Fixing Housing Means Fixing Finance🏡💸

Added: 2026-05-31

[00:00:04]Housing debates today are dominated by one idea. If we just legalize more types of housing, supply will increase, rents will fall. And it's that simple. Well, what if it isn't? What if that story is incomplete? My guest today, economist and real estate investor Mike Felman, argues that the real constraint on housing supply isn't just the types of homes that are allowed to be built, but it's how those homes are financed. In his report for the US thinktank groundwork collaborative titled fixing housing means fixing finance, he makes the case that we can't just deregulate our way to affordability. Because what gets built and whether anything gets built at all really depends on how housing is financed and the returns that investors expect. In this conversation, we unpack why traditional economic thinking breaks down in housing, why upzoning alone isn't enough, and how changing the cost of capital might be the missing piece. And we also connect these ideas to what's happening here in Canada, where programs like CHC's MLI Select are quietly reshaping the economics of rental housing in Canada.

[00:01:14]Here's my conversation with Mike Felman.

[00:01:17]All right, Mike, thank you so much for taking the time to join me. uh on our Move Smartly YouTube channel and podcast to talk about your latest paper. I'm really looking forward to hearing some of your thoughts on that.

[00:01:30]>> Thanks for having me.

[00:01:31]>> All right. So, you know, I wanted to kick off by talking about what I think uh has been a shift in the dialogue around housing, at least that I'm finding like over the I've been in this business for a very long time. Um and I feel like over the past, you know, I don't know how many years, but it seems very recent. There's been a big shift towards this supply story where you know people think about housing affordability and high rents and home prices. you know, the narrative has become that it is almost exclusively driven by land use restrictions, um, you know, and zoning. And I guess before we even kind of talk about your paper, how, you know, how do you feel like you're you're an economist, how did that become the dominant narrative when people are talking about housing?

[00:02:17]Because it seems like a relatively recent trend that I've been observing.

[00:02:21]>> Um, you know, the origin stories are interesting. uh at least uh in the US there's two economists who's uh um Ed Glazier and Joseph Guro uh and um they wrote a bunch of papers in the early 2000s really before the you know last US housing bubble I guess you can say this is the second US housing bubble we're in right now um uh but before the 2008 uh uh crash which didn't affect Canada or really most other countries. Um uh the uh they were already writing about kind of that they thought that land use restrictions was driving up home prices and it was responsible for uh the uh you know the runup in home prices from like 200 from like 2000 to 2006 or so in the US. Um I think it lost a lot of its salency because like you know of course the market we like know the end of the story is like the market crashed and home prices were like looking back now um ridiculously low in the US and lots of major areas for a very very long time uh after the great financial crisis. Um you know condos were selling in Florida for like $20,000 and like I mean kind of like insane low prices. So I think a lot of the urgency and the salency went away and then now back we're kind of back to it that people are looking for a easy explanation for like why housing is expensive again.

[00:03:59]>> Yeah. I mean I think they do lean on easy explanations. I find in the challenging explanations. You know a lot of the the explanations they used to talk about were you know kind of singling out regions like Texas as kind of having solved this. Listen, if you look at Texas home prices before the 2008 bubble, they were pretty flat, you know, but since 2008, I mean, they've kind of skyrocketed. They've outpaced most of the rest of the country, >> which, you know, I feel goes a bit at odds with this theory that Texas has kind of solved housing through abundance. Uh, when you look at price growth there.

[00:04:35]>> Yeah, I think that's definitely right.

[00:04:36]and and also it's just you know different regions of the country and you know real estate is incredibly regional and localized and it's actually very uncommon um to have like a nationwide decline in home prices that's happened in the United States twice uh which was in 2008 and the Great Depression um and instead just you know regional housing markets perform differently because people sort into different, you know, metro areas constantly. The average person moves, you know, 11 times in their life. Uh, and there's trends of where people are moving to and where people are moving from. And like everyone, you know, now California is painted as like this huge villain that everyone's leaving California. Well, in the 1980s, everyone was moving to California and every no one was moving to Texas. And I don't think that and they built tons of housing in California in the 1980s. And people want to blame SQA and which is a California law that supposedly is, you know, was signed by Ronald Reagan when he was governor of California uh in the 1960s is supposedly stopping home construction in 2025 or 2026, excuse me. Um but you know, they didn't stop them in the 1980s when California built a record amount of housing. You saw a record run up in home prices in California followed by a you know humongous crash and through the 1990s home prices were flat in California >> uh for the whole decade like if you bought a house in LA in 1990 you were about even in nominal terms in 20ou until 2001.

[00:06:18]>> Yeah.

[00:06:18]>> Right. So I I I think that people forget that these things happen and they think that when you seeing home price increases in certain markets, it must be because of some regulatory reason when a lot of times it's just market forces.

[00:06:33]>> Yeah. So I mean your paper makes a subtle but I think important point that uh it's not that supply doesn't matter but that deregulation alone won't deliver affordability effectively. And I'm wondering if you could kind of explain or unpack that idea for viewers and listeners.

[00:06:52]>> Sure. So, so, but before I do that, I want I want to I want to people throw and I do this in a lot of interviews, so indulge me, but >> people really throw around uh the words supply and demand. And if I can hat tip Cameron Murray, who I think you had on the show if I'm not mistaken, Australian economist, that we have to define supply and demand really really precisely.

[00:07:19]>> Um, and he he you know just made me wise to the importance of this. So supply does not mean the entire homes number of homes in existence and demand doesn't mean like the number of homes that people want to buy. Like so uh supply is just a um mapping or or a function which maps that says if you had a whole bunch of prices like $1, $2, $3, $4, how many how many homes would be purchased at uh you know $50,000? Well, obviously that's an incredibly low price. So, people would probably want to purchase a huge number of homes. And then if you doubled it to $100,000, well, fewer people would buy the would buy homes. And you went up to, you know, up to where home prices are now, then you you see uh a de a decreasing uh number of of homes that would be purchased. And that's the demand curve. That's downward sloping.

[00:08:14]And the supply curve is upward sloping.

[00:08:16]It's just the inverse. says, "Well, how many how many willing sellers would there be if the market price of a home were x number of dollars?" And then that's so the higher the price, the more willing sellers you're going to have.

[00:08:29]And so when we talk about supply, we don't want to talk about the fixed number, the number of homes in existence. Maybe you could talk about the number of homes per sale, but that's just giving you one point on the supply, what we call the supply curve, right? So, it's saying, well, given the market can market prices for homes today, how many are for sale, right? Um, and so really, uh, when when when you're talking about fixing supply, when you're talking about like solving the supply problem, what people really want to do is they want to shift the supply curve, which means they want to make it so the same number of homes today that are being sold today at whatever the market price of a home is. We want more to be sold today at the same price, right? And to do that, well, why would you know, if you want more willing sellers, but you want to keep prices fixed, well, that's going to take some you're going to have to change the way homes are built. One way you could think of that is if it costs less to build a home, then you should get more you should be able to sell the home for the same amount, but have more willing sellers because it suddenly becomes more profitable to sell a home even at keeping prices fixed. Um, and so I think that one of the things with our paper is we address a key uh kind of constraint on on home building which is financing. The fact that you need a really high rates of return on real estate to hold real estate to operate real estate to build it to build to develop it. Um and we're saying that hey if we if we have uh higher if we if we can change the way housing is financed we can actually shift the supply curve where we don't have to sell you know we can have more homes constructed uh but without raising prices without having price without needing prices to increase to to to have more homes constructed which as again I was mentioning California it's very easy to get more homes built just have just you know have housing prices go way up in Cal in the 1980s there was a humongous real estate bubble in California And lo and behold, they built the record number of houses because it was it became so much more profitable.

[00:10:40]>> You know, the the the market price of a home went up and yeah, you have tons of willing you have tons of willing sellers, in this case investors that say, "Yeah, let's let's throw some let's roll the dice. Let's throw some homes up and try to sell them because the price is so high." Um, but that's not what we want. we actually want to, you know, so that if you if you if you use the thinking of like, well, just the number of homes in existence is supply. Well, then you're going to get well, you know, then you'd always see, well, the number of homes is probably that number is probably correlated with higher home prices. Doesn't mean it's causing higher home prices. Um, but yeah, so I guess with our paper, we're really focused on the financing side. There's other things that people have tried to focus on of like uh one is you know construction techniques that's very you know people have been in that space for a long time though trying to automate construction techniques or or so to make it cheaper to build a home the same way like we automated cars um or like other manufacturing or other consumer durables um but but yeah we're focused on the on the financing side >> so I think you touched on a couple points now before we talk about, you know, you mentioned something I thought was interesting, which was, you know, how do we build more homes without requiring rents to increase? And now, before we talk about that, I I want you to help me understand or unpack what I feel is kind of the abundance theory and the the Yimi theory, like the yes in my backyard kind of advocates who often talk about increasing supply alone will drive prices down. Uh and if you upzone somehow builders will want to continuously increase supply in a market of falling rents, you know, to unleash all of this housing and make housing affordable for all of us. You know, this idea that it is a is a deliberate goal of the builder to drive rents down and keep building housing. Um, and this is at least a lot of the narrative that has been going along that that you know that this is how we're going to solve housing or just build more, rents will fall.

[00:12:48]It's how the market functions. So maybe you can unpack how I mean that does happen. It seems it seems to me like it happens sort of by accident, not deliberately, but why does ramping up supplying in a in a period of falling rents a challenge uh in and of itself?

[00:13:06]>> Sure. So really uh housing is an incredibly longived asset. It's a capital asset. So meaning it just it's going to be you make an upfront investment in it and then it produces income over a very long time period. You know homes can last for hundreds of years. Uh you know the oldest apartment buildings in New York City are you know built in the 1880s.

[00:13:29]Uh and so you know what really matters there is what is rates of return. what rates of return these investments can generate. And you know, surprisingly, uh the most of the return on or not most, but at least half of the return on any sort of real estate deal, uh that's developing multif family housing is going to come from a capital gains, not from rental yield.

[00:13:57]And rental yields are, you know, surprisingly, uh low. um can be between 3 to 6% uh depending on you know the market conditions and then the rest of it comes from appreciation. Well, why would an apartment building appreciate?

[00:14:13]Because rents are rising. You know the the value of an apartment building is just a extrapolation of the income stream it's going to generate during the rest of its life. Um and so if that income stream uh is increasing because rents rise well suddenly the value the value of the building reprices upwards and you know the same thing can happen if rents are flat or falling the value of the building reprices downwards also shifts in interest rates because the the discounting rate you use on the income stream. Uh you know the present value of the income stream is going to change if interest rates rise or fall. Uh so you saw a lot you know you saw you know TW in 2022 was basically the top of the market for multif family because interest rates rose substantially after that and uh there's you know substantial monetary tightening around the world uh both in the US and Canada of course and it uh drove down uh uh interest rates or drove um it drove up interest rates and that drove down the value of apartment buildings. And so, um, you know, typically you're going to need rising, you know, for for a deal to pencil out or to make sense financially, you have to be able to reasonably expect rising rents because you're just not going to get a high enough return.

[00:15:32]>> Mhm.

[00:15:32]>> With the rental yield by itself.

[00:15:34]>> Okay. And um and so you know 6% 3 to 6% it's not very much money to own and operate operate a apartment building you know especially all the risk and the liquidity and the hassles you're dealing with and so you're going to need um you know some solid rent growth so the price of that building is going up every year and you're also going to need some leverage uh to to also juice your returns a little bit. So the kind of the three factors is is you know does your is your going in rental yield enough to cover your debt? That's one thing. Uh are rents rising fast enough so that your rate of return or so that you're getting enough appreciation to make the deal make sense. And then even on top of that this is also in rate interest rate dependent. uh you know are rates low enough so that when if you leverage up that you can carry the debt and that you aren't going to get like what's known as negative leverage which is where you know interest rates are actually higher than your rental yield. So any sort of leverage you push on is actually lower is actually lowering your your your cash on cash returns. Uh um and so yeah and so if rents are falling that's just kind of or flat even that's kind of just a deadly you can it's just deadly to the equation that you just can't you're not going to get any appreciation and you're yeah I mean it kills the build the value of existing buildings as well. So the two ways to look at it you could look at it one way and say hey I'm not going to get any appreciation so my rates my rate of return to own this asset is just not going to be very good and so I can invest in something else.

[00:17:06]it makes more sense to invest in something else. So, you know, the S&P 500 or the what's it but what's what's up in Canada? The S SPX >> TSX.

[00:17:18]>> Yeah. Uh and then uh uh you could do that or you could, you know, uh what what else I was going to say? Yeah, you're just not going to get the rate of return if you just don't have rising rents. And uh you know, it's just >> Yeah, that makes sense. I mean, I think one of the most striking lines in your piece was that uh I think you said when the rents drop, the building stops, which I thought was fascinating. And I think >> Yeah, I think I tweeted that. I don't know if that's actually in the paper, but but yeah. So, and people accuse me of saying, well, you know, do you believe in a builder cartel where they're all colluding with each other and they like they say like, well, you know, once rents fall down, we're going to cut off supply. And no, I'm not saying that. I'm saying that the people who are funding these deals are incredibly sensitive to rates of return.

[00:18:07]And anyone can look, you know, all this data is there's a lot of publicly available data generated by the government, the federal government.

[00:18:17]Uh, and there's tons of private firms also generating data sets on the real estate market.

[00:18:24]>> Yeah.

[00:18:25]>> Um, and you know, they're they're very sophisticated. They have drone like like so like CoStar is a big one of them and not I'm not paid by CoStar but they have like literal planes and drones flying around over the country taking aerial photographs of construction sites trying to estimate the the pace of deliveries.

[00:18:43]>> Oh wow.

[00:18:44]>> And they give it to all their subscribers. And so if I'm a if I'm a uh a developer who all they all subscribe to these data feeds, they can just say, "Hey, you know, maybe it's not such a good idea to try to build in this market right now because they have a huge bunch, they have a huge number of units under construction. And so I don't want to be in kind of a crowded trade, so to speak, of everyone trying to deliver at the same time and then having trouble leasing up and having to make a bunch of concessions. And so yeah, I think that now do they always get it right? No, they can. I think that you you see over you see overshoot. You see the market overshoot and you see the market undersshoot as well as far as you know I I think if you Austin, Texas is what everyone loves to talk about. But, you know, Austin saw humongous rents increases from like very very strong rent growth from, you know, 2010 to 2019 and then from like 2020 to 2022, uh, record rent, you know, rent rose like 50%. So, everyone wanted to pile into that trade because they said, "Hey, look, if rents are going to rise at this pace, any sort of uh construction, new construction is going to look great."

[00:19:57]Oh, and the other thing I wanted to mention, I said there was two ways to look at it is just you can look at it as just is rent growth um fast enough so you can make your return. And the answer if the answer is, you know, if the answer is no, you shouldn't build. And the other way to think about it is that when you build a building, it should be worth like your cost to build a building plus the land uh should be less than the value of the building when it's created, when it's completed.

[00:20:26]And you know again the value of the building when it's completed is just going to be the ex is just going to be the present value of the future income stream it generates. Well if rents are flat like that income stream is going to be much lower than if rents are rising.

[00:20:39]And so the the probability your ability to produce a product that's going to exceed that whose value is going to be greater you know exceed your costs and so you make a profit is going to be very very difficult when when when rents are not when rents are flat or stagnant or falling god forbid. I mean for God forbid I mean obviously for tenants that's great but god forbid for a developer you know um >> uh you know it's just going to be impossible a decline now like can a declining annuity so to speak be valued yes I mean so the value of the value if I said what's the value of an apartment building if rents are falling by 5% every year for infinity well the value of that apartment building is not zero because you're still going to be able to collect rents in year 1 and year two and year three and year four and year five obviously if you extrapolate ated that out to infinity. At some point the rent would go to zero, right? But um or approach zero more precisely. Uh but um you know the value of that building is going to be very very low. It's going to be like almost worth less than a uh it could be worth it's it's very soon going to be worth less than a single family home because it just the income stream is not there. So, >> so that kind of creates a bit of a paradox in in some ways I think like where we want you know affordability but this system in some ways requires rising rents uh function. Is that is that fair you think?

[00:22:04]>> That's absolutely right. And I think I think where you see there's there's I call you know there's an asset there's an equilibrium rate of like where as I don't deny and this is where you know as new deliveries as units are delivered to the marketplace it puts downward pressure on rents. I don't I like that's absolutely true and that's trivially true and a lot of people tend to zero zoom in on those periods where you have a a time period of high deliveries and say oh well look you know these high deliveries reduced rents but the problem is as soon as the high deliveries start to flatten rents then the starts tend to pull back and because you know again in an environment where rents are flat rents are are not really rising very very much sufficiently like your rates of return on these projects are going to be significantly lower and that's going to attract way less capital and so then you get less building and then that sets up for another phase of an upsw an upswing in rents and where you might get more investment again and so is very well known it's just known as the building cycle of you know high rents lead to investment which leads to um a flattening of rents which leads to disinvestment which again leads to rising rents again. And uh you know I I don't think that it's very it's not fair or fair is not the right word. I think it's not very insightful to just zoom in on the pure on the on the on when there's the cycle of high deliveries and low investment and ignore the the the uh the the the part of the cycle where there's you know virtually no deliveries and rising rents is that >> almost all these almost all of these almost all these and again Austin I will venture to say uh that even in the Yimi superstar our cities.

[00:23:59]Well, first of all, there was a period of very low deliveries and incredibly high rent increases before the current kind of record deliveries we saw in the US in 2024 and 2025.

[00:24:13]Um but you know if you look out to you know 27 and 28 you know you're going to see record you're going to see really low deliveries in Austin and it's going to lead to uh you know the rental market tightening substantially and then you know where will the what will the story be? Wasn't the planning, you know, wasn't the planning system supposed to prevent this that, you know, why why is it that rents are are rising again or are the rental market's getting competitive again and and and it's harder to find apartment? Like all that's going to happen and it's because, you know, the the the overshot was so high in Austin that, you know, it's going to it's taking me a long time to work for this stuff to work through the system. It's great for renters. I don't deny that. But it's I don't think it's reasonable to expect that in like the most volatile uh building cycle that's really been seen in a generation which is you had record rent increases leading to a record amount of investment leading to a huge drop in softening in the rental market. Um you know that that kind of stuff happens you know one once every 30 40 years. The last place that happened, ironically, was California. And again, it had to do with the 1980s uh uh real estate bubble in California, which is again everyone was moving to California in the 1980s. And and record amount of house caused record home price growth and rent increases and that led to a huge amount of investment and then you saw there was overinvestment and and very soft real estate market for 10 years afterwards. And uh I I just think that in in you know if you see how much the pipeline in Austin is the delivery pipeline has has diminished um you're going to see uh low deliveries and and higher and you know probably stronger rent growth in 27 and 28. And hopefully that leads to some hopefully uh I think one bone I will throw to the Yimbees is that you know hopefully if you have permissive zoning and you don't overregulate then uh if you do see some green shoots um uh uh in the Austin rental market you know starting in the next year or two.

[00:26:36]Hopefully that should attract some capital again and you can get pro you can get projects off the ground. But I'm I'm I'm a little scared. I'd be a if I was at least as where as I'd put my money, I'd be a little skittish given that you know how poorly uh projects in in Austin have performed uh in the past couple years.

[00:26:54]So >> interesting. So one question I wanted to you know maybe unpack for listeners is you know and you talk about it in your paper this idea of how rental housing construction is financed. Who are the different players in financing it? Of course, some of it's driven by debt, different types of debt, uh, equity, and the types of returns that those investors are looking for. Um, and maybe you can kind of unpack at a high level why the, you know, five or 6% rent growth if it stays flat is not enough for as a as an incentive for builders to actually build rental housing. So, you know, you kind of talked about the different capital stack required. Maybe you can kind of give people a rough idea of why that return isn't enough for the people who are putting in their own capital, their equity into housing construction and why this effectively is one of the constraints if I get what you're saying from your paper. Like this is kind of one of the challenges.

[00:27:56]>> Uh yeah. So, so it just it just has to do with you know rates of return in the broad asset market. Um you know housing is one of many things you can invest in.

[00:28:05]uh and you know literally developers are just calling at least in the US it's a very very fragmented system where there's very few like large uh developers with access to the public capital markets that's either the stock market or the bond market. Uh so they're not issuing shares, they're not issuing bonds. They're literally just calling up uh wealthy individuals and saying, "Hey, I have this deal. you want to invest in it. It's a very inefficient way to raise capital and you know anytime you have capital you have an investment that's illquid and high risk that's going to demand a very high rate of return because right now you know you can just invest in a passive index fund and you've done really really well. you've earned you know over the past 20 30 40 years you know they have a very strong these index funds have very you know the stock markets and uh the US and Canada have pretty strong track record of delivering you know about 10% a year with perfect liquidity and you're you're fairly diversified because you own a bunch of companies and so kind of the ask when you when you uh uh call up someone and say, "Hey, do you want to invest in this real estate deal?" You know, you have to, you know, realize that, well, your investment is going to be tied up for a long time.

[00:29:31]It's liquid. You're not diversified at all because you're you're in fact you're you're investing in a specific project in a specific city, maybe even in a specific submarket of that city. Um, so you're you're not diversified at all.

[00:29:44]And the risk is pretty high, too, because anyone who's tried to con there construction risk is anyone who's tried to even do a substantial remodel of a of your house knows that it's every something goes wrong and is over budget 100% of the time. uh and even even you know uh uh when even operating rental housing if if you typically uh project is sold upon completion but you know even if you're going to operate rental housing that's pretty non-diversified illquid and high risk as well. And so you're going to have to to to get these investors to to to to pony up some money, like you're going to have to offer them a sweeter deal potentially than what they could get just investing in in the stock market or in some other vehicle. Um, and so they're going to want, you know, 15 20% maybe more. Uh um and those rates of return sound really high because the average person maybe has a has a retirement account where they're invested in index funds and expecting to get their 10% or maybe they're being a little more conservative uh and they want seven or 8% that they're they're satisfied with that. But you have to realize is those kinds of investments are liquid and they're diversified and >> low risk.

[00:31:02]>> Low risk much lower risk. And so yeah, so in order to the to to to attract capital into the into the into the into the market into the into the real estate sector, returns have to be very high for those for because it's competing with other investment vehicles and there's big substantial disadvantages to investing in real estate. It's mainly risk and illquidity. That's helpful. So I mean and this kind of gets to the heart of I think your paper that you know one of the bottlenecks is certainly financing and con you know financing of rental construction and the returns that uh investors need and that you eventually can potentially con constrain supply and it sounds like from what you're saying this is kind of what's going on in cities like Austin you know Austin I mean I don't follow that market closely but I feel like every housing advocate kind of tweets about how they've solved housing by making house, you know, housing abundant and prices are falling, but it seems like rental construction starts are plummeting, you know, and it seems like, again, it's it doesn't seem like it's because they've made home building illegal. Uh, but, you know, it's easy to ramp up supply when rents are increasing, a lot harder when they're falling. Um, and especially given sort of the financing model for housing. So, you know, I guess moving on like what is maybe if you can kind of unpack the piece that you're talking about like fixing housing finance, what does that actually look like to kind of address some of these bottlenecks that you're talking about? What is kind of the approach that you're kind of proposing in your paper?

[00:32:41]>> So, so one approach is is there's several approaches. So, one approach that we take is that we want to use uh the public balance sheet. So, uh the federal government or it could be a state and local government uh can directly invest on the equity side in some way and there's a million models to carry this out. Um and say, "Hey, you know, we can invest at a much lower rate of return than what a private investor would accept because we have a public policy goal." and and uh so if if if uh if a uh public investor is willing to accept maybe 10% on their money on the on the investment uh you know that enables rents that enables way more housing to be constructed because rents don't have to be nearly as high going in and rents don't have to grow as fast as well. Um and so that that's that's one approach.

[00:33:43]Uh the other approach is we look uh kind of more directly at um uh where are some of the bottlenecks for that that private developers face and at least uh in in the US one places in construction lending is very constrained um need a much bigger down payment uh so you have to put up usually around 40% equity uh to to to to for a construction loan versus maybe 20% for if you're going to if you're an if it's an acquisition and uh the construction loans are higher risk they're because they're adjustable rate.

[00:34:22]Um and uh yeah and so construct and you know the the the reduced leverage um also uh lowers returns potential returns, right? So you need to have a you have a bigger profit margin built into the deal in order to hit your rate your target rate of return because leverage the leverage is lower. And it makes sense the leverage like if it's not the leverage isn't lower because of some regulation. It's lower because, you know, if you think about it, it would be a lot riskier to lend against a construction project and to lend against a building that's already up and producing an income stream, right? And so, it's just, you know, the banks are being completely rational by saying like, hey, you know, we want a bigger we want we want you to have more skin in the game in this deal if we're going to lend to you on this on this. But, you know, so we we have an we think that uh you know, one way we could have the the uh government come in and offer uh construction loans on better terms. Uh probably higher leverage, so higher loan to value uh uh ratios or or at lower interest rates. Um so that's one one another approach that we take.

[00:35:34]>> Mhm. So basically the public sector getting involved whether it is through uh some equity investment or better financing terms on the debt. Um >> yes and and I think your paper touches on this idea that without >> and so and so the point the point the point on both of those is that >> if it's coming in on the equ if you come in on the equity side directly >> Yeah.

[00:35:57]>> you can just say the government's going to accept a or the public investor is going to accept a lower rate of return on the project period. Mhm.

[00:36:05]>> And that's going to lower the amount of rent growth you need to make the project viable, which should inc allow more housing to get built or it's going to lower the going in rent. Or the other magic is that if you give better deal a better a better deal on the debt side again, the overall project can return less but equity can still make its target return, right? And so because less of the money is there's you have less money flowing to uh the debt that's been on you know on that's uh tied to the project. And so e both of those ways is help it just helps you clear that hur helps equity you help you clear that hurdle rate either by lowering it by say on the on the public side of just saying you know we're willing to just accept a lower return because it meets our public policy goals as a government or if you stay completely on the private side is just just say hey you know because you're you have better finance you have better debt you're getting debt on better terms your project doesn't have to perform as well to get built because you're you you because less money is going to to the debt investors and then that leaves more behind for the equity investors.

[00:37:14]>> Yeah, that makes sense. Now, you did mention in your paper that you know without some form of public financing that broad affordability is unlikely.

[00:37:25]Um and what does that mean in practice?

[00:37:27]I guess it goes back to this idea that housing construction depends on rent growth and then without if we don't have public financing, it's difficult to finance that. So that's public financing really solves this dependency it sounds like on needing rents to increase to justify the returns for private investors. Is that pretty much it?

[00:37:48]>> That's pretty much it. And I think that you just if you leave it to the if you leave the market to its own devices, I just think you see you're just going to see these cycle these very volatile cycles of heavy in of maybe of investment and disinvestment as you know rents as the rental market uh uh tightens, you see some more investment.

[00:38:07]And then if that as soon as that starts to to push put downward pressure on rents, then you're going to see capital withdraw again because you're not going to it's very difficult to make it just it's impossible to make your returns without rising rents. And that that statement has, you know, again ruffles some feathers, but I just say talk to any sort of person who underwrites these deals and they'll tell you the same thing that it's just not possible to really make a decent return if rents are flat. And that's just because the value of an apartment building or any multifamily project is coming from both the rental yield but also substantially from the appreciation and the value of the asset is going to be just it's just an extrapolation of the income the present value of the future income stream. And if that income stream is flat or declining it kills the asset value and you can prove it to yourself in Excel if you want or you can vibe code that of just >> a simple model. So I mean interestingly enough I think just yesterday or this week at least I noticed that you know two of the biggest advocates of you know the supply story of course have been uh Ezra Klein and Derek Thompson with their book abundance and I saw I think it was Derrick Thompson mentioned recently in a podcast interview that one of the very fair critiques he feels that they received about their book was that's to really build a lot of housing that people need to be obsessed with how that housing is being financed and he talked about how um it certainly one of the things that kind of they missed in the book and and I think they say it's a pretty valid criticism which I feel like speaks exactly to what your paper kind of touches on. So I think the timing of both were pretty interesting.

[00:39:50]>> Yeah. No, I was I was certainly uh happy to see uh them acknowledge that yeah, the financing uh really matters and rates of return really matter and it's just incredibly difficult to get, you know, if financing if the if the market conditions are not conducive to generating high rates of return, it's very hard to get housing built no matter what the regulatory environment is. And I'm not saying that zoning and that sort of stuff doesn't matter. So, I definitely think the Yimi movement is absolutely directionally correct in that we don't want to be going out of our way to make it hard to build. We don't want to permissive zoning is good in general.

[00:40:33]Uh because I think the market does a decent job deciding like where housing should go. But that's a very different question than affordability. And it's it's it's also because it's a It's a it's a I think whatever zoning you have, you're still going to end up with these volatile cycles of investment followed by disinvestment as as as rent as the rental market, you know, loosens and tightens and and I think it's very difficult to you're never going to get a continuous, you know, what it would take to get to really increase affordability is you need to have a continuous stream of deliveries even into falling or flat rents and that's just not going to happen. uh because you're just not going to make the rates of return would just you know would not be attractive enough for investors.

[00:41:24]>> So on that I mean I think it's an interesting segue to what I think is um really the Canadian example of what you're talking about in your paper. Um, and for, you know, listeners who don't know, Canada's federal government through their housing agency, the Canada Mortgage and Housing Corporation, uh, has been very active in financing rental construction. Uh, in some cases, they're actually financing the construction and favorable terms. Uh, in in most cases, the bigger program is actually how they finance it after the the multiplex or or the apartment building uh has been built. And they basically are giving uh very high loan to value ratios. So you know 90% or 95% uh debt 50-year amortization. So very very long amortizations which obviously lowers the payments uh and very low interest rates.

[00:42:19]So all of these programs um are contributing to a rental housing boom in Canada during a period of falling rents which is kind of fascinating. Um, and my from my experience, you know, at least City of Toronto legalized multiplexes several years ago, a lot of people are building them. Um, you know, but I can tell you for a fact that almost none would be built without this program, >> which I think which I think touches again on the the point that you made that, you know, upzoning all of these policies are sufficient, but they're they they're necessary. are not sufficient on their own, right? And I think this is we're seeing this in the Canadian example where um if it wasn't for these government programs offering investors these really favorable terms, nobody would be building multiplexes in Toronto.

[00:43:16]>> Yeah, exactly. And I think the other the other magic about that program, it sounds like is that they're really offering developers a really favorable exit almost without an exit. is that really whenever you complete a project, most developers are looking to sell because that construction loan at 60% loan to value and it's adjustable rates.

[00:43:36]You're you're bearing interest rate risk. Um, and so you really want to sell and pay off your construction loan and hopefully make a profit. Um, the other option is of course to refinance, but if the Canadian uh government is coming in and saying, "Well, we're willing to refinance you at a very very high loan to value, so you're going to get way more leverage than you ever could in the marketplace if you bought if you if you if you took and reinvested that money and we're going to give you a super low interest rate and oh, by the way, it's, you know, fixed rate for 50 years." I mean, yeah, who wouldn't take that deal?

[00:44:11]And so the fact that you have such a clean exit once you finish construction, that's that's on way f more favorable terms than you'd ever even get if you, you know, didn't have that government program. It it I'm not surprised at all that it's spurring a lot of construction.

[00:44:26]>> Yeah. And absolutely. And for I mean, for the average listener, I mean, the way this program effectively works is for the most part, the investors are, you know, they still have to buy the land. They still have to have some capital up front to finance the construction, but once the project is done, let's just say that multiplex is worth a few million dollars, uh they're basically able to pull out all of their initial equity because the valuation that 3 million, you touched on this earlier, is higher than the cost of the construction and the cost of the land, which basically means at the end of the project, they have zero of their own money in the in the project. like they have equity because the value has gone up, but they've effectively taken out all of their own cash. Um, so this is why or most of it, you know, and and this is why these projects are super favorable for investors because once it's completed, they don't need a lot of their own money to own a $3 million >> multiplex. And and you mentioned that the interest rate is is lower than what you know they would have gotten in >> Yeah, absolutely. Because it's governmentinssured. So the governments aren't financing it. It's through banks, but it's effectively like a governmentinssured loan, right? So it's it's guaranteed by the federal government. So they're getting like the cheapest rate possible.

[00:45:41]>> So you're getting the cheapest rate possible on the debt. So that means the so that means you can, you know, the the rent you can le and with combine it with the leverage that can say, you know, if the rental yield is maybe not that great, but you're leveraged, you know, 20 to one and the interest rate is low enough so that you can carry the debt.

[00:45:59]>> Yeah. like it looks great, you know.

[00:46:02]>> Now, I guess one I'm gonna push back because we have to push back a little bit, you know. Sure. And my own kind of critique of the program is aren't we just, you know, burring this affordability math in sort of the financing structure and effectively socializing the downside risk of these projects. So, you know, when you're super high leverage, certainly the people investing them get all of the upside. But if the market doesn't go their way, if on renewal rates are higher, rents decline, and they can't afford it, and they're defaulting it, it's this it's the taxpayer who's obviously eating some of that loss. So, is that really a great model to, you know, to argue the flip side?

[00:46:48]>> No, it's it's a it's a fair point. And so I think also the other thing I I I you know one argument that I've pushed back that I've gotten is and I think it's a fair it's fair criticism is that hey these rates of return in in the uh in the marketplace are high because of the risks and so if you want the government to come in and offer financing on really favorable terms and accept a lower return but not get you know but they're not actually lowering the risk you know isn't that an effective public subsidy and the answer is yes. Um but it's not an in accounting sense as long as the government doesn't lose money, it's not going to increase the deficit. And um it is a public subsidy in economic sense because you're taking risk without being fairly comp fairly in quotation marks compensated and that's real. Um but again, I think if there's not an I think politically if there's not an actual accounting cost to it, people aren't going to care. And also I think that you know the the the public subs as long as the public as long as the economic subsidy I should say is going to meet a public policy goal which this case could be housing affordability. I think that it's I don't really I wouldn't have a problem with it as a voter. um you know uh in the long run if the expected value of the project is enough to cover the government's cost.

[00:48:15]Yes, there's going to be years where sometimes the returns are going to fall short and sometimes the returns are going to exceed uh the expected value of the of the of the of of uh of whatever the portfolio of projects the government's financing. But as long as in the long run the government is covering its costs, I I don't see a problem.

[00:48:40]>> Now, do you see any risk with this idea that basically the entire I mean, at least in Canada, we're getting to this point where the entire rental construction pipeline is almost entirely dependent on a single policy lever, right? Yeah. Which is the, you know, obviously dependent on the government loading up on debt to finance a lot of our new rental housing. So is that uh a risk or or one of the you know this idea that >> it could be one single policy that's driving all of it?

[00:49:13]>> It could be. I mean I think I think that I mean the risks are just are capture of like you know I don't know uh you know people uh on the government side who are underwriting these deals are they being captured by the industry so they're just shoveling money out no matter what or you know not actually saying like hey you know are we are we actually yes this is this is unfavorable terms it's designed to be unfavorable terms but we also need to get our money back right um and if we wanted to not get our money back, we could just build the housing directly and not have the private investors involved at all. Yeah.

[00:49:49]>> Right. Um and so so yeah, so I think I think that's the biggest risk. It's a political economy risk of just I think of just the the the people at the let's what's the name of it again? The Canadian >> CMHC, the Canada Mortgage Housing Corporation.

[00:50:06]>> Canada Mortgage Housing Corporation. uh if they I if the people working there I'm sure there's lots of industry people who maybe move from industry into that into those roles and so if they if they become captured uh uh that would be a that would be a bad sign I think could that that potentially that you know if you did have a big downturn um and these deals were not underwritten responsibly but that's always a risk with any government program. Yeah, absolutely.

[00:50:35]>> So, >> awesome. Mike, any final thoughts before we wrap up for today?

[00:50:41]>> Uh, no, you can check the paper. It's with a place called Groundwork Collaborative. Uh, again, we're a economic policy shop, uh, based out of Washington DC. Um, so obviously we're very US focused, so I apologize to the Canadian listeners, although my my grandmother's Canadian, so I'm an honorary >> uh Canad Canadian. Um but uh you can read the paper there and it's called uh um fixing housing means fixing finance and you can just uh go to the put groundwork collaborative into Google and then it should be the first thing that comes up and then under research uh you can read the paper.

[00:51:18]>> Yeah, absolutely. We're going to include a link to the paper uh in the show notes online as well for people who are interested in reading it. Yeah, it was a great it was a great read and again I think as I said very relevant. I feel like I don't I haven't seen anything like this. A lot of the narrative has been about upzoning all of this and I think you touched on what I think is uh really at the heart of what's driving rental construction in Canada right now.

[00:51:43]Yes, you know, legalizing some upzoning is important and and you know, it's good, but it's really this this public financing model that has fueled rental construction. And it's especially interesting that it is during a period of falling rents, which is again counterintuitive, doesn't typically happen, and I think it's a good example of how public policy can drive construction even during market downturn. So very relevant. Thank you so much for joining me to chat about your paper uh this week, Mike. Thank you.

[00:52:14]>> My pleasure. Thank you.