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ALWAYS CONSULT YOUR INVESTMENT PROFESSIONAL BEFORE MAKING ANY INVESTMENT DECISION

April 23, 2020 | The Big D

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

Tom’s a Westjetter. A pilot. He married April, whom he met at the Calgary airport six years ago. In Starbucks, Concourse D. She works the cabins.

So now they’re both out of a job, despite Ottawa’s payroll subsidy plan. The airline laid off most of two thousand pilots a few days ago, as it sinks deeper into the abyss. Most routes cancelled. US flights suspended. Passenger loads down 95%. The new owner, Onex, says it has enough cash to keep its 36 businesses afloat through the pandemic, but many people (Tom’s one of them) doubt if normal will ever return.

Not just Westjet, of course. Air Canada has cut 90% of its routes. Travel has been decimated. In downtown Toronto the upscale King Edward Hotel, owned by Omni, was running at 100% occupancy six months ago with rooms starting about $700 a night. It’s shut now. Everybody, from the uniformed doorman unloading limos to the kitchen staff and lowly room cleaners is laid off. The flagship Royal York Hotel is collecting food donations for its furloughed staff. Hotels in Halifax, the cruise ship capital of Canada, are closed. There will be no ships this year. Hotel Vancouver is shuttered. So is the Chateau Laurier, perched elegantly beside the Parliament buildings.

We need to think about such things, in case they portend an altered future.

This is why a barrel of oil became worthless on Monday, and remains in the dumps. Transportation consumes 60% of the world’s crude, and oil has been our nation’s largest export. But when Tom isn’t flying, when the hotels are closed and the highways are empty, demand collapses. So do commodity prices. Now Airbnb is essentially kaput, putting added downward pressure on real estate values. Economies hobbled by the virus have cut energy consumption by a third in just a month. There are now 26 million Americans collecting jobless pay and seven million Canadians are on the dole. Never happened before, so deep, so fast.

 

As of this week, 80% of all small and medium-sized business in Canada are shut, or barely operational. Estimates are that tens of thousands of them will never open again. Jacob knows. He opened a hair/spa business in Vancouver a couple of years ago, and told me this week that revenues fell from forty grand a month to zero. All cash flow went to employees, overhead and debt repayment. Now he has seven years left on a lease costing him $11,000 every four weeks. “I’m done,” he says.

Add in climate change and the political pressure mounts to never return to the way things were ‘way back when – in February. Oil locked into the earth. Parked planes that never fly. Employees working from home, emptying the roads. A global economic and environmental reset, brought on by the most unlikely force – cooties.

If this becomes our future, change will engulf us. Our resource and real estate-dependent economy will be impacted. Cheap oil and falling asset values are disinflationary at first (Capital Economics now says inflation will tumble below zero), then possibly deflationary.

There’s no guarantee this will occur. Hopefully it will not. In the best case scenario, the planes will start flying again (in a limited way) in June, hotels will edge back into operation and people may start planning business trips and vacations for 2021. Restaurants could recover – or patrons may balk at servers in masks and tables set metres apart. Large corporations may conclude it’s cheaper to have people pay personal mortgages and rents and supply their own toilet paper at home than to warehouse them in expensive towers. So no commuting. Fewer new cars. Less fuel. Lower insurance. Gas taxes fall. Commercial lease rates, too. Vacancies. Municipal revenues decline. Fewer workers. Unemployment becomes structural.

In a deflationary world prices go down, not up. Incomes also decline, so things don’t get more affordable. Just the opposite. Debts remain and become harder to pay. This can be fatal with real estate, where the value of the property fades with demand, but the financing upon it remains as a legacy of the pre-pandemic world. Rents drop. Landlords earn less. Condos take a hit.

In the midst of deflation pulling economic activity south, governments are faced with supporting the permanently unemployed. Coming off a pandemic where politicians opened the floodgate and spent as never before in history, amassing epic deficits and debt, can the spigot be turned off? There will be pressure to raise taxes, but without the economic activity to support those levies. Either public debt builds wildly, entombing the next generation, or benefits fall.

Now, once again, let’s make it clear deflation is not on the horizon and Mr. Market fully expects an economic rebound to come. Pent-up demand will have people out shopping again. Factories will be running overtime to make up for lost months. Families will still want holidays, new clothes, haircuts, pizzas, toys and houses to live in. The world in September will likely not be the dystopian one we now inhabit.

But, but, but. Will there also not be change?

If you believe so, be careful. Deflation is the enemy of property. Having the bulk of your net worth in one real asset, especially when ten-times or 20-times leverage was used to buy it, could be financially fatal. Deferring six months of mortgage payments now, only to have all that debt added to your principal later, could be a bad decision. Hanging on to a rental condo with its nebulous (or negative) cash flow could be a big mistake if values falter. Owning four or six units bought as short-term or vacation rentals could be a serious income drain. Holding real estate in regions where resource industries reside could yield sustained losses.

In such a world, cheap debt helps. Refinancing old loans at post-pandemic levels would be wise. So would be selling property where the income stream’s in doubt. In a world of deflation, owners pay and tenants rule. Try evicting somebody for non-payment, and find out.

The greatest defence in a deflating time? Liquidity. Assets that can be sold quickly and easily, while generating dependable cash flow. That does not include your house.

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April 23rd, 2020

Posted In: The Greater Fool

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