What is going on with immigration?

Population growth cap

The Canadian government website states in their release on the international student cap that: “Canada to stabilize growth and decrease number of new international student permits issued to approximately 360,000 for 2024”

There are a few highlights here: “Starting September?1, 2024, international students who begin a study program that?is?part of a curriculum licensing arrangement will no longer be eligible for a postgraduation work permit upon graduation.”

This change alone has been met with significant pushback from Canada’s massive population of international students: “We Want Transparency and Residency” International Graduate Protests Spread in Canada

Net zero first year

A Net zero first year growth model is mentioned in an April statement from Canada’s Immigration Minister:

“The national cap is based on the amount of expiring study permits this year. This means that the number of international students coming to Canada in 2024 should be the same as the number of students whose permits expire this year. For 2024, the target is 485,000 approved study permits.

“About 20% of students apply for an extension each year and remain in the country. Therefore, IRCC subtracted that amount (97,000) from the target of 485,000 and set aside a small buffer to allow for other variations, resulting in a revised target of 364,000 approved study permits in 2024.

Based on the way this is distributed by population share, Ontario is expected to see a 62% reduction (not far off the 65% originally proposed). These numbers were adjusted again to bring us to a -41% reduction in student population in Ontario:

In the current environment, a lot of investors really like renting to students for a few main reasons:

1. they’re high turnover tenants, meaning that
2. landlords are less likely to be demonized for being “parasites”, “hoarders”, and “housing destroyers” given they’re not

If and when this cap and policy take place, the Great Canadian student-rental bull case would lead me to believe that there is a pretty decent investment thesis to be created in rental demand growth markets in Canada:

• Alberta + 10%
• Newfoundland and Labrador + 10%
• Northwest Territories + 4900% :|
• Nunavut + 6567%
• Quebec + 10%
• Saskatchewan +10%
• Yukon + 205%

Similarly, it would be reasonable to expect a rental demand contraction in markets looking to reduce that population:

• British Columbia -18%
• Manitoba -10%
• New Brunswick -10%
• Nova Scotia -10%
• Ontario -41%
• Prince Edward Island -10%

If you are having a hard time understanding this phenomena, I would direct you to this table, which shows the growth in international students in an uncapped environment across Ontario. I would encourage you to independently observe what happened to asset values (house prices) and rents in these markets during the same period of time.

Fraser Institute also put out a great publication about this, which charts each province based on interprovincial and international population growth, with the highest supply deficits being found in New Brunswick, Saskatchewan, and Newfoundland.

Genuinely curious… if all the GTA TikTok real estate bulls think that excess demand is the bull case, why aren’t they piling into these markets at deep discounts?

New records

Perhaps the Canadian government was referring to an alternative definition of “cap” when they created this policy. According to urban dictionary (and most Gen Z’s): “no-cap” is a verb meaning - To not be lying or deceiving. "Cap" is another word for lie.

I say this ironically because Canada just hit another new record number of International Study Permits in March, and throughout Q1 2024, per Alex (@xelan_gta), who is one of my favourite folks on twitter:

Rush the gate

Hopeful students are applying and being issued study permits in record numbers in Q1 of 2024 in Canada, ahead of the cap’s impact on the 2024 school year (September)

Similarly Karlstack shows a chart from NBF Economics and Finance, illustrating what Alex (@xelan_gta) implied above:

Moving NPR to PR residents:

NBF also observed that the Canadian economy depends heavily on population growth to boost our GDP:

The consequence of this is a falling GDP per capita - to the point where we’ve basically seen no growth in GDP per capita since 2016.

Without that population growth, I understand that Canada would be experiencing something of a demographic crisis. Our population is aging quickly, meaning that a few risks would materialize over the coming decades if we can’t balance our population pyramid:

1. Worker shortage - insufficient labour to take care of the aging population
2. Pension capital - insufficient payment into the pension system used by retirees
3. Health care - insufficient labour & capital to keep health care serving

This is generally called an increased dependency ratio, where an increasing number of non-working people depend on a decreasing number of the remaining population.

We have 11 million people approaching retirement age in Canada, and we got a pretty good look at what our healthcare system looks like at capacity during the covid-19 pandemic. I can understand the fear and the problem. I’m not sure I understand the solution.

Standard of living

According to the OECD, Gross Domestic Product (GDP) per capita is a core indicator of economic performance and commonly used as a broad measure of average living standards or economic wellbeing; despite some recognized shortcomings.

In Canada, this is compounded by the reality that our GDP is highly exposed to housing, as mentioned in my last post. Furthermore, it makes housing one of the areas in which Canadians are most likely to “feel” the reduction in standard of living or GDP per capita, because it’s typically the largest expense each household has:

As a result, the impact of a reduced GDP per capita would be most pronounced on a household’s largest expenditure within that category. The most notable sign of this can be seen in the fastest-growing household type in Canada: room mates.

For most of Canadian history, room mate households have also been the most common type of household type for students in post-secondary institutions.

The second most notable sign is housing unaffordability, which is hitting new records regularly:

How did we get here?

To put it simply: Canada’s population grew at a much higher pace than its housing production could sustain. We have been building too few homes per new Canadian for a sustained period of time, leaving us with a massive backlog of housing supply, and a palpable excess demand for housing.

Excess demand, also known as shortage, is an economic phenomonenon where the demand for something exceeds how much the economy can produce.

Canada has a housing shortage. This isn’t news.

The CMHC recently noted that they believe we actually do have the capacity to produce enough housing, noting that Canada’s potential number of housing starts could be around 465,000:

I’m not sure exactly what they think is the cause of us not building at capacity, but they do acknowledge productivity in a chart from the same website, shown below. This lack of productivity relative to resource allocation could only mean some combination of a couple of things:

1. Labour is becoming less productive, reaching a point of diminishing marginal returns
2. Residential construction labour is shifting away from housing starts to other jobs, such as renovations,
3. Material inputs are becoming less productive as a result of cost inflation
4. Capital inputs are becoming less productive as a result of increased capital costs and fees.

The 4th factor seems like a most likely contributing factor, simply because we can visibly observe the increase in capital costs (interest rates) since residential GDP and starts peaked in 2021, alongside the increase in development charges and fees in most municipalities in the same period of time.

At the same time, we’re seeing a huge drop off into low condo sales in both 2023 and 2024 that will likely sustain onward, meaning that the future pipeline of new condominium construction is contracting at pretty alarming rate.

The end of an era

In the absence of supply, excess demand should either a) influence price levels to rise, or b) influence more supply to be built to meet demand.

Currently, none of those things are happening, though we’re seeing a lagging impact of supply from our previous housing model, in which units were pre-sold to buyers (often investors) and their capital would be used to fund the construction of the building. There was only one catch: the investors were losing money. Or, more succinctly, they were willingly entering into a negative cash-flow position for the promise of capital appreciation.

This previous housing model got affordable housing created this way. Let me give you a very conservative example:

• A buyer buys a condominium for an all-in cost of $600,000
• The condominium costs them $3,291.70 per month to own:
• They can rent that condominium for $2,500/month

The majority of condos are owned by investors, according to StatCan. This would mean that there are thousands and thousands of examples like the one above, actively delivering rental housing to the market below the cost of ownership of that housing. These investors are (or rather, were) willing to do this because they felt they’d make their money as the condominium units went up in value over the course of their ownership. During that time, they’d also be receiving principal paydown of $480,000 over 25 years and they’d pay about $357,511.18 in interest for that privilege.

This is, in effect, a socialization of affordable housing. Who wins in this scenario? The tenants? The investor?

I say the banks. (As a fan and shareholder of Canadian Banks, I don’t have an issue with this).

More for the banks

Interestingly, a decent amount of that apartment housing supply is being backfilled by purpose-built rental. This is almost exclusively due to CMHC’s MLI Select Financing Program, which allows qualifying purpose-built rental builders the ability to get:

1. the best interest rates in the market
2. the highest loan-to-value ratio; and
3. the highest amortizations (up to 50 years)

A 50-year amortization allows banks to collect up to 2.26 more interest over the ownership of a rental project when compared against a 25-year amortization.

This allows developers and owners to privatize the creation of affordable housing and spread it out over an extended timeline, insured by taxpayers.

In this scenario, a developer could build the same project as before, but carry the property at a monthly mortgage payment of $2,000 rather than $2,791, by halving the principal payments (25 years is half of 50 year amortization).

So, in the absence of cash-flow negative investors willing to socialize the cost of affordable housing, we’re expecting developers to bear that burden by spreading the risk across 50 years. But it seems to be working, a bit:

Unfortunately, we’re still under building to the point that our housing supply deficit hit a new record in Q1 of this year, though just as much of this is happening as a result of demand side (population growth).

So, what happens now?

Let’s summarize and examine the setup here:

1. We probably already had too many people for the existing supply
2. We just saw a record quarter of growth
3. We’re going to continue having more people at a reduced rate moving forward
4. We’re building a record low amount of housing relative to each new Canadian coming here.

The answer is so simple it might surprise you. In London, a common housing type is called a flat. A "flat" is a term predominantly used in the UK and several other countries to describe a self-contained housing unit that occupies only part of a building.

Many of these flats are located in old single-family residential homes that have been cut up into multiple units. Why did this happen? And when did this happen?

Let’s look at London 100 years ago, when they were experiencing a similar population boom. They’re just getting back to the population seen during that period of time.

We have the space

In Canada, we have enough space to make this happen pretty easily. In fact, we’re technically overhoused. Canada has the 3rd largest house size in the world, behind only Australia and the USA:

This tracks similarly on a square footage per capita basis, as well:

Much of this supply is held by baby boomers and Gen-Xers who are now becoming empty-nesters. As a result, the number of people per household in Canada has fallen since 1850

:

The same was true for the US until 2015, when the number of people per household started growing for the first time ever

:

The writing on the wall(s):

This is extremely visible in the policy objectives of most governments, who are actively encouraging the upzoning of neighourhoods to allow for multiplexes, functionally allowing the existing housing supply to be cut up into “flats”. This is the most agile type of supply available to solve Canada’s housing crisis, and it can be delivered at a fraction of the cost of alternatives, such as highrise or new construction, and in many cases, it can be done so without development charges. These cost advantages make the asset class compelling for investors, given they can rent the units for comparable rates to neighbouring highrise, whose total creation costs are often 2x higher.

The Annex, one of Canada’s most famous neighbourhoods, was full of massive Edwardian mansions that were converted to multiplexes in this fashion. The Annex was admired for this very character by the legendary urbanist Jane Jacobs, who I’d say is relatively qualified to judge this.

One of the easiest ways to understand this is by looking at the OECD chart below. From a policy perspective, do you think that Canada is designing a nation that emulates countries to:

1. our right, such as Finland, France, Sweden, Austrian, Germany and Switzerland, where homeownership rate is lower; or
2. our left, such as Romania, Slovenia, Poland, Lithuania, and Bulgaria, where homeownership rate is higher.

I try not to get into the game of predictions in real estate, but these are a few things I can say with near certainty:

1. Our homeownership rate will continue to fall
2. Square footage per capita will continue to fall
3. The number of people per dwelling will increase
4. Baby boomers will sell their oversized houses, and investors will convert them to multiplexes

What do you think?