The Ins and Outs of Real Estate: Mortgage Rate, Rentals, REITs and Variable Annuities (EP.58)

Episode Summary

Executive Summary: Episode 58 focuses on evidence-based investing through three lenses: mortgage rate structure in Canada, the rapid rise in Canadian housing valuations, and whether REITs deserve an overweight in portfolios. The hosts argue that current yield-curve conditions favor fixed mortgages, that housing affordability has deteriorated sharply relative to rents and incomes, and that REIT returns can largely be explained by ordinary equity and bond factors rather than unique skill or compensation.

Main Topics: Canadian mortgage rates and the inverted yield curve (Priority: 5/5): The hosts discuss how fixed mortgage rates have fallen below variable rates, reversing a long-standing pattern. They connect this to an inverted yield curve and argue that, for borrowers planning to stay in a home long term, fixed rates are currently more compelling. Bond returns, term structure, and the yield curve (Priority: 4/5): They link strong fixed-income returns in Canada to the shape of the yield curve rather than just rising or falling rates. The conversation emphasizes duration, term premium, and why bond/GIC outcomes depend on yield-curve changes. Canadian real estate affordability and housing inflation (Priority: 5/5): Using updated Visual Capitalist data, they examine how Canadian home prices have surged relative to rents, incomes, and inflation. They discuss affordability, investor assumptions, and the strain this places on families and younger buyers. Parental support for home buying and retirement trade-offs (Priority: 4/5): They note a large share of parents expect to help children buy homes, with many already doing so, and highlight the implication that this may delay retirement and should be incorporated into financial plans. REITs as a factor-driven rather than unique asset class (Priority: 5/5): The hosts review academic papers showing REIT returns can be replicated with mixes of small value stocks and bonds, arguing that REITs are exposed to priced factors but also to uncompensated idiosyncratic real-estate-sector risk. Behavioral finance and investor underperformance (Priority: 4/5): They discuss the Dalbar report and a comparison of variable annuity investors versus mutual fund investors to argue that behavior often matters more than product structure, and that restrictions can sometimes improve discipline. Critique of unsupported active management claims (Priority: 3/5): They close by criticizing an article claiming it's a great time for active management because of passive flows, arguing that such claims need data rather than anecdotes or beliefs.

Key Arguments: When fixed mortgage rates are below variable rates, fixed mortgages become more attractive, especially for buyers with a long time horizon. The inverted Canadian yield curve explains why bond prices can rise even when rates are up, because returns depend on changes in the curve shape and duration exposure. Canadian housing has become dramatically less affordable, with prices rising much faster than rents and incomes, suggesting sustainability concerns. Many real-estate investors appear to rely on unrealistically high expected capital gains to justify weak or negative net rental yields. Parents increasingly help children buy homes, which can materially affect retirement plans and should be modeled explicitly. REIT returns are largely explained by known factors like size, value, term, and default; therefore, overweighting REITs may add uncompensated sector-specific risk. Behavioral discipline can matter more than fees: even higher-fee, restricted variable annuities may outperform because they reduce harmful investor behavior. Claims that passive investing has created unprecedented opportunities for active managers were presented without evidence and should be treated skeptically.

Data Points: Berkshire Hathaway Class A shares YTD performance vs S&P 500: Underperformed by 18% year to date - Used as an example of the risk of concentrated bets and the importance of reliability Canadian prime rate: 3.95% - Referenced as the benchmark for variable mortgage pricing Five-year variable mortgage rate: Around 2.9% - Compared with fixed-rate mortgage pricing in Canada Five-year fixed mortgage rate: 2.69% - Shown as lower than variable rates, reversing the usual relationship Canadian bond index fund returns this year: About 7% - Attributed to yield-curve changes and duration effects Canada prices relative to rents since 2015: 195.9 - Visual Capitalist infographic showing prices rising far faster than rents New Zealand prices relative to rents since 2015: 196.8 - Highest in the comparison set, slightly above Canada Canada house prices relative to income since 2015: 155.0 - Illustrates worsening affordability versus earnings Canada house prices relative to inflation since 2015: 124.0 - Shows housing outpacing general inflation Parents with kids under 18 planning to help buy a home: 48% - Financial Planning Canada / Léger survey Parents with children over 18 who already helped buy a home: 24% - Same survey Parents expecting home support to delay retirement: 40% - Same survey; highlights planning implications Average Canadian rental wage: $22.40/hour - Canadian Centre for Policy Alternatives report estimating income needed to keep housing costs under 30% of income Vancouver rental wage for a two-bedroom: $35/hour - Highest among cities mentioned Toronto rental wage for a two-bedroom: $33/hour - One of the highest-cost rental markets discussed Victoria rental wage for a two-bedroom: $28/hour - High-cost rental market REIT index return (1989 to June 2019): 9.24% annualized - SP Global REIT Index performance in Canadian dollars ACWI return (same period): 7.77% annualized - MSCI All Country World Index in Canadian dollars REIT/ACWI correlation: 0.5 - Indicates moderate but not perfect diversification benefit REIT factor replication (Mladina paper): 60% small value, 40% high-yield bonds - Estimated portfolio equivalent for REIT returns from 1986 to Dec. 2015 REIT factor replication (Kaiser & Grover paper): 67% small value stocks, 33% corporate bonds - Alternative replication model used to match REIT factor exposures Equity investor underperformance vs S&P 500: 5.88% annualized over 30 years - Dalbar result cited to illustrate behavior gap Variable annuity investor performance vs mutual fund investors: Outperformed over 12 months, 3, 5, 10, 15, and 19 years - Cited as evidence that restrictions may improve investor behavior

Pivotal Quotes: "It changes the whole conversation for the moment about fixed versus variable mortgages." — Benjamin Felix: Discussion of current mortgage pricing where fixed rates are below variable rates "There is no better time than now, and even more dramatic in the value space." — Warren Coons (quoted in article): Example of an active-management claim criticized for lacking supporting data "Despite the extra fees and penalties, perversely it seems because of them, investors in variable annuities outperformed those in mutual funds over 12 months as well as over 3, 5, 10, 15, and 19 years." — New York Times / Dalbar discussion quoted by hosts: Used to illustrate how behavioral constraints can improve outcomes

Implications: Listeners should favor evidence over narrative: fixed mortgages may be attractive now, housing affordability is stretched, and REIT overweighting may be less justified than it appears. Planning should account for family support, and investment decisions should prioritize discipline and factor exposure rather than flashy claims.