Canadian homeowners are quickly becoming further constrained in their ability to access the equity in their homes. Potential home buyers are being regulated out of the housing market. As a result property values will slide and our economy will slow. This may seem like bad news, but for you, it is not! As long as we have the foresight, this will be a fantastic opportunity to create wealth.

In response to a slowing economy brought about by the new regulations, and the onerous capital requirements of the regulations themselves, Banks will overreact in order to please the financial markets, tightening credit just as we saw with the credit crunch post-Great Recession. As the Banks retreat from secured lending an even greater opportunity to deploy private capital toward excellent risk weighted returns will open up.

Here are the 3 steps to us creating some wealth together in the next 5 years:

1. Be Prepared.
Access the equity in your home now. This equity is only valuable if it’s being used. If you have no immediate intentions of selling your home, a reduction in property values only negatively impacts your ability to use your home as a source for low cost investment capital. Access that capital now and watch the value of that capital increase, while those around you see their ability to borrow limited by reducing property values and increased regulation.

2. Be Disciplined.
Begin investing in low risk mortgages with low Loan-To-Value weightings. This requires discipline. While others look to make higher returns, foregoing diligent risk management in the blind pursuit of yield, we must look for low risk mortgages that provide safe and stable returns. Those who are rushing to reap massive returns on second mortgages now will be panicking to sell those second mortgages at a discount in the future, wiping out their extra yield and likely a large chunk of their initial investment.

3. Be Patient.
As the Banks retreat from lending there will be some downward pressure on property values. Yet property values will not be as impacted as capital availability, particularly considering the government’s failure to address the supply side constraints that are a significant contributing factor to the strength of our target GTA market. When the mortgage market is affected by a lack of common sense lending and rates artificially increase, investors will see much higher risk weighted returns.

Let’s look at this in more detail:

This week the Minister of Finance announced some changes to take effect in the Canadian Mortgage Market. As an investor in our Mortgage Investment Fund you have probably heard me discussing the possibility of further regulation limiting the amount of equity Canadians will be able to access from their homes. Well, here we go!
It is our belief that we must access the equity available to us in our homes to make investments now. Very soon our access to that equity will be extremely limited by the new regulations and their knock-on effects (reduction in values, and retreat of conventional lenders from the marketplace).

Interest rates are at all-time lows and will continue to be for the foreseeable future. We are in uncharted territory. Typical sources of investment income for Banks, Insurance companies and Pension Funds are being assaulted. Soon mortgage rates will be artificially inflated by the new regulations being imposed. In fact we’re seeing this already, as lenders price in the new policy framework. This is precisely the government’s goal – to artificially raise interest rates within the housing market, without raising rates affecting the broader economy. It’s hard to know the full extent of unintended consequences this action will produce, but one thing we can be sure of is this: increased profits for Banks. Unfortunately, it could also result in a drop in the value of our real estate which, broadly construed, is estimated to account for around 50% of our economy.

By limiting access that Canadians have to low cost institutional funds and then placing restrictions on who can lend money and who can borrow money the federal government is devaluing the wealth Canadians have in their real estate assets. This is a dangerous game. If the measures being imposed are too severe they could create a more serious recession that will likely result in further interest rates drops and a reversal of some of the policies now being implemented.

Regardless of how this unfolds one thing is certain: When Banks no longer approach lending with common sense principals the market will require alternative sources of funds. Cannect will be there. By patiently investing in low risk mortgages now we will be able to take advantage of greater opportunities in the future.

If you are lucky enough to be able to access the equity in your home, what should you do with it?

The Cannect Mortgage Fund has been created to take advantage of opportunities in the mortgage market.
Our fund is currently at a Loan to Value weighting of under 58%. This means that the total value of the loans we have provided represent a little over half of the value of the real estate they are secured against. Over the past year we have worked to reduce this, Loan To Value Ratio (LTV) in order to protect the fund, but more importantly to prepare for the coming changes in the market. There are still many Mortgage Funds, and Lenders active in the market place lending money at or above 85% LTV! These lenders won’t go away because of the new regulations, they’ll thrive. And next to them, we feel very comfortable.

In the short to medium term we expect prices to see some downward pressure as the market adjusts to the new rules imposed by the Canadian Government (have a look at our recent MorCan Direct newsletter explaining those rules here). In the longer term we believe that more opportunities in the market will become available allowing us to generate greater returns as we purchase distressed mortgages and take advantage of a far more profitable market from a risk vs return perspective.

If you or someone you know has equity available to them they should consider using it before these new barriers created make it impossible to access. Our roadmap for the future is clear. Our commitment to our Investors is to protect their investment and make conservative decisions that will create wealth.

Mortgage Brokers typically only focus on using their clients’ equity to pay down higher interest rate consumer debt; our focus is also on helping Accredited Investors use the equity available to them in their homes to increase their wealth. We take this job very seriously.

As the guidelines for refinancing begin to make it impossible for Canadians to access their equity and home prices begin to slide those of us who have accessed the equity in our homes will be in an incredible position to take advantage of opportunities available to create wealth.

This email is not intended to pressure anyone into making a risky decision regarding the hard earned equity in their homes. Many people view this equity as their nest egg, or their savings account, and they are right to be careful. But what happens when you can’t access the money in your savings account and the rate of return offered to you on it becomes negative? Accessing the equity available in your home before it is too late and using it to make an informed investment decision will create wealth for you and your family well into the future.

If the Canadian Government and our Banks are successful in limiting our access to capital and therefore our ability to lend to one another we will be forced to rely solely on the Banks. This will slow down peer to peer lending platforms, and reduce the funds available for investment in assets like private mortgages. It will ensure that Banks can return to making greater profits on lending out our own money back to us at higher returns.

US Recession

While Canadians insist on their cultural differences from the United States, economic ties are more difficult to deny. The United States is by far Canada’s largest trading partner, and any fluctuation in the US economy has an effect on Canada. Investors whose assets are not directly tied to US interests may not be as directly affected, but with the increasingly interlocked nature of the global economy, seemingly distant economic events can have a major impact on the value of investments. Many corporations with a Canadian public face are closely tied to, and even owned by, American interests. Canadians have good reason to keep a close eye on the health of the American economy.

Exchange Rates

The issue of exchange rates is also closely related to the question of the American economy and its effect on Canada. If the loonie begins to sink in relation to the US dollar, imports become more expensive. However, if the loonie gets too strong, foreign buyers are deterred from Canadian goods, damaging the export market. Economists attempt to keep things on an even keel, allowing a slow and steady rate of growth that doesn’t alarm buyers and sellers on either side of the border. Particularly in volatile economic times, this balance is not always easy to maintain.

Inflation

Invested assets gain value over time, if they are increasing at a greater rate than inflation. If your investment is increasing by 2 percent per year, and the inflation rate is also at 2 percent per year, you’re simply breaking even. Inflation rates must be evaluated when seeking out potential investment opportunities.

When all the variables are taken into account and combined with the uncertainty of future trends, investment decisions can become complex enough to require the help of a professional.

According to a Bank of Canada, that so-called “new neutral” rate could be lower than we thought and it may take longer than previously projected to get there.

“The bottom line is that potential output growth in Canada and other industrialized economies will be lower than it was in the years leading up to the crisis,” said Carolyn Wilkins, the central bank¹s senior deputy governor in a speech Monday, which coincided with the release of a new discussion paper by bank.

“We also think that the neutral rate of interest is lower,” she said, now at between 3% and 4%, compared with a range of 4.5% to 5.5% in the mid-2000s.

Ms. Wilkins, in her first public speech since becoming the bank¹s No. 2 policymaker in May, told a Toronto business group that policymakers estimate potential output growth will average “just below 2%” over the next two years. Compare that to the bank’s estimate for actual growth in the current year of 2.2%.

In her speech, Mrs. Wilkins said: “The neutral rate is to economists what dark matter is to physicists. We are convinced it exists, it plays a central role in our models and analysis, but we can¹t directly observe it.”

Opinions also vary on when the output gap — the difference full capacity and actual performance of the economy — will be closed and the neutral interest rate can kick in.

For now, most economists expect the gap to close by mid-2015 or slightly later. But there are also different views on when that will prompt the long-awaited rise in interest rates — which could also come before the gap is closed.

The Bank of Canada¹s benchmark has been at 1% since September 2010.

“But even with a closed output gap and inflation at target, the policy rate may not be at neutral,” Ms. Wilkins said. “As long as the factors leaning on growth persists, a policy rate below neutral would be required to maintain inflation sustainably at target.”

In other words, a rate hike by the Bank of Canada could come even later than many economists have forecast.

Ms. Wilkins took over as the bank¹s No. 2 policymaker in May, replacing Tiff Macklem in role.

Mr. Macklem left the bank to become dean of the Rotman School of Management at the University of Toronto shortly after being passed over for the top job when Mark Carney left to head up the Bank of England.

Tenants: An income property is only worthwhile if it is making income, and that means you have to rent it. In Ontario, the Residential Tenancies Act places a whole range of restrictions on what you can do as a landlord, including how much you can increase the rent and what you have to do when you want your tenant to leave.

Diversification: Your home probably represents, if not a majority, certainly a big chunk of your net worth. Buying another piece of real-estate in the same town increases your exposure to that market in the event that it takes a dive. Of course you could buy an income property well away from where you live, but that has problems as well (see Tenants above).

Transaction costs: Buying and selling real-estate is expensive. Between real-estate commissions, land transfer taxes, legal fees etc., the cost of selling your investment can easily be 7 – 10%.

Liquidity: The long bull market in Canadian real-estate has made people complacent about liquidity, but that can dry up very quickly if the market takes a dive, as people who owned property in the US in 2008/09 can attest.

Does this mean you should stay away from investing in the housing market? No! Instead, consider investing in Mortgage Investment Corporations. A Mortgage Investment Corporation gives you access to a diversified real-estate portfolio, whose owners, unlike tenants, are very motivated to make the payments on time and keep the property in good condition. The Cannect MIC has an average return since inception of over 8%, which compares well with the property market, and liquidity is good. Even in the worst case scenario (redeeming the investment after 18 months), the redemption fee is capped at 5%.