Brandon Donnelly — Daily insights for city builders. Published since 2013 by Toronto-based real estate developer Brandon Donnelly. — Page 438

I am so tired of sensational headlines:

The Ontario Line will zip across the core and up to Eglinton, easing gridlock and alleviating TTC misery. It will also plow through peaceful Toronto neighbourhoods, displacing homes, businesses and everything in its path.

I know exactly what business model it is serving and why it is done, but I'll ask the question anyway: Why do we need to make everything out to be a problem?

In this case, we're talking about a new and important piece of city building infrastructure. A subway line that will run through the densest parts of this country and alleviate congestion at key interchanges, as well as broadly across the city.

It is something that we, as a city, have been griping about for many decades. And now, it is finally happening! Will it involve constructing things? Yes. Will it actually displace "everything in its path?" No.

But as we all know, this is the way media works today. They set the agenda (i.e. tell us what we should be terrified and/or pissed off about) and then they sell our attention. And an effective way to do that is to make sure that the headlines get us really worked up.

Earlier this month, Howard Marks published a memo called " Sea Change ", where he argued, among other things, that it is "nearly impossible to overstate the influence of declining [interest] rates over the last four decades." In fact, he goes on to say that he would be "surprised if 40 years of declining interest rates didn't play the greatest role of all" in the success that investors have seen since the 1980s. Of course, the reason the memo is called "Sea Change" is because his overarching point is that this tailwind is now over.

Let's consider this in the context of commercial real estate. If you bought a real asset at a 4% cap rate (calculated by dividing net operating income by the price of the asset) and were able to put debt on it at say 3%, you would be receiving positive leverage. Your cost of debt is less than the yield that your asset is generating, and so you are in effect magnifying your returns.

Now let's imagine a scenario where interest rates decline even further and somebody could put debt on this same asset at 2%. This is likely to put downward pressure on the cap rate, meaning that somebody might be willing to pay more for the same amount of yield. That is, they're willing to accept a lower yield. This phenomenon is what Howard is describing in his memo. Declining interest rates tend to create upward pressure on asset values. And in the world of real estate, this is referred to as a compression of cap rates.

But what happens when things go the other way? Well if you had the same real asset generating a 4% yield, but now the only debt you can find is at 7%, then you are in a scenario where, unless you can afford to pay with all cash, you will be receiving negative leverage. Your cost of debt is greater than the yield that your asset is generating. And that's the thing about leverage: it cuts both ways. It can magnify your returns, but it will also magnify any losses.

If the only debt that you can find for your asset is now at 7%, then your 4% cap rate is almost certainly going to need to widen/increase. That is, investors are going to want to pay less for the exact same income stream. This is significantly less fun than cap rate compression, where values just seem to always go up. But, it does also create new opportunities for well-capitalized investors.

All of this is playing out right now. And it is part of the "sea change" that Howard has called.

This is one of my Christmas gifts. And it is, of course, exactly the sort of thing that gets me excited. Thank you Bianca. You clearly know me.

I am endlessly fascinated by cities. I keep a running list of places I want to explore (everywhere from São Paulo to Shanghai). And frankly, I consider it to be an important part of my job to think about how to make our cities better.

As I was flipping through the book this morning, I was reminded of something that I have been saying for years on this blog. Toronto could use a floating public pool like the Badeschiff ("bathing ship") in Berlin:

Constructed from the hull of an old cargo vessel, the Badeschiff opened in 2004. The Spree itself is too polluted to swim in (or at least that was the case back in 2004), and so this has become an important swimming outlet for the city.

Paris is in a similar situation with the Seine, but it's looking to clean it up in time for the Olympics .

The real benefit of a floating pool is that you're mostly in a big body of water, but now you can also heat it. In the winter, the Badeschiff is covered and turned into a spa/sauna . This would be particularly useful in a place like Toronto.

It's easy to bring people to water in the summer. Apparently Summer-Badeschiff even has a bar and regular DJ sets (presumably all techno given this is Berlin).

The real challenge is in the winter. And if you've ever read an RFP involving a public space in Canada, you'll know that this question invariably comes up: So, how do we, like, get people to come here when it's 10 below?

Hot water, nice views, and a little food & drink. I promise that's all you need.