Brandon Donnelly — Daily insights for city builders. Published since 2013 by Toronto-based real estate developer Brandon Donnelly. — Page 374

Reading Howard Marks' investment memos is up there with reading Paul Graham's essays . You just need to do it. Howard's latest is about " taking the temperature " of the market and I think you'll find the lessons invaluable for everything from equities to residential real estate.

Here's an excerpt that I liked:

We don’t say, “It’s cheap today, but it’ll be cheaper in six months, so we’ll wait.” If it’s cheap, we buy. If it gets cheaper and we conclude the thesis is still intact, we buy more. We’re much more afraid of missing a bargain-priced opportunity than we are of starting to buy a good thing too early. No one really knows whether something will get cheaper in the days and weeks ahead – that’s a matter of predicting investor psychology, which is somewhere between challenging and impossible. We feel we’re much more likely to correctly gauge the value of individual assets.

These are investing words to live by. Avoid your own emotionality and value the asset. If it's not cheap, don't buy it. If it's cheap, buy it. Then take a long-term view. It all sounds simple enough, but it's clearly not so easy. And that's why we have extreme highs and extreme lows in the market.

Eighteen months ago, everyone wanted to buy residential real estate. Today, prices are lower, but fewer people want to buy residential real estate. Part of this is obviously because of interest rates. But part of it is also just because of emotion.

The Eglinton Crosstown line is going to open, here in Toronto, sometime next year -- I think. And I'm sure that it is going to be a massively beneficial addition to Toronto's transit network. But at the same time, we should be talking about this :

Urban transit stations shouldn't look like this. It's a missed opportunity, both in terms of the foregone housing (and other uses) that could be on top of these stations and the additional value that could have been captured from these air rights. Transit is a crucial lever for land values and development overall, and so it's no wonder that many of the best transit authorities around the world think in terms of "rail + property".

So what happened here?

I don't know exactly. But I do know that nearly a decade ago I called up Metrolinx and said, "Hey, so I'm a developer who can build things. I see that you're building a number of exciting transit stations along Eglinton. Want me to build on top of them for you?" Now obviously Metrolinx wasn't going to be able to sole-source to Brandon, but regardless, I thought it should happen and I just hoped to be in the mix.

In 2015, things did start to happen . Avison Young, on behalf of Metrolinx, issued a request for proposal to developers for 4 sites/stations along the line. There were two at Keele Street, one at Weston Road, and one at Bathurst Street. And at the time, it was thought that these sites could generate somewhere between $14-22 million (speaking of reasonable).

I think it was also being viewed as a bit of a pilot. If things went well with these 4 initial sites, then this same approach was going to be rolled out across all suitable sites on the line. I'm not sure what happened with the RFP or the broader intent -- maybe some of you know -- but it clearly didn't pan out as planned.

That's too bad. But I suppose done is better than perfect. Plus, now we're building the Ontario Line and so we have another opportunity to get it right. And right means lots of density on top of stations -- both directly on top and all around it .

Here's a potential scenario :

“When you have investors competing with first-time buyers who walk in with a couple of [baby] strollers, typically the investor is going to win,” Mr. Pasalis says. “They are well capitalized. They can pay a higher price. And this is why our home ownership rate is declining, because more and more homes are actually going into the hands of investors who rent them out, and amplifying home and amplifying condo prices. We are seeing that.”

But let's break this down a little.

Where are these first-time buyers walking into? Is it a resale home showing or is it a pre-construction showroom? If it's the latter, then we know it's going to be difficult / atypical for them to make a buy decision so far in advance . They already have multiple strollers in hand, do they want to wait 4-7 years for their pre-construction home to be ready?

I would also add that in our current environment -- where investor demand for pre-construction homes has waned significantly -- the development industry has not seen a marked uptick in end-user demand. Why are they not stepping up now that they're not being outbid by investors? In my opinion, it's an ideal time to buy!

One reason could be that people who own strollers still largely prefer low-rise housing. Maybe it's for reasons of affordability, maybe it's a cultural bias, or maybe it's a genuine preference. Either way, let's turn our attention to resale homes. In this scenario, who is likely to pay the most?

If you're an investor, then you are looking for a specific yield. And so in theory, it should be a mostly dispassionate decision: "Here's the most that I can pay in order to meet my minimum returns. Do not exceed." But the question is whether is this is going to be more or less than what a stroller-owning group of people would pay.

The answer is probably that it depends. However, if the answer is that the investor wins and they then turn around and rent it to people who own strollers, is this actually a problem? And if this same investor happens to own 25 other rental homes and they're all rented to people who own strollers, is this an even greater problem?

I suppose it is a problem if you're worried about Canada's homeownership rate, which has in fact declined from about 69% (in 2011) to 66.5% (in 2021). But what does this even mean? Is a higher homeownership rate always better? Does Canada have a target number? As of February of this year, the homeownership rate in Switzerland was only about 36.3% . And the last time I checked, it was still a rich country.

There is nothing wrong with renting. I know wealthy people who have opted to rent their entire life because they enjoyed the flexibility and/or had better places to put their money.

All of this said, the argument in the above scenario is that, but for investors outbidding people with strollers, these homes would be more affordable and that would in turn increase the homeownership rate. It's a similar argument to, but for foreign buyers or but for Airbnbs, these homes would be more affordable.

But in a city like Toronto, we are building very little in the way of new low-rise houses. New supply is virtually non-existent. Similarly in Seattle, they are now building more accessory dwelling units than they are single-family houses . So it is any wonder that demand is constantly outstripping supply and that prices are being bid up?

In my opinion, a better solution is to rethink how we build our low-rise neighborhoods. And here and here are two good places to start.