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Webinar Transcript – Investing in Times of Market Volatility featuring Benjamin Tal


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Wayne Byrd: [00:00:05]

Hello, everyone. I’m Wayne Byrd, Chief Financial Officer at Skyline Group of Companies. And welcome to today’s webinar, Investing in Times of Volatility, brought to you by Skyline Wealth Management. This is a pre-recorded event recorded on June 12th, 2023, exclusive to Advisor.ca readers and organized by NewCom Media’s Content Solutions Team. Joining me today is Benjamin Tal, Managing Director and Deputy Chief Economist, CIBC Capital Markets, Inc. Benjamin is responsible for analyzing economic developments and their implications for North American fixed income, equity, foreign exchange, and commodities markets. During the webinar, you can write questions for Benjamin and myself by typing them into the questions panel located in the control panel on the upper right side of your screen. After this webinar, we will be connecting with you directly to address some of your questions. Welcome, Benjamin.

Benjamin Tal: [00:01:05]

Thank you very much. It’s a pleasure to be here.

Wayne Byrd: [00:01:07]

Thank you. Well, let’s get right into it and kick things off by looking at the big picture. Benjamin, what current Canadian market trends are creating the most significant economic impact, and how do you anticipate these trends to evolve over the next year?

Benjamin Tal: [00:01:23]

So let me count three. The first one is inflation. The second one is inflation. And the third one is inflation. It’s all about inflation. And the Bank of Canada, the Fed, the ECB have established their reputation as inflation fighters for the past 30 years. They will not let it go. Therefore, although everything is about inflation, at the end of the day, this is really not about inflation. This is about the cost of bringing inflation down to 2%. The Bank of Canada, the Fed, to maintain their reputation, will do whatever it takes, even if it means taking this economy into a recession. And I think that’s basically where they’re going. I think that we are in the midst of an overshooting episode. We can talk about it later, but clearly, they have to maintain their credibility and they have to fight inflation. Now, we can discuss until we are blue in the face, to what extent 2% is the right target. It’s irrelevant. They will not change it anytime soon. I believe that the target should be higher than that. Irrelevant. They will not change it anytime soon. So the target is 2%. They will do whatever it takes to bring it to 2%. Which means that. if you look at the next six months, we are talking about the impact of higher interest rates and even rising interest rates to bring the economy into basically 0% GDP growth, maybe even a recession. Call it a wannabe recession, maybe, basically, a recession without too much blood in the labor market. But we are clearly slowing down under the weight of higher interest rates. And that’s exactly what the Bank of Canada and the Fed and the ECB in Europe would like to see.

Wayne Byrd: [00:03:00]

So with that, Benjamin, I mean, you talked a lot about, obviously, inflation and the target being 2%. And how are they battling that? Well, obviously it’s been by rising interest rates. Well, let’s dig in a little deeper. How have these rising interest rates impacted and affected real estate investing? And how do you anticipate that playing out over the balance of this year and the next couple of years?

Benjamin Tal: [00:03:22]

Yes, clearly, higher interest rates are very negative for the real estate market in particular, because interest rates is a very high sensitivity market to interest rates and that’s something that will continue to be the case. In fact, I believe that the Bank of Canada will continue to raise interest rates, maybe, in September, so it’s not over. Now, before we get into real estate, we have to look at the trajectory of inflation, and basically where inflation is going. And I suggest that there are six forces of inflation now. And all of them are actually on the way down, which eventually will have an impact on real estate investment. If you look at the six components, which is energy prices, food prices, the Canadian dollar vis-a-vis the import prices, if you look at supply chain, if you look at real estate inflation, and if you look at the wages; namely, the labor market, all of them, in my opinion, are going in the right direction, maybe, basically slowing down. However, the Bank of Canada and the Fed will not take any chances. Listen to this, and that’s extremely important when it comes to real estate. Every economic recession over the past 50 years was helped, if not caused, by a monetary policy error in which central bankers raise interest rates way too much and kill the economy. The 91 recession is a very clear example of that. The housing market crashed. We know the story. And I believe that we are in the early stages of overshooting. If you look at inflation, it’s actually behaving. You just have to wait and let it happen. But again, the Bank of Canada, the Fed will not let it happen. Therefore, they will continue to raise interest rates. That will slow down real estate investment in general, and, basically, in the housing market in particular. We have a situation in which the housing market slowed down dramatically over the past year. And that’s a good thing. That’s, in fact, a very good thing. We have to realize that what happened during COVID was something unusual. Prices in the recent market, in the residential market, went up by 46% in two years. Why? Because of the asymmetrical nature of these prices; all the jobs that were lost were low-paying jobs. Young people are renters. And that’s why actually rent went down during the pandemic. Home buyers? They were Zooming. Their income was there. Their position was there, and interest rates were in the basement. This was a once-in-a-lifetime opportunity. So to understand real estate during COVID is to say that home buyers got the benefit of a recession, vis-a-vis extremely low interest rates, without the cost of a recession, vis-a-vis a broadly based increase in the unemployment rate. We have never seen anything like that. There was a sense of urgency to get into the market. And when there is a sense of urgency to get into the market, you front load activity, you borrow activity from the future. And the future has arrived. We are in the future. This is not a free for all. This is not a correction. This is a reallocation of activity over time. And the market is now, as we all know, is starting to stabilize. Prices, actually, are rising in places like Toronto and Vancouver. That’s not a good thing. That’s premature, and that’s one of the reasons why the Bank of Canada will continue to raise interest rates. However, whatever we see now, in terms of the slowdown, is the blip. The fundamentals of this market are so strong, we simply don’t have enough supply. We now realize that. You know, for many years, governments at all levels were fighting the situation by using demand tools to fight supply issues. For the first time, governments are realizing that supply is the issue. So if you look at the overall situation, last year we got no less than 950,000 people into this country. Permanent residents, non-permanent residents, students, foreign workers, people from the Ukraine. This year, 1.1 million. None of them is carrying their house on their back. We have a situation in which we are in a housing market shortage crisis. We are in an affordability crisis and we have to wake up. So I think that this has major implications for the rental market, for apartment buildings. We see significant slowing in condos and that will continue to be the case. Why? Because, for the first time, condo investors are in negative cash flow. In fact, 52% of them are in negative cash flow. And that’s rising, reflecting higher interest rates and other factors. In fact, the cost of owning a house now is rising faster than the cost of rent. So many of them will be exiting the market or, at least, will not be entering the market. That’s 50% of the condo market in places like Toronto and Vancouver. So, therefore, that will slow down. So, what to do? We need purpose-built rental. We are going to see a significant, significant upward pressure on rent. And there will be some major impact. I’m talking about, quite frankly, and I’m not saying it lightly, civil unrest type of situation, anti-immigrants type of situation, If we don’t wake up to realize that this is urgent and we have to fight it. And we can fight it in many ways. We can discuss it later if you wish. I think that the government should be involved in a very significant way because the government that set up the quotas for newcomers must be part of the solution to house them.

Wayne Byrd: [00:08:36]

Yeah, very much the case. Obviously, as we unpack this a little further and you talk about a supply issue, as we are facing these rising interest rates, well, how do we fix the supply issue when we, in the apartment industry, are faced with the rising interest rates? So, it is that uncomfortable awkward situation where, where do we increase supply. What’s your view on that?

Benjamin Tal: [00:09:01]

Well, I have very strong views on that. I think that the government should be a part of the solution. Again, the government that set the quotas must be part of the solution. Now we know that the condo market cannot be the rental market, and the rental market cannot be the condo market. Investors will not be there as they used to be; therefore, we need more purpose built. So first of all, we have to create a new mentality in which you are 35 years old, you are married, you have two kids, and you are renting– nothing is wrong with you. The only way to achieve that mentality is vis-a-vis healthy, stable, predictable supply of purpose built. Because the new wave of renters will be young people with families. They don’t want to deal with a landlord; they want to deal with a company, a stable company, a predictable company. The other wave of renters will be older people downsizing. Again, they need stability. So the only way to get out of this affordability crisis is through the rental vehicle. Now, how do you do that? Today, as you know better than anybody else, if you are a developer and you have two options, a condo versus a purpose built, you choose a condo, unfortunately. That has to change. How do you change it? Incentives. We had major discussions with CMHC and Finance about that. I see something simple as deferring HST as a major move in the right direction. Reduce development charges, major move in the right direction. I met with many rates, many developers, and look at the Excel spreadsheets pro forma, and I can see that only a move just defer HST by, let’s say, 10 years or until you sell the building, will make a no into a yes. That’s tens of thousands of units in places like Toronto. So if we are in a crisis, we have to behave in a consistent way and we have to face this urgency. Development charges. I know that cities don’t have the money, but governments, federal governments can send a check to cities. We can do that. We have done it during Covid. You can do it during this crisis. So there are ways to do it. Accelerated depreciation to developers of purpose built rentals. That was huge in the 70s. Let’s revisit it. It will not be very expensive. You know, surplus land, make purpose built rentals priority. We know what to do; we just need the guts to do so. And again, if you really want to be serious about, at least moving in the right direction when it comes to this affordability crisis, and it is a crisis, we have to wake up here.

Wayne Byrd: [00:11:42]

Yeah, definitely. We definitely agree there that supply is the issue and we need to produce more supply, increase it when we’ve got such a strong influx of immigration of increase in population each year. So, we’ve touched a lot upon multi-res. Do you do you have any insight or viewpoints on the retail and industrial sector?

Benjamin Tal: [00:12:04]

Well, first of all, industrial, we know that it’s extremely expensive. It will remain expensive. Is it too expensive? Yes. Can prices go down over the next six months? Yes. After the weight of higher interest rates, we’ll see some changes in cap rate. But this market will remain extremely tight. The demand is very, very strong. Supply is limited. Many of the buyers are not price sensitive. So I’m not thinking a linear trajectory, that it will continue to go up forever. I think, in fact, over the next six months, I will be a bit defensive on that. But from a structural perspective, this is an asset class that I would like to be in because quite frankly, the economics are very clear. Retail is better than expected, quite frankly. High-quality retail, good experience retail doing better than expected because there is this pent-up demand for offline shopping. I think that will continue and retail that is low quality will suffer and that’s exactly what we’re seeing. But if you look at the cap rate in retail, if you look at valuations, if you look at demand, better than expected just six months ago.

Wayne Byrd: [00:13:04]

And I’m sure you could agree that with the industrial sector, with the strength of the retail sector, it’s all significantly tied to the overall increase annually in population growth. As we are looking to increase supply in multi-res and we have more resident Canadians arriving, well, we need more logistics, we need more industrial, we need more warehousing, and then obviously we need more retail.

Benjamin Tal: [00:13:32]

And not only that, but those new immigrants that are coming, the five, 600,000 that will be arriving every year, they are more employable than they used to be. If you look at the employment rate of new immigrants, it’s actually higher than the people that were born in Canada. If you look at their wage, just two years ago, three years ago, before COVID, it was about 20% below average. Now it’s 10% below average, which means it’s accelerating. So it’s not only you’re getting more people, you’re getting more employable people that are being paid more. Therefore, the demand story is there. The demand for rental, the demand for industrial, the demand for retail is there. And that’s something that is going to drive the Canadian economy. We have to make sure, however, that those new immigrants are also employed in the right industries. For example, take construction. We all know that the number one issue when it comes to supply, regardless what part of a real estate it is, you don’t have enough labor. We know that. We had dinner with Mr. Ford just a few weeks ago here in Toronto, and he said he would like to build 1.5 million units in the next ten years and I said, you know, Mr. Ford, I don’t have my calculator with me, but I think 1,500,000 in 10 years is 150 K a year. You know what? We never built more than 70. Why? Because we don’t have the capacity. Capacity means, in addition to other things, labour. You need much more labour. So if you look at the number of apprentices, apprentices going down. If you look at the number of new immigrants in construction, only 2% of them are in construction, going down. If you look at the number of non-permanent residents, foreign workers in construction, going down. It’s the opposite trajectory. So we need to build the capacity of this industry to achieve what we need to achieve.

Wayne Byrd: [00:15:28]

So in a lot of what we talked about here, Benjamin, I know you’ll reference Toronto, you’ll reference Vancouver and then all Canadians, then obviously, then will think of Ottawa and Montreal and Calgary. What do you see as some of the secondary communities, whether it’s London, Ontario, whether it’s Guelph, Ontario, whether it’s the suburbs of Calgary or Edmonton and Victoria, what do you see as the impact on the secondary markets across this country?

Benjamin Tal: [00:15:56]

Well, we know what happened during COVID when people basically fled the big cities in order to find something more affordable working offline. You know, I think that will be the story in the long term. You know, many cities are becoming too expensive. Simple as that. Let’s face it. Toronto, Vancouver, in many ways, Ottawa, becoming way too expensive. So we have seen the reversal of this trend. People came back to the city, but with all those new immigrants arriving mostly to the cities, the demand will continue to rise, where foreign students that add to demand for rental, people will simply leave and go. So if you ask me over the next ten years, if the share of Toronto or Vancouver in Ontario or B.C. will go down, I’d say yes.

Wayne Byrd: [00:16:41]

Yeah, that’s a that’s a great outlook and a great viewpoint. As we look at the strengths in our markets is beyond just the major metro centers. You would agree with that?

Benjamin Tal: [00:16:53]

Absolutely. Absolutely. And the fact that the metro centers are so expensive is part of it. The fact that you can work from home, which is a huge story, is part of it. You know, whatever we do, we have to ask ourselves to what extent COVID is an event or a condition. So let’s pray that, medically speaking, it’s an event, but economically speaking, it’s a condition. E-commerce and working from home is part of the story. This working from home is a significant force that is really changing the way we live, with the way we work, and the way we function. And that’s a big part of it. So I think that you cannot basically look at the big cities and say that’s where the growth will come from. I think that you will see more and more people moving to other smaller towns just because of affordability reasons.

Wayne Byrd: [00:17:36]

That’s great. We, obviously, very much agree that the strength is in all markets across the country. So we’ve talked a lot about real estate. Let’s switch gears here and talk a little bit about social, sorry, sustainable infrastructure. And, you know, how do you assess the current state of clean energy investing in Canada, and what factors do you believe will have the most significant impact on this sector in the short and long term? If you’ve got any point…

Benjamin Tal: [00:18:00]

You know, don’t follow it very closely. But I can tell you one thing, the direction is up. There is no question about it. I think that it’s not just about the environment, it’s about people starting to realize that the market will punish you if you don’t do that. So it’s not about believing in global warming, although you should, quite frankly, we all know that and we feel it on a daily basis, but also the realization that it’s good for business. The market is now going to punish you if you are not playing the right game. So I see a significant increase in green infrastructure investment. I think this is a very, very strong market down the road. And again, it’s not just about the right thing to do. That was the case five years ago. It’s basically the right thing to do economically speaking, financially speaking, and for the stock price to continue to rise. I think that’s basically it’s a financial decision.

Wayne Byrd: [00:18:48]

Yeah, absolutely. You’ve talked about that environmentally and economically. And as you get the big automakers that are starting to set a goal or an objective on a year, whether it’s 2035, on moving to all electric vehicles, how quickly do you think that this industry needs to make its shift, or are we already behind?

Benjamin Tal: [00:19:09]

We are behind. We are big-time behind. It’s starting to move in the right direction. Again, all those CEOs are doing it not because of the fact that they are green, but because of the fact that they see green because of that. I think that’s really worth talking about. It’s good for the bottom line. So that will accelerate because, again, if you do it because you want to be a nice citizen, that goes slowly. If you do it because you want to increase your bottom line, that’s definitely going faster. And we have to realize that companies will have to invest big time to improve productivity, and part of it will be green. Why? Because if you look at all kinds of forces that in the past added to profitability, today, they are negative. I’m talking about globalization. It was good for business, now it’s not. I’m talking because it’s de-globalization now. Back then, we are just in time inventories. Now we have just-in-case inventory. So that’s not good for business. Back then the labor market was giving, now it’s not so giving. And clearly, we have the cost related to green; that’s inflationary but also has a negative impact on profitability. So, as a CEO, you have two options. One is to pay. The other is to do something about it. You will do something about it. And this something will be to replace labor with capital. So you will see more and more investment rising over the next ten years. For the first time we have the money and we have the will. People are, you know, companies are sitting on a mountain of cash. Ten, 15 years ago, Mark Carney, when he was the Governor of the Bank of Canada, was complaining that we are sitting on dead money, he called it, criticizing corporate Canada for not investing. If, back then, it was dead, now it’s very dead. And it’s very, it’s a large amount of money that is sitting on the sidelines. Companies will have to invest because that’s the only way to increase profitability in this environment. A big part of it will be green because the market is rewarding it.

Wayne Byrd: [00:20:57]

Do you see the current market that we’re sitting in with the rising interest rates being an inhibiting factor in the types of investments that need to get done in the green?

Benjamin Tal: [00:21:07]

Well, I don’t think it’s going to happen very soon in this kind of environment with interest rates, but with interest rates going down with the full clearing; namely, second half of 2024, I think we’ll see a surge in business investment in general and green in particular. So we just need to see interest rates starting to go down. We need a trend that is very predictable, and we need the fog to clear, which you will be probably in the second half of 2024, and you will see the green light for this kind of investment.

Wayne Byrd: [00:21:35]

So between now and the end of 2024, do you see more rising rates coming?

Benjamin Tal: [00:21:42]

And I think that the Bank of Canada will raise again in September. But it’s a tough one. I don’t know. The Fed, maybe, will go twice more and will call it a day. The next question is, okay, when are they cutting? So the market, until recently, was expecting the Bank of Canada and the Fed to cut in the second half of 2023. I’m not sure what the market was smoking, but clearly, it’s not going to happen. I’m talking about mid-2024, the first move down. And then when you move down, by how much? Remember, we started this cycle at 1.75, Bank of Canada rate. We are going to five, probably, staying there for a while. And then cut to what? I say three, because all those forces that are going to reduce profitability are also going to increase inflation; namely deglobalization, just-in-case inventories, the labor market, green, all those forces are going to put some upward pressure on inflation. The target is the same 2%. It’s not going to change. So by definition, if the target is 2% and you have more and more forces, interest rates have to be higher. Let’s say you cut it from 5 to 3, which will be notably higher than it was before, maybe two and a half, still higher than it was before.

Wayne Byrd: [00:22:53]

Yeah, very good. That kind of covers off through the overall context here. I think we’ll move into the Q&A session. I know we’ve got some questions that we’d like to address here. So prior to starting our Q&A session, I’d just like to update the viewers on the following. CE accreditation is powered by CE Corner. We will be applying to ICM, ICS, AAC and the Institute for Continuing Education credits. You will receive an email from CE Corner when your CE certificate is ready, which can take up to a month. This webinar will be available on Advisor.ca within the next week, so you can replay the webinar at any time. Got that covered. Now let’s start with some questions we’ve received prior to recording. Benjamin, so we’ve talked a lot about interest rates, talked a lot about the economy, core centers, secondary markets. What is your take on private alternative investments and how can these types of investments fit into an investor’s portfolio?

Benjamin Tal: [00:24:01]

I think it’s going to be a growing part of this pie. No question about it. I think that given where we are, the volatility in the market, higher interest rates that will remain high, relatively speaking, to the future and to the past. I think that we are talking about a situation in which private alternative investment will be in high demand. It will be a major source of funding into the system. And remember, we’re talking about the situation in which interest rates were extremely, extremely low for a long period of time. That kind of confused the market in a very significant way. I think we are going back to a normal rate of interest, and that will be healthy for the economy, but also for this vehicle.

Wayne Byrd: [00:24:39]

Thanks, Benjamin. This next question is then directed more towards me, and it’s specifically about Skyline’s Funds and how Skyline’s Funds mitigate risk amidst these market trends that Benjamin, obviously, spoke in very, very much detail to. And in addressing that, I’m just going to, as Benjamin addressed, there’s three components. There’s inflation, inflation, inflation. And where we’re dealing with inflation is obviously rising interest rates and that affects our funds, which is the Apartment REIT, Skyline Apartment REIT, Skyline Industrial REIT, Skyline Retail REIT and Skyline Clean Energy Fund. I will really just, sort of, address the impact of interest rates in this regard. And amid rising interest rates, inflation, and now some very early indicators of rising unemployment rates, obviously, the economy is in a state of instability. And at Skyline, it is our mandate to manage through this and create stability for our investors. Our history of strategic decision-making on acquisitions, dispositions, existing asset investment, and financing remains very similar through this current state of the economy as it did prior to in very strong times. We’re very much opportunistic investors grounded in accretive decision-making. Any investment decision is made with the best interest of our investors at the forefront. And, for example, in this period of current rising interest rates, when we’re looking at any refinancing that we’re conducting in our portfolios, we’re currently taking a shorter-term position on the mortgages. And this really relays to Benjamin’s comment about kind of plateauing rates and in late 2024, starting to see possibly a downward movement on the rates. And while we’re analyzing whether to maximize loan amount today or at the end of a shorter new term. While we agree that the very low interest rates that we were the benefactors of a couple of years ago and we do not expect to see these rates be reached at any time soon, we do believe that the interest rates we are facing today will stabilize in the short term and then subside in the midterm. So with this, when we traditionally look at refinancing on five, seven and ten-year terms, today we’re looking at two, three and five. And with that, we are very much focused on ensuring that any of our portfolios, we do not have more than 20% of our mortgages maturing in any given year, so that we mitigate the risk in time like this. So these are very much key to continuing through our success in ensuring stability for our investors. We do reinforce with our investors that during the instability in the economy and in the market, that investing in hard assets, bricks and mortar and infrastructure is, and always has been a traditional hedge against inflationary pressures on other investment classes. Couple that with our strategic investment parameters within our funds — Skyline Apartment REIT, Skyland Industrial REIT and Skyline Clean Energy Fund, our investors have been realizing peace of mind and stability in this portion of their investment portfolios. So the strength does exist in this alternative format. So let’s go back to you, Benjamin. In what ways do you think inflation will influence investment trends over the next six months and through to late 2024?

Benjamin Tal: [00:28:13]

Yeah, I think that it will be negative for investment trends, quite frankly, at least in the near term. And then you will have stability and interest rates start going down, and that will inject some energy into the market. I think that people will start talking about this recession coming because of higher interest rates. The uncertainty about inflation will continue to be the case. Remember, central bankers have to be militant in their language because they want to maintain their credibility. They don’t want you to think that they’re behind the curve. That will keep the market guessing. So in this environment, the appetite for investment is limited, and I see a situation in which the market will be a bit defensive. However, the minute we reach a point in which the market is convinced that the Fed and the Bank of Canada are done, and that might be something around September, October. What the market needs is not really just lower interest rates. They need clarity. We have seen the market actually starting to improve the minute the Bank of Canada said that they are pausing five months ago. So what they need is clarity. I think that, that would be towards the end of the year. And despite the fact that interest rates will not be rising, will not be, falling in the first half of 2024, the market will start expecting it to happen. That will be positive enough. But for the next few months, I think the market will be a bit defensive.

Wayne Byrd: [00:29:23]

Thank you. That Benjamin. Now, I’ll give you the last opportunity here as a closing point. Is there anything you’d like to leave our investors with or the general community with? Any parting comments to consider for the balance of 2023?

Benjamin Tal: [00:29:39]

Yes, absolutely. I think that we have to realize that we are going to deal with a lot of inflationary fear comments coming from many corners of the economy. But the reality is that the trajectory of inflation is downward. We are at the risk of overshooting, and that’s something that we have to take into account. However, we have to realize one thing, this economy, the fundamentals of the economy, extremely strong. The fundamentals of the real estate market, extremely strong. The apartment building segment of the market will be extremely strong because we get so much, so many new immigrants. Industrial is very, very strong. And I think that office is better than expected. And, clearly, retail is better than expected. The minute you get low interest rates or lower interest rates or even stable interest rates, I think that sentiment in the market will change dramatically.

Wayne Byrd: [00:30:25]

Great. Thank you very much for this, Benjamin. We’re now at the end of this webinar. I’d like to thank you very much, Benjamin, for joining today and share your insight in the current trends and economy. And if we have been able to answer questions today, those watching, we will reach out to you directly by email. You can also visit SkylineWealth.ca for more information on Skyline and its alternative investment offerings. And I’d like to invite participants to fill out a brief exit survey form as we value your comments and feedback. And thank you very much, everyone. Thank you, Benjamin, and wish you all a great day.