FidelityConnects: Canadian real estate and insurance – Analyst insights

[00:04:15] Glen Davidson: Hello, and welcome to Fidelity Connects. I'm Glen Davidson. The world is arguably becoming a riskier place with weather events and natural catastrophes happening more frequently and more severe over time. How are insurance companies adapting to these changes? In real estate, the rental market faces challenges marked by oversupply and financial strains on developers with winners and losers in this sector. How is this affecting market dynamics and investment opportunities? Joining us today to discuss evolving trends, challenges and market dynamics in the insurance and real estate sectors, and break down the risks and opportunities in the months ahead is equity research associate, Connor McGrath. Connor, great to have you here.

[00:04:53] Connor MacGrath: Good to be here. Thank you.

[00:04:54] Glen Davidson: Conor, the last webcast you did, if I'm not mistaken, was back in January and the wildfires in LA were happening at that moment. You talked a lot with Pamela about what you thought may be happening and the analysis that you were going to do through that whole event, if you will. Now we sit here in Augus, tell us what's happened, what you've learned through it, and what's likely to be something we should keep an eye on going forward?

[00:05:17] Connor MacGrath: I think the biggest takeaway is I think this is just another validation of I think what I've spoken about on a few past episodes around these large natural catastrophe events happening more frequently but then also when they do happen they're more severe and the damage is more severe. Unfortunately, what we're seeing is a growing divide between the societal impact, the larger economic impact, but then also what insurance companies see. A lot of that stems from the fact that there tends to be growing coverage gaps after these events happen. The large event happens, the insurance company takes damage, their margins go down but then they tend to pull back on coverage, which means that consumers are left without homeowners insurance coverage or a business can't insure their factory or whatnot. When the next event happens they're left in a bit of a tough spot or they're having to look to more expensive insurance coverage options. What happens now is that we continue to see more and more of these events happen. Six months ago it was the LA fires, now we're talking about wildfires in Canada, in cottage country here in Ontario, we had the floods in Texas, it's hurricane season right now in the Atlantic so there is that growing coverage gap, undercoverage and underinsurance, but then at the same time these events are happening more frequently and with higher severity and it's just a continuing problem that doesn't seem to be resolving itself at any point soon.

[00:06:40] Glen Davidson: I'm curious with what you saw in LA, can it be combined with what we've seen in Florida where some insurers are just saying, we're not even going to provide coverage, or it's for an elite few. What are you seeing?

[00:06:51] Connor MacGrath: It's the exact same thing, it's the exact same pattern. Unfortunately, at the end of the day the insurance companies do have to earn an economic profit. They have shareholders that they are stewards of their capital and, unfortunately, it can be a combination of the fact that these events are becoming more severe but then also there is a regulatory aspect to this as well. When you want to increase prices that you charge to homeowners you have to usually get the regulator, maybe at a state level, to approve that. At times there may not be proper approval so you may not be able to earn a good enough economic return to justify you operating, let's say, in the California market. Your natural response is, well, I'm just going to operate to a lesser extent. I'm going to stop writing policies, I'm going to drop your coverage in that market. That, unfortunately, leaves the consumer in a tough spot and creates a larger societal impact of people who, as I mentioned earlier, either have to access more expensive coverage or have to resort to options where they maybe don't get full coverage for the value of their home. When the next event happens it leaves them in a not so great situation.

[00:07:52] Glen Davidson: Or they're relocating completely to a different state or a different province, if we're talking about Canada, which is interesting that your responsibility is insurance and real estate, and, actually, there's a real combination. We're talking about events in the U.S. and Canada, your focus is on Canadian companies but you should be, and are, looking at what's going on in the U.S. because, really, there's connection to all of that. This has an effect on real estate as well, doesn't it, where people will say, I just can't live in that state or province or whatever.

[00:08:21] Connor MacGrath: I think it's, obviously, very well understood around higher interest rates impacting affordability and whatnot but I think there are also demographic and population movement changes within, let's say, the U.S., for example, where, yeah, it may be really expensive now to acquire homeowners insurance in Florida or in California so maybe I'm going to move more inland, let say, or move to another state where there's a little less of risk of these events happening and damage happening in my home, but then also it is just maybe a little more affordable for me to actually live somewhere and not have to worry about, yeah, can I actually get adequate coverage of my home.

[00:08:55] Glen Davidson: That has massive trickle-down effects on builders, on malls, on recreation but that's a whole other story. Now, what do you do — I've always been impressed with the access that equity analysts have at Fidelity to whatever it is that you need to do the right thing for the unitholder. With all that's been going on how do you keep an eye on what's happening globally?

[00:09:18] Connor MacGrath: It is a real advantage being in Fidelity because everything, it feels like, is a flight or a phone call away. Whether that's my counterparts in London or other parts of the world that cover U.S. and European and Asian insurance companies so I can understand what's going on in different parts of the globe, but then also I get access to experts, we can talk to a lot of the largest insurance companies in the world but then you can also travel to where they do business. I was in Bermuda last December, it's where a lot of large reinsurance companies operate out of and you really get access to how these companies think about these different problems that we just spoke about and how they tackle it. You have to look at it from different perspectives and take into the fact that the insurers may look at from one perspective, investors in those companies, we have to look at it from another perspective but then also look at the larger societal implications of some of these events that are happening. At the same time, too, we get access to various forms of alternative data. It's hurricane season right now so I use satellite data to track storms that are forming in the Pacific and Atlantic, try to understand their course trajectory, the strength of the storm, you can analyze certain things around wind shears and moisture levels in the atmosphere, ocean temperatures, things like that. I think, again, it really speaks to the strength that the research platform that we have that I have access to this and I'm able to kind of help our portfolio managers make very informed decisions around some of the companies that we invest in based on a lot of this work and a lot this data that I have access to.

[00:10:43] Glen Davidson: It must be fascinating for you to have a keen eye on what's happening with the tumultuous weather, etc. When you were in university you probably never thought you'd be monitoring weather but it's impactful to what it is that you do. You mentioned the conference for reinsurers that you went to, to visit all of them, typically domiciled in Bermuda. How do they factor into this? Maybe a reminder for me and for our viewers, how does a reinsurer work and are they, potentially, cutting off insurers who are then cutting off the consumer?

[00:11:12] Connor MacGrath: Yeah, it's a great question. To put it very simply, reinsurers exist as insurance for insurance companies. They are essentially a way for insurance companies to protect against tail risks. Think very large events, a one in a hundred year event, a one in a thousand year event, where an insurance company at the end of the day is very focused on protecting the capital on its balance sheet. That's paramount. There's different ways to do that but one of the easiest ways to that is purchasing reinsurance and kind of additional coverage where if a loss comes in and it exceeds a certain threshold then the reinsurer takes a piece of that. As you mentioned, yes, reinsurers do play a very important role in the whole value chain of offering insurance to an end consumer like yourself, let's say, because at the end of the day if I'm an insurance company, I can't get access to some of that tail risk protection then I'm going to maybe reduce my risk appetite and write less business, let say, maybe in a higher risk market like California. That has a trickle-down effect on the end consumer because then they have less available options to purchase insurance at the end of the day. There really is an end-to-end impact that you see that flows through the whole value chain, especially when some of these large events like the LA fires or hurricanes do happen. You may not think about the trickle-down effects through the value chain but they are very real, and from my perspective I can see the full end-to-end impact of that play out.

[00:12:33] Glen Davidson: A comment I have with auto insurance, and I'm going to relate it to home insurance. I think people sometimes think the auto insurance is based on what I've paid for a car. I bought a Honda Civic, it shouldn't be much. Then they get the bill and it's huge because of the probability of problems because there's so many that are out on the road. Is that happening with houses more so?

[00:12:54] Connor MacGrath: Yes, and it's interesting you bring that up because when I talk to some of the insurance companies I cover they give some really interesting examples of ways that they use AI, ways that they use machine learning, and all the different data points that they get to, as you mentioned, become a lot more segmented in how they ascribe a certain amount of risk to maybe your house and maybe the one right down the street. They may factor in things like the slope of the road that you live on, the grade, soil quality. They may also look at past events in your claims history versus their claims history. They may look at past precipitation levels in that certain part of the city that you may live in. They all factor that into, hey, Glen may have to pay a slightly higher premium than someone a few doors down mainly just because of factors X, Y, Z that we're able to put into our model and it spits out a bit of a higher risk profile, let's say, for your home versus someone else's. They can adjust pricing and they can just the way that they segment that based on those factors. It is really interesting and, again, technologies like AI and whatnot do enhance their ability to make those kinds of decisions. At the end of the day, they're trying to get the best outcome for you, obviously, but they also are trying to get the best outcomes for shareholders like ourselves if we invest in them as well.

[00:14:10] Glen Davidson: How do you use AI in what you do every day?

[00:14:13] Connor MacGrath: I use AI, I guess, to probably speed up certain workflows, whether it's going through conference call transcripts or summarizing long forms of text or whatnot. I think I've maybe been a slower adopter of AI maybe than some people on our team that are maybe a bit more front-footed there. I think it does have its use cases, though. You think about our job as analysts, there is a lot of information coming at us in a given day, we get hundreds of emails, there's a lot of research reports and things like that that you can read so if there are ways to automate or speed up some of those workflows, make it a little easier for us to synthesize information and pull out kind of key takeaways and summaries and whatnot, I think those are some examples of what's happening. I think I'm maybe on the slower end of adoption maybe versus some others on my team. Hopefully, I can kind of recalibrate that a little bit moving forward.

[00:15:04] Glen Davidson: Not the slow end, you're just being cautious. You're doing your due diligence. What's great, though, is that you have access to it and where you see you need it you'll be able to utilize AI appropriately, and you've got examples around you so that's a good thing to know. Interest rates have a bearing on the balance sheets for insurance companies. Talk about that and where we're standing right now.

[00:15:24] Connor MacGrath: Sure. Very simplistically, insurance companies make money in two ways. You make your underwriting profit, your premiums minus the claims you pay out, that's your underwriting profit. The second piece, and Warren Buffett talks about this, the float of an insurance company, you pay your premium up front, you take that and you invest it mostly in bonds, corporate bonds, government bonds, any kind of fixed income instrument, and you earn interest income on that. That makes the second component of earnings. Generally, higher interest rates are good for these companies. It means that their earnings go up, they earn higher yields and whatnot. We have seen an interesting interest rate dynamic now where the Bank of Canada has made several rate cuts over the last year or so. There seems to be some probability of the Federal Reserve starting to cut rates later this year. At the same time that we have seen a bit of stability in interest rates in certain parts of the curve, just I think people are still trying to figure out longer term inflation expectations just around ways that the economy is growing, tariffs and things like that. Generally, though, higher interest rates are good for my insurance companies that I cover. Lower interest rates are maybe a little less advantageous for them in terms of power and returns on capital.

[00:16:35] Glen Davidson: Can you talk about the overall vibe of insurance companies in Canada, kind of the macro on that from an investment standpoint?

[00:16:45] Connor MacGrath: Even through the tariff landscape we've seen pretty stable employment levels in the U.S., maybe a bit of a tick-up in Canada. You have to sort of think of some of these companies as a little less macro sensitive, at least on the property and casualty side, because at the end of the day what tends to drive a lot of their pricing and premium growth is driven by inflation. They have inflation in the underlying claims that they pay out and so they have to price adequately for that. A lot of their growth is gonna be driven more based on those factors than others. In certain parts of the economy that they play in inflation is running a lot hotter than you would see in the headline CPI numbers that we see every month so they have to make sure that they're adequately priced for that. Then you layer on additional risk factors like storms and frequency and intensity of those as well, that's another consideration. Generally, right now, though, they have been trudging along quite well. Higher interest rates have been beneficial to earnings power for these companies over the last few years. They are earning higher returns on capital and that has been good for these companies, has allowed them to perform quite well on a relative basis versus the TSX over the last few years.

[00:17:59] Glen Davidson: Well, interest rates also connect us to real estate. That's your other portfolio so let's move to real estate. Perhaps, we'll talk about residential purchasers versus commercial first. Interest rates, where's the buyer at these days?

[00:18:13] Connor MacGrath: It's funny because you would think with the amount of interest rate cuts we've had from the Bank of Canada so far that you'd see some kind of rebound or a bit of recovery. We haven't quite seen that, it feels like. A lot of my companies, I cover apartment landlords for reference, there is some direct competition with them versus the condo market in Canada. That's a market that has been in quite a tough situation for the last few years. You had a lot of condo supply being built during COVID. We exited COVID, interest rates went up and right as a lot these condos are being delivered and finished you have a very high interest rate backdrop and not quite a very robust demand backdrop for buying these apartments or these condos. What you're seeing is a lot of these condos are now coming into the rental market. The owners need some form of cash flow, they're willing to just rent them out, maybe at a discounted price versus a traditional apartment. That's creating oversupply issues within the broader rental market, I think to a much more tougher degree than what we've seen in past cycles, unfortunately. The data I track does show that apartment rents across most major Canadian cities peaked in about fall of 2023 and they've continued to come down year-over-year since then. A lot of that has been due to some of these oversupply dynamics that we've been seeing both in the condo market but then there also has been some in the traditional rental market as well.

[00:19:39] Glen Davidson: From a rental standpoint, or ownership, when it comes to condos  we're seeing massive buildings come along as well, which is probably builders getting over their skis, developers getting over the skis. One Bloor West is an example, I see that a lot coming downtown. I think it's 85 or 90 stories but they've had issues with who's going to be the retailer on the main floor, that's changed. They've had issue with what five-star hotel is going to come in. They've had issues with bankruptcy. I believe Tridel who's running it now is saying, we're actually going to subdivide more units so that we can get lower rents for people and get more people in here. Are we going to see this more often because I hear about more and more of these massive buildings being proposed.

[00:20:17] Connor MacGrath: You've seen examples, I think, of some of these smaller developers maybe a little less well-capitalized starting to struggle or projects go under. In terms of the larger developers, I think right now are still in an okay spot. The thing is, what you sort of have to remember is a lot of these projects have a certain percentage of their condo units that are already pre-sold. The risk then is kind of more on the buyer not being able to close on that unit when it eventually becomes available and finished and then they have to get financing to buy that unit, and is the unit still worth what they originally paid for it a few years ago? Right now what we've seen is stable, maybe slightly higher, I guess you could call it default rates on some of those pre-sold condos not quite closing yet but we haven't seen anything dramatic to kind of cause major alarm in the market. At the same time, though, the strength of the buyer is still not super robust and there isn't a big appetite from incremental buyers to step into the market quite right now.

[00:21:19] Glen Davidson: I want to pick up on new buyers. You are, by far, much closer to graduation than I am. What is happening with new grads as far as interest in buying versus doing just other things with their income?

[00:21:33] Connor MacGrath: I think it's interesting, and you sort of see this across broader parts of the economy. You think about household formation, I think has been pushed out almost a few years versus maybe pre-COVID. I think we've also seen people allocate income maybe more towards experiential activities like vacations, things like that, maybe versus more materialistic purchases and goods and whatnot. I think that is an example of some maybe demographic shifts that are kind of going on in terms of buying behaviour and whatnot. There also is the broader interest rate sensitivity that is also going on. Interest rates are higher than they were before COVID and during COVID and that does have an impact on people's propensity to be willing to make a large down payment and commit to a mortgage or whatnot for that. At least within my generation, though, those are sort of some of the things I'm noticing. My hypothesis is that that could potentially be playing into some of the behaviour you're seeing.

[00:22:32] Glen Davidson: To sum up what you just said, what looks better on Instagram, a trip or a mortgage paper? Why don't we shift to commercial now. Boston, you and I have both been down to Boston to see Fidelity's head office many times. It seems there's a shift down there to the seaport area versus the Back Bay area and the core. In Toronto, we're seeing more of a shift towards Lakeshore, where the big bank buildings have gone up. I'm sure that's the same in many other cities across the country. What's that all about?

[00:23:02] Connor MacGrath:  I think what you're seeing, and this ties in really well, actually, with the office market which is an area I spend a lot of time looking at and companies I cover play in there,  what you are really seeing is a big bifurcation, I think, between, call it, the old city and the new city, I guess, is maybe the best way to kind of characterize the dynamic you're talking about. I think what your seeing is a real bifurcation between these flashy new office buildings, the new bank buildings, let's say. Companies want to be in there. They have really good amenities, they're right by the lake, they're right on major transit lines, they have good restaurants on the ground floor, let's say, they have access to the path. You're seeing companies shift from some of these older maybe more legacy buildings. They're maybe not quite as kept up and whatnot and they're now looking to move to an upgrade to something a bit more robust. I think part of it too is I think their employees want that, and I think they're listening to what their employees want, especially coming out of COVID. Unfortunately, what you're seeing is some of these older buildings being a bit left behind. I think the risk is that over time a lot of those buildings continue to be left behind, the winners kind of keep winning and there's risk, potentially, that some of these buildings become obsolete over time and maybe need to be repurposed into something that has a higher and better use, perhaps. Boston, I think, is a good example, and other cities as well, that have kind of followed that similar trend but you are seeing signs of that, though, in Toronto.

[00:24:29] Glen Davidson: I know you've got premium locations and then more mid-tier locations. You mentioned about maybe a redevelopment or a repurposing, is that what we're going to see, maybe a conversion to condos? I guess it all depends on what are the bones like in the building, what are the ceiling heights like, what's the HVAC, everything else. Really, there's a gutting that needs to happen, a huge cost.

[00:24:49] Connor MacGrath: It's just as much of an engineering problem, as you mentioned, as it is a financial problem. You need, obviously, the money, and these are expensive, they're not cheap to fully repurpose a building into something much more than it was. Again, you have seen examples of these office conversions that have happened. Boston is actually a great example where there are certain tax incentives that the city may offer to developers to incentivize this. We've seen this happen a few times in Ottawa and in Calgary in Canada. Even in Toronto there's examples of companies that I cover and have come across that have existing office buildings or assets that they're looking to repurpose into more of a residential use case. It is quite the engineering endeavour. You have to figure out is the floor plate conducive enough to sustain a residential condo. There's considerations around elevator shafts, HVAC, lighting, even the window set-up on the exterior of the building and everything like that. We haven't seen anything immediate but I wouldn't necessarily be surprised if you see more of that start to happen over time as some of these potentially obsolete buildings or these legacy buildings start to be repurposed into something that the owner can get more economic value out of.

[00:26:02] Glen Davidson: In most large cities across the country there's a classic building right in the middle of town, and it used to have a sign on it that said The Bay, what do you think is going to happen there?

[00:26:10] Connor MacGrath: I hope that they stay there. I'm a fan of some of the legacy architecture in the city. I think it adds character to the city and kind of keeps us grounded in our roots and whatnot. I hope it continues to maintain some of that character while also being able to serve a better purpose for the local economy and whatnot. Hopefully, over time you can maybe have a combination of some that legacy architecture in some of ground floors and you're able to build up from there, but I hope they never go away.

[00:26:41] Glen Davidson: Preserve the historical aspects, that would be beautiful. Now, what's happening with return to the office because that's something else. Companies have signed up for large floor plates and numbers of them. They may change that, that changes rents as well. Can you monitor, is there a way that you can see how many people are coming to the office and what's happening in that respect?

[00:26:58] Connor MacGrath: I actually can. Say when you come into the office, you have your badge, you swipe your badge or you tap it, it lets you into the building, that is data that we can see in terms of total cities in downtown Toronto, New York, Calgary, whatnot. You can aggregate that and see how many people are coming into the office every day.

[00:27:17] Glen Davidson: You have access to how many people are coming into a particular company that's unrelated to the company that you work for but not by person, you get an aggregate.

[00:27:25] Connor MacGrath: Not necessarily by company, it's more aggregate by downtown Toronto. But yes, I can see kind of average utilization in a given day of the week versus pre-COVID, let's say. That's actually the best benchmark to kind of compare to. What you're seeing is utilization levels broadly are still below where they were pre-Covid but we have been slowly grinding higher as you see in the news around return to office mandates. A lot of this, again, is somewhat company-specific but I think you are starting to see a bit of a broader trend of people being in the office more frequently. Again, that, I think, also plays into what I was speaking about earlier around the bifurcation of companies wanting higher quality space. They want their employees coming back, they want them in the best office space. They want them to have the best amenities. They want to be close to the subway line or Union Station, let's say, in Toronto. That, I think, all sort of plays into what we're seeing right now.

[00:28:21] Glen Davidson: Transit is a touchy subject in Toronto so we won't go there. Earnings overall, earnings seasons wrapped, what was your vibe for ... let's talk about insurance and then real estate.

[00:28:30] Connor MacGrath: I'd say the vibe was okay. I'd say overall a lot of the trends I spoke about earlier for both I think have definitely continued to play out in the actual fundamentals. It's not just narrative, I can see it in the numbers. In general, I would say things are continuing to track along with kind of what we've been seeing in the broader economy. You've seen companies on average start beating earnings across Canada and in the U.S. Again, there's a lot of company-specific factors and industry-specific factors that are going on but you're still seeing the same things. You're still seeing office occupancy continuing to grind higher. You're seeing continued softness in the rental market in Canada. At the same time you are continuing to see some of this weather-related volatility, some of the insurance companies that cover, but there is obviously still that underlying inflationary component that they have to be cognizant of as well.

[00:29:27] Glen Davidson: Makes sense. I just want to pick up on something we discussed earlier in this webcast which is the access that you have. You cover Canadian insurers, Canadian real estate companies, but it's imperative that you understand what's happening south of the border and all around the world. You're constantly doing that through electronic means on your desk but through visits that you can make, companies that you could see anywhere you need to, conferences that you attend, colleagues around the world that you can talk to. Can you touch on that resource and what it means to you?

[00:29:56] Connor MacGrath: When I first came into Fidelity I had heard about all of these resources that I had at my disposal but then it's one thing to hear about it and then another to actually live it and see it. I feel quite privileged to be in this position where I'm able to have the access that you just spoke about because at the end of the day, I do think it does speak to our ability as active managers to add value to clients to be able to access to these resources not just in Canada or in the U.S. or a local market but just globally, and we're able to leverage a lot of those insights across the globe to make better decisions at the end of the day for clients. I think it does give us a real competitive advantage versus some of our competitors. At the same time, though, it does enhance greatly my research process and I think the research process of the other analysts and portfolio managers on the team. At the end of day I think it's been our bread and butter, historically, has been able to leverage this access. I only see that as something that continues to strengthen over time.

[00:30:55] Glen Davidson: Good stuff. You're certainly not in a silo which would be to the detriment of the investment process. If I'm not mistaken you're three-ish years into real estate and insurance, correct?

[00:31:07] Connor MacGrath: Yeah.

[00:31:07] Glen Davidson: My understanding is that an investment analyst at Fidelity cycles through a number of different sectors in order to get great exposure, great understanding, great learning so they can become a diversified portfolio manager. Where are you at with that?

[00:31:20] Connor MacGrath: I'm about at three years, actually, on my current coverage. I'm actually currently in the transition process onto a new coverage package. I'm kind of pulling double duty right now, if you will. As you mentioned, though, there is a very well-defined process of how we go through these rotations. As I'm rotating onto a new coverage it's not like I'm leaving all my old stuff on its own and leaving portfolio managers hanging out to dry or anything like that. There is a replacement, actually two replacements, I have one for insurance and one for real estate, who are subsequently picking up coverage of my existing companies. I'm sort of helping...

[00:31:53] Glen Davidson: They replaced you with two people.

[00:31:55] Connor MacGrath: Essentially, yeah. I'm helping them transition along the way. They're adding unique insights to portfolio managers as they're new to the space and whatnot. As that's going on I'm rolling on to a new space, learning all about that. Again, it's quite an interesting experience because it's really right as you get very comfortable and very knowledgeable about the space that's exactly when you rotate, that's exactly what's happening internally. But it is a very well-defined process, though, and there is a real method to the madness that you see.

[00:32:26] Glen Davidson: Makes a lot of sense, and I hope to be here some day with you talking about whatever the new sector is that you're responsible for. On insurance and on real estate you were very informative today. Thank you so much for your time.

[00:32:36] Connor MacGrath: Appreciate it, thank you.

[00:32:37] Glen Davidson: And thank you. On Monday, Fidelity's Director of Global Macro, Jurrien Timmer, will be back to set you up for the trading week ahead and help you better understand what's moving the markets around the world with his signature charts and data.

[00:32:49] On Tuesday, Ilan Kolet, institutional portfolio manager, will share the latest insights from Fidelity's Global Asset Allocation Team, where the team is positioning portfolios for the second half of 2025 and how they're navigating market dynamics across asset classes. Tuesday's web cast will be presented in English with live French interpretation.

[00:33:07] On Wednesday, Étienne Joncas-Bouchard, Fidelity's Director of ETF and Alternative Strategies. Étienne will appear at 10.30 a.m. for a French webcast and at 11.30 in English during our regular Fidelity Connects time. Thanks for watching. I'm Glen Davidson. Take care.