed as investment advice, as an offer to sell or ... Although we endeavor to ensure its accuracy and completeness, we assume no responsibility for any reliance upon it. This should not be construed to be legal or tax advice, as every client's situation is different.
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