Financial Jungle

In his new book, Retire Rich From Real Estate, Dr. Marc Andersen doesn’t teach you how to flip your way to overnight sensational success. Get-rich-schemes only enrich those authors, who otherwise, couldn’t score big in the tortuous world of real estate investing. Marc is none of that. Rather, he advocates the safe and steady approach to real estate riches by using tips and tricks stemming from 2 decades worth of investing experience.

In his introduction, Marc highlights a dire U.S. Census finding where just 4 out of 10 private landlords were profitable in the year surveyed. In another study, 1 in 3 owners would not buy the same property again if given the chance, and less than half reported a profit on their investments. “The average investor in real estate is not successful and continues to make the wrong investment decisions,” Marc warns, because unrealistic assumptions are dumping investors to the poor house. However, don’t let this dampen your spirit.

To help place yourself in the top tier of all property owners, Marc outlines a series of practical guidelines in his book, which is filled with lesser known techniques (at least to me) on how to identify bargains, deal with realtors, calculate cashflow, finance the investment, screen tenants, manage properties, and much much more.

Probably the most important subject is on cash flow. The primary culprit that sinks property owners into financial hardships is the optimistic assumptions used when estimating cash flows. Is the 5% projected vacancy conservative? Will your renovation remain within budget? Is the existing landlord artificially inflating rent revenues by accepting risky tenants? Is the landlord artifically lowering expenses by neglecting maintenance? Marc recommends artificially fellow landlords in the neighborhood to ascertain the neighbourhood’s market rent. Good point. Some sellers will attempt to dress up their financial statements just prior to a sale. Always “verify, verify, verify,” and never accept financial figures from seller’s agent at face value.

The topic on valuing properties based on CAP rate is also neat. Investing based on CAP rate is akin to investing in dividend-paying stocks based on yield. Generally speaking, the lowest CAP rate has the best growth potential. Meanwhile, the highest CAP rate has little or no growth prospect. A happy medium is 1-2% above the prevailing mortgage rate so you get a balance of both good cash flow and reasonable growth. For example, ING Direct is offering 6.25% on 10-year fixed, so investors should strive for a 7.25% to 8.25% CAP rate. (I’m not sure if ING Direct charges a premium rate on rental properties.)

Sample lessons

• “For Rent” sign on the lawn is a cheap and effective way to find tenants.
• Think like a landlord, not a homeowner. Buy on highly visible areas rather than the one that’s tucked deep in the neighborhood.
• Landlording is the most unpredictable business because it deals with people. Always enforce lease agreements with descriptions of the lease, deadlines, and consequences.
• Flat paint types are easier to touch up without repainting the whole wall.
• Offer fast closing and hassle-free “as is” purchase as incentives to lower prices.

What I want to see in future editions

• Sample letters to tenants on evictions, warnings, new rules, late rents, and rent increases.
• Sample dialogs on negotiating for lower/higher sales prices, lower mortgage rates, and higher rents.

All in all, I think for anyone serious about becoming a property owner, Retire Rich From Real Estate is an essential book that is furnished with real-life solutions to circumvent real estate investing hazards.

Also check out reviews from Thicken My Wallet and Million Dollar Journey.

This has been a hot topic among bloggers, so I’ll throw in my 2-cents.

Every asset you own can be classified into 3 broad categories: necessities, luxuries and investments.

Examples include:

• Necessities: electricity, gasoline, food, water, clothing, banking, medicine and *shelters*.
• Luxuries: Tag Heuer watches, iPods, Coach bags, Ferraris and sailboats.
• Investments: stocks, bonds and rental properties.

No. That’s not a typo. I did place “shelter” as one of the necessities, but I believe the crux of the misunderstanding centers around what exactly do we consume: is it the warmth provided by the shelter, or the ownership of the shelter itself? Let’s clarify by drawing parallels from my dividend-paying stocks.

I consume electricity, but also consider my ownership of Fortis as an investment. Similarly, I’m a part-owner of Saputo, Canadian Oil Sand, Reitmans, Royal Bank and Johnson & Johnson, which all provide essential products and services including milk, gasoline, clothing, banking and medicine. Yet, I consider these stocks as investments. Furthermore, I don’t plan on ever selling these dividend stocks because they pay for my everyday living expenses; similar to how home ownership pays for rents.

Let’s recap:
Milk = Essential, Saputo = Investment
Home = Essential, Home ownership = Investment (… added)

Yes, home ownership is inessential and I have proof — me! And along with 33% of the population like me. If you think all renters live below the poverty line, you ought to meet the Millionaire Mommy Next Door and Jack Hough, who choose to invest their money in the stock market while “renting” their ways to financial freedom.

Okay, so maybe home ownership isn’t a necessity, but how about pride of ownership? What exactly is pride of ownership anyway? Does owning a BMW give a sense of pride? What about the snazziest cellphone on the planet? Are they essential? Probably not.

If pride of home ownership is neither an essential nor an investment, then that leaves luxury as the only logical option by virtue of the process of elimination. Seriously. 1500 sf? 4 bedrooms? 3 bathrooms? Hardwood floor? Granite counter tops? Home Depot’s Behr paint? 2-car garage? Views? Balconies?

My belief is that for most people, home ownership is a bit of both investment and luxury. Where you draw the line is up to you.

Sure, you can invest in this 3-bedroom Vancouver old timer yielding a meager 3.5% to 4% CAP, but why torment yourself? Instead, you can indulge yourself with an 8.2% yield by owning these sexy office towers within H&R REIT’s portfolio:

As you may recall, the market has been punishing the Real Estate Income Trust (REIT) sector for much of 2007 and into early 2008, while the average yield is inching up each day. No one knows how long the spanking will persist, but as of this moment, the whole sector is roaming into bargain territory as many REITs are yielding well above 7%. That is far more attractive than the 3.74% offered by Canada 10-year bond, a popular yardstick to judge how attractive the REIT sector is relative to a guaranteed income investment.

I have taken an interest in H&R REIT - the largest Canadian office REIT and the overall second largest Canadian REIT behind RioCan. Today, HR.un is distributing an annualized $1.44 or 8.2% based on closing price of $17.49. That looks pretty cheap to me, and insiders agree. CEO Thomas Hofstedter and directors collectively scooped up $3 million worth of units in Nov & Dec at prices above $19. I picked up half a position at $18.05, but if we’re lucky enough, the trust will trade below $16 for a 9% yield. Otherwise, I’m happy to hold on to the half position for the long haul.

Back in 1999 when euphoric investors were dumping REITs while flocking to the ecstasy of dot-com land, HR.un traded briefly above a 12% yield at a time when 10-year Canada bond was yielding 6.25%. Outside of this anomaly, HR.un’s yield was around 10%, or a 4% premium above Canada bond. Today, the market is giving us a second chance to own this REIT at a 4.5% premium above Canada bond.

HR owns a portfolio of 35 office, 125 industrial, and 142 retail properties across Canada but principally in Ontario. Some of their well known creditworthy tenants include Bell Canada Inc., TransCanada Pipelines, Bell Mobility, Telus , Royal Bank, Public Works of Canada, Nestle, Canadian Tire, Finning International, Circuit City, Rona, Lowe’s, Shell Oil Products, Home Depot, Wal-Mart, Chapters, Famous Players, Walgreens, Sobey’s and Shoppers Drug Mart.

The trust has steadily bumped their distribution over the years, rising from $1.03 in 1998 to $1.44 today, or an annualized 3.8% growth. (They just increased distribution by 5.1% this month.) Together with the 8.2% yield, that’s a total return of 12%. Not too shabby for a hard asset class that’s traditionally weakly-correlated with the stock market. And if you’re into DRIP, HR offers a 3% bonus if you reinvest the monthly distribution to buy more units.

Real estate, by nature, is a highly leveraged asset class. HR’s average mortgage term is 10.4 years, but this is paired with an average tenant lease duration of 12.2 years with only 12.8% of leases expiring by the end of 2012. Nothing is bullet proof, but mortgage payments appear well covered. Nimble management was quick to snap up cheap buildings in a hot real estate market. New properties acquired during the first 3 quarters of 2007 cost the REIT a weighted average mortgage interest of only 5.67%, giving them an expected levered return on equity invested of 12.1%.

The only thing peculiar about HR is that their payout ratio actually exceeds 100%. The portfolio released $133.2 million of cash during the first 3 quarters of 2007, but distributed $133.7 to unitholders. This practice appears normal judging from other landlords in the REIT space. For example, bellwether REIT, RioCan has a shocking 116% payout according to a TD Waterhouse report. My only explanation is that REITs with a deeper pipeline can afford to over distribute in the short-term; RioCan has 10 properties in the pipeline versus HR’s 3.

** This is not a recommendation to buy. I’m not a REIT expert. If you have an opinion on HR or REITs in general, I’d love to hear about it.

For more info, please visit www.hr-reit.com.

There are different debt management companies, which want you to free from debt. You can learn from different websites that how to pay debt easily and can provide you every type of debt help. Now you can get online insurance leads by different companies and also online mortgage services. Low bank home loan rates are being offered by a number of banks. The home insurance is also available at cheap rates making it easy to pay installments.

My parents called the other day reminding me to cut back on dividend investing and start securing a house for our future. A house is a hard asset that always goes up, they reasoned, but stocks are just pieces of paper which can vapourize into thin air.

Predictably after the call, I was in no hurry to scamper to the real estate parade and satiate realtors with fat commissions. Contrary to the popular belief, hard assets do stand firm behind stock certificates: factories, equipments, pipelines, phone towers, cheese, hot water tanks, railways, trains, pills, hydroelectric plants, customers, revenues, profits, bank accounts and many more. Moreover, real estate doesn’t always go up. Suppose you bought a home in Vancouver during the peak of 1980, it would have taken 26 years to recover your money.

However, I must concede that our net worth is running dangerously low on real estate. What should we do? Perhaps we should buy stocks with real estate on the balance sheet. That’ll drive the parents crazy.

When it comes to real estate stocks, Riocan tends to balloon to the A list. That’s because Riocan is the de facto alternative for frugal investors wishing to save the 0.55% MER on the iShares CDN REIT sector index fund; Riocan commands 24.4% of the fund. The flip side of the coin is that this artificial inflated price premium is hard to justify considering Riocan’s 6.3% yield is well below the average (~7.6%), while their distribution growth hasn’t exactly raced ahead of the pack.

Rather than placing all my real estate eggs in Riocan, another option is to diversify the cash between Calloway REIT and Brookfield Properties. That way, I get exposure to both retail and office properties.

Calloway’s success is riding on the ferocious Walmart invasion into the Canadian retail market. Over 100 Calloway malls are anchored by Walmart who are contributing over 25% of Calloway’s total rent revenues. According to Andrew Guy of Sentry Select, Walmart is a tough negotiator. But having their presence serves as a super magnet attracting foot traffic and secondary tenants to the retail stores. With 125 retail properties under its belt, the trust isn’t that much smaller than rival Riocan’s 208. REIT expert, Dennis Mitchell, forecasts Calloway to surpass Riocan as the largest REIT in Canada within 2 years. There are many more reasons to like Calloway: it’s trading approximately 15% below NAV, the 6.7% yield is higher than Riocan’s 6.3%, and it’s been raising distributions at a vigorous pace. Expect more of the same from Calloway as it’s laying the foundation with 15 properties in the pipeline for development versus Riocan’s 10. Additionally, 92% of total properties are little babies, all of which younger than 13 years.

When you buy Brookfield Properties, you become a proud owner of trophy office assets around key metropolitans in North America, most notably New York. CEO Ric Clark projects a 50% increase to operating profit from the current development pipeline, but that’s before plowing their way to become the lead contender to win the Manhattan-based Hudson Yards project which should pad another 30% to 40%. The Hudson Yards project would be an image booster according to Sinclair Stewart, “[Brookfield Properties] is widely regarded as a formidable office landlord, with a portfolio of roughly 100 properties that punctuate the skylines of New York, Los Angelas, Toronto and Boston, … As a developer, however, its credentials are far less certain… The Hudson Yards would change that perception overnight, conferring instant credibility, nearly doubling the company’s development portfolio.” So far this year, the lingering concern over Merrill Lynch’s upcoming lease expiration sent the stock tumbling 50% from its peak in February. According to Dennis Mitchell, Brookfield is sporting a juicy 25% discount to NAV. BPO offers common shares yielding 2.8% of pure dividend.

Admittedly, real estate stocks are notoriously challenging to analyze due to the ever morphing balance sheets. What are you thoughts on these 2 real estate trust/stock? Do you have suggestions on how to approach real estate investing?

You can now check frequently asked questions and answers for mortgage basics information. The mortgage calculator and the amortization table help you to check the extra payments on mortgage. Several buy to let mortgages offers are very attractive for the landlords and others who are interested in real estate specially. Now banks easily provide home loans with out any home mortgage. Different kinds of credit cards are also available with loans.

I have a confession to make. I’m a pretty nosey fellow. If you’re an over-achiever flourishing in an unforgiving world, you better watch out. Financial Jungle just might drag you into an interview, grilling you on all your financial philosophies.

Yesterday, I had the pleasure to meet Mike through a mutual friend of ours. The tall, slim-built, self-employed software solution consultant from Britain was half-jokingly proclaiming to be retired at a tender age of 30. And why not? He has accumulated enough net worth to sustain a modest retirement, but more importantly, he’s living the job of his dream. You see, Mike has a knack for solving corporate pains and sufferings, and he loves it. Stories of process improvements flared the initial 20-minutes of the conversation. In particular, Mike rejoiced at the time when his simple Excel Spreadsheet consistently salvaged 10 unproductive hours each week in a client’s time-tracking process. His high spirit feeds off the gaping look on his clients’ face, and he enjoyed being a super hero in the business world, so to speak. All that, and Mike still gets to choose his hours, projects and “get out of bed” rates.

Life hasn’t been always been honky-dory from day one. Like many of us, Mike was a prisoner with a salaried position in a corporate rat race for 12 years. But he concocted an escape plan: live within his means, and invest the difference - the tried and true method. He is a habitual analytical consumer. It doesn’t matter if he’s pondering on a bigger house or a trivial anti-glare feature upgrade on a laptop. If he can imagine living without them, he walks. And invest the money into real estate. Oh yes, he has a more ambitious plan to tackle on.

The Robert Kiyosaki (Rich Dad Poor Dad) inspired Mike has been on a string of real estate acquisitions. Four years ago, he immigrated to Vancouver while hanging on to his lone property in UK. His timing was impeccable as the Vancouver real estate boom was just at its infancy. After much research, Mike snapped up a condo in the prestigious neighborhood of Kitsilano. With his real estate holdings roaring over the past few years, he took another plunge by selling both his properties and leveraging up the proceeds to acquire 3 condos in Downtown Vancouver. Quite impressive for a 30-year old bachelor. If he keeps this up, his real estate portfolio just might multiply to 4, 5 or 6 properties within the next decade.

In addition to his consulting business and real estate, Mike also hauled away a generous stock option with him after fleeing his 9-to-5 job. When I asked what else was in his investment portfolio, he was stumped, and later replaced “investment portfolio” with “wealth”, which is broader in scope. He quipped that his wealth included both hard assets - real estate and stocks - as well as the intangibles, such as intellect. After all, he did invest countless hours and dollars to foster qualifications to become the heart-and-soul of his consulting firm. That should count for something. So much so he pegged his consulting know-how as an equal one-third weighting against his stock and real estate holdings.

I will summarize some of Mike’s key lessons contributing to his hat-trick performance:

1. Live within your means. Know the difference between needs and wants.
2. Invest, but only in something you understand. (E.g. real estate.) Collecting interests off a saving account is not investing.
3. Don’t abandon an investment too easily unless you have a more compelling alternative.
4. Take your time on key financial decisions. Leave your cheque book at home.
5. Have a 5- and 10-year financial blueprints.

I want to thank Mike for sharing his lessons with us. Please feel free to post any questions that you might have.

Little did he know, the modest condo Warren bought 8 years ago would pave the way for a lucrative ride along the surging Vancouver market. I became intrigued with Warren’s story when he started posting regularly on Financial Jungle, so I requested an interview.

1) Back in 1999, when all investors were flocking to the technology binge, you made a life changing decision to migrate to the secluded land of real estate investing. Take us back to that time… what was going through your mind? Why didn’t you plunk your money into technology stocks like everyone else?

In 1999 I had little to no experience in the stock market. I saw the rise of tech stocks, but did not have the first idea of how I could be a part of it. I had a desire to move to downtown Vancouver. While looking at various rentals, I realized that the price of a 5% down mortgage payment was the same as rent, so why not buy? I bought a pre-sale about 6 months prior to completion. Its amazing to think how much the market has changed in terms of pre-sale availability and overall price. It was more dumb luck than anything else.

2) I understand you lived in a condo until 2003, but later rented the unit out to other tenants. What prompted you to open the door to strangers and become a tenant yourself? Did you feel home sick afterwards?

My apartment is a studio, and I wanted to move in with my girlfriend, so there wasn’t room for both of us. My goal for the apartment was always to keep it as a rental when I left. I became a tenant myself because we didn’t have any long term goals at the time, and I don’t think I could have handled the risk of another mortgage (if I was even approved). I don’t live too far away now, but I do miss the neighbourhood. My plan is still to purchase again in that area, but prices will have to come way down for it to make any sense. We have an excellent rental suite right now, probably below market rent, so its even harder to leave for an expensive mortgage.

3) Most landlords I know howl about tenants from hell. What process do you have in place to alleviate tenant problems?

I got lucky with my first 2 tenants, that lasted about 3 years. I never did a credit check, but did employment and rental reference checks. I did have a bad tenant, and she had great references from both her employer and a property management company she had rented from for 4 years prior to moving into my suite. She ran into credit problems after moving in. I don’t think there is any foolproof way of judging a person, unfortunately. My advice would be to hang on to a good tenant if you get one, but also don’t be afraid to use the law to its fullest extent to get rid of a bad tenant, or scare them into paying up. Some “scare tactics” worked a little with my bad tenant. The longer you leave a problem, the more money you are missing and/or
hassle you are dealing with.

4) Do you have any plans to expand your real estate empire? If so, please give us a vision of your portfolio. Individual homes? Apartment buildings?

My next real estate purchase will be a primary residence, but I don’t plan to sell my rental property. The Vancouver market is probably the worst in the country (if not the world) for investment yield on rental properties, so my current investment focus is in other areas. I think in general people have too much money tied up in real estate. I’d like to be well diversified in other areas before another RE investment.

Being a landlord is more work that some people assume. I don’t think I’d ever consider a SFH as a rental investment, at least not in any large urban area. Better to have an apartment where a management company takes care of many of the routine details and maintenance. Its well worth the (tax deductible) monthly fee.

5) How does real estate fit into your retirement plan? Do you plan on living off the rental income?

Its tough to argue with cash income every month. My yield has recently gotten a lot better as I now use a specific management
company that handles my unit almost like a hotel, shorter term rentals for corporate clients. There was some initial cost to get it set up and well furnished, and I provide all utilities, but it is really starting to pay off. And the best part is zero hassle, they handle everything. Passive income is really what I’m after from any investment I look at. I think a mixed portfolio of rental properties and dividend payments would be my ideal retirement plan, probably no more than 2 properties though.

6) With 4 or 5-years worth of experience under your belt, what nuggets can you share with us in terms of real estate investing? What were your proud moments? What would you do differently if you have to start all over again?

Proudest moments were probably cashing my first check, and paying the mortgage off a few months ago.

My advice would be: beware! My story looks great because I got in during a bad time for real estate. Good thing I didn’t know anything at the time or I may have scared myself off. I don’t think I would touch RE right now, you just have to do the math, it doesn’t compare to other easier, more secure investments out there. Your local market may vary, of course.

If I could go back and talk to my 1999 self, I think I’d tell him to buy a slightly bigger place. It stretched my 1999 income a lot to get in where I did, but I think I’d push for as much as I could get. Its easy to see in theory how your early income will increase quickly as you get out of school and start your career, but tough to see when you’re at the bottom. My studio is 420 square feet, so pretty small, which can limit your rental opportunities somewhat.

7) Outside of real estate, are you currently experimenting on other types of investment?

I’m just starting to get into dividend investing (DRIPs and others), and I own a few stocks, but nothing major so far, I’m a novice. My girlfriend and I are looking at some business investments that would give us a lot more flexibility than our 9-5 jobs, but nothing solid just yet.

I had a solid goal of paying off my rental apartment so it would become true cashflow, but when it got close I started thinking “what next?”. That’s when I stumbled across Derek Foster’s “Stop Working” book, which solidified my plan to retire early by gradually building up a passive income stream from various sources. I have no desire to retire “rich”, only early…

The finance blogs like yours are a fantastic resource and its encouraging to work towards your goal and see others succeeding at the same time.

Thank you for your kind words, Warren. The cheque is in the mail.

Please stick around as I’m sure other readers will have some questions or comments.

The best time to plant a tree was twenty years ago. The second best time is now.

The Chinese who came up with this proverb sure wasn’t thinking of Vancouver real estate, and certainly not not inflation.

One of the persistent excuses I hear from wannabe investors today is, “I’m in it for the long-haul. Real estate always goes up.” That may be so, but the perseverance required for an overpriced investment may shock you off your seat.

Consider this: Euphoric Vancouverites, who invested near the height of the 1981 bubble, did not recover their original inflation-adjusted principal until 2006! Again, that’s inflation-adjusted; a dollar can buy a lot more Big Macs in 1981. For the unfortunate investors looking for an immediate vengeance, the hiatus turned into a 26-year hibernation. I believe the reality in 1981 was far worse beneath the chart. Devastated by 20%+ interest rates and hefty closing costs, I suspect many of the under-achieving investors were counting their blessings in light of foreclosures and bankruptcies devouring their peers.

CMHC has recently pumped a few more pockets of air into the bloated market by eliminating the down-payment threshold required for investment properties. There’s a big catch. The new CMHC premium is a mammoth 7.25%. Let’s work an example. A potentially insolvent Vancouver investor looking to capitalize on the housing momentum can borrow 100% plus 7.25% on CMHC insurance for a $339k 1-bedroom 580 sqft condo. The monthly mortgage payment on a 6% rate and 25-year amortization is $2,326. Throw in another $400 for condo fee, property tax, insurance and other maintenance, the payments balloon to $2,726. Consider that the suite was previously rented for $1,450, it would be a miracle for anyone with perseverance to hold this property until the first dime is made.

With the glaring agony in US housing, I just don’t see a prosperous long-term outcome with the recent move by CMHC. It’s bad enough to borrow 100% for a primary principal home, but to borrow 100% for an investment property and 7.25% mortgage insurance is preposterous; rent yield is low, and now so too is cash-flow. CMHC just removed the housing air bag. The landing will likely be gruesome.

You know what I love about our recent paid vacation? Beside the privilege of receiving 3 paid cheques while hiking the Great Wall of China, our ever jolly landlady awarded us a rent freeze for being troublefree tenants. Who knew being good citizens could be so profitable?

This shouldn’t come as a surprise for us though. Between my wife and I, we collectively rented 4 separate suites in different occasions, and never had to bear any rent increases! In fact, one landlord even tried to persuade my wife to remain by offering a rent decrease. Perhaps he’s a nut, but more likely a brilliant business man. Having been a landlord myself for 3 years, I can attest that keeping a dependable tenant is much more nourishing to your bottom line than having to endure lost revenues, advertisement fees, lose of personal time, and not to mention the risk of inviting a professional tenant-from-hell to ruin your retirement plan.

Having said that, I can understand that freezing the rent can be a double-edged sword. Keeping a good tenant protects your cash stream, but over time, the investment loses its edge from eroding purchasing power and opportunities lost. To the best of my knowledge, any missed increases can’t be carried forward to future years. In BC, landlords can hike their rents by 4%, max. By forgoing the raise this year, the landlord cannot no longer “catch up” by double-boosting the rent next year. The conclusion? It pays to be good tenants. We’ll save an equivelant of $1,000 pre-tax income, and this saving is repeatable as long as we remain with this landlord.

This MSN Money article by Jack Hough of SmartMoney is a must read if you’re a renter. I love this article for a number of reasons; it’s provocative, but more importantly, it’s like seeing myself in the mirror, since we share so many similar opinions together!

It’s not easy being a renter. Letting the world knows you’re a renter is like walking around town with a prominent “L” on your forehead. It’s just human nature. Renters are stereotyped as financially irresponsible people, however that’s simply a myopic view. There are just as many irresponsible buyers who live beyond their means by borrowing high-ratio mortgages. I don’t see homeownership as a necessity. Rather, it’s a culture, and sometimes, it’s even a status symbol like owning a BMW. No offense to Beamer owners.

Jack Hough starts his article with a confession that he rents despite having enough to buy a house. The reason? Stocks returned 7% inflation-adjusted over the previous century, while …

the average real return for houses over long periods might surprise you: It’s virtually zero.

Surely, that has to be a mistake! In the midst of one of the most glorious housing booms in Vancouver, homeowners roll their eyes when all the evidence point to double-digits return. Let’s not forget that over this short period (yes, 5 years is short), anything goes, but they don’t call it average for nothing. Sometimes prices overshoot, but eventually they’ll revert to the mean.

Over the long haul, home prices rise in tandem with rents. When prices race ahead of rents, the equilibrium is disrupted temporary until either (a) prices fall or (b) prices plateau in order for rents to catch up. In the case of Vancouver, rents haven’t gone up as much, so price appreciation comes mostly from valuation expansion. To steal an analogy from the stock market, a stock can trend higher via P/E expansion even with earnings remain flat, but P/E expansions aren’t sustainable. Only fundamental improvements like earnings growth can push the share price higher over the long term. To give you some perspective, we sold our home in Nov 2006. The earning yield (which I inflated to satisfy any nit picky readers) was 3.9%. It was 5.2% when we bought 3 year earlier, and 7% when our former neighbors bought theirs.

Make no mistake about it. Renting and investing the difference in the stock market isn’t for the faint at heart. If you don’t have the stomach to face recurring setbacks in your portfolios, the little butterflies in you will hinder the execution. This post aren’t to encourage readers to sell their homes, but to point out that diverse point-of-views exist and they’re just as rational.

In his article, Jack Hough tackled a few common objections to this approach:

“You can’t live in your stocks” or “Renters throw money down the drain.”
No, but with a combination of diversified income trusts (read my income trust series) and dividend yielding stocks, it’s possible to derive close to a 3.9% yield to cover most of my rents. Moreover, yields from dividend-paying stocks and growth-oriented income trusts will outpace inflation, while rents will move in tandem with inflation.

“What about the pride of homeownership?”
Pride of homeownership is overrated to me, though I admit it’s a matter of preference. Similar to Jack, I relish the pride of owning successful businesses. When I have the urge, I munch at my favourite Korean food court to admire the Telus building across the street. On a good bicep day, Scotia Bank is also only a stone’s throw away from my office.

Another one that I heard, “income trusts and dividend-paying stocks aren’t diversified”
That’s true to a degree, but it’s still considerably more diversified than a home. The leaky condos fiasco in the late 90’s serves as a reminder to complacent homeowners that a single misstep can send anyone to bankruptcy. Contrast that to REITs where with a few mouse clicks, your portfolio is instantly diversified across the nation and different real estate segments including residential, office, retail, hotel, industrial, storage and nursing homes.

Pretty soon when you look up “Vancouver Bear”, you just might find my face on the Oxford dictionary.

Nah, I shouldn’t flatter myself. There are plenty more unpopular Vancouverites in the city claiming the podium; one being Mohican from Langley Financial Planning. Mohican found this hilarious gem on MLS.

MLS®: V643849 $529,000

House on a quiet street. 1/2 block East of Nanaimo. 3 bedrooms up & 3 bedrooms down. New paint on main. Low basement ceiling. Tenanted at @ $1,050/month. Hold and build later. Needs notice to show.

$1,050 a month is quite pathetic when you consider that’s only $12,600 a year, or a 2.38% rent yield, which is barely above inflation.

We’re not done yet. The rent yield is before expenses, which include property tax, water and sewer tax, home insurance and maintenance. All taxes combined should amount to more than $3,000 per year. We ought to set Tax Freedom day on Mar 31st, when all rents collected up to this point are funneled to the government.

Needless to say, the “earning” yield is much lower than 2.38% after expenses, but we’ll be generous and dock only a quarter off to make 1.78%

The recommendation from the seller is to either “hold or build later”, but neither options are sensible. Who would want to hold for a 1.78% yielding property with a scant growth prospect? (In BC, landlords are restricted up to ~4.2% rent increases each year.) Might I add the 5-year mortgage rate is up - again - to 5.79%? Borrowing 5.79% to buy a slow-growth property yielding 1.78% is ludicrous. Some people belittle renters because “rents are money out the window”, but so is paying mortgage interests, taxes and insurance.

The second option of building later will cost dearly. I know a couple of friends who paid a vicinity of $250,000 to build a home in Vancouver due to labour shortage and higher material costs. Add the construction cost to this purchase price, and you’re a proud owner of an $800,000 Vancouver special. Now you really must push the throttle to earn your 5.79% interests back, or $3,860/month. Remember, the interests aren’t the only expense. Tag along another $250 of taxes, insurance and maintenance to round up the figure to $4,110/month.

Wouldn’t it be funny if I get a spanking from the seller? The things I do for my readers.

Yikes! I just discovered that the new 5-year fixed mortgage rate had risen sharply to 5.69%. Wasn’t it only 5.25% just two weeks ago?

Readers are aware that I’m increasingly leery of Vancouver’s housing prospect. I still remember those cheap mortgage rates at 4.55% back in 2003. Since then the market advanced 60%, but that’s not the whole story. When you throw in the effect of rising mortgage rates, Vancouverites are actually paying twice as much mortgage interest.

Here’s a comparison. For simplicity, I assume an 80% loan-to-value mortgage.

If a house was worth $400,000 in 2003, the mortgage interest would’ve been $400,000 x 80% x 4.55% = $14,560. Today, the same house appreciates to $640,000. With the prevailing 5-year mortgage rate at 5.69%, the new mortgage interest becomes $640,000 x 80% x 5.69% = $29,133.

Ultimately monthly mortgage payments matter, not the sales price. Even if we assume prices remain idle, affordability is still deteriorating due to rising mortgage rates.

Related to this, Statistic Canada revealed some grim numbers on provincial weekly earnings:

Average weekly earnings for B.C. payroll employees are the third-highest in the country, according to Statistics Canada, at $755.70. That’s about $40 behind Ontario and $70 behind Alberta. But B.C. recorded the lowest percentage increase (2.4%) of all provinces when comparing the first quarter of 2007 to the same period last year.

As Vancouverites are facing the worst affordability measure (68.5%) in Canada, our solvency is in jeopardy unless we see a meaningful boost in wages accompanied by falling rates. Otherwise we’ll literally run out of cash, and possibly endure the “inconceivable” outcome of stagnating prices or even a broad correction.

Vancouver, the most bubbly city in the world

declared by Yale economics professor Robert Shiller, the oracle who predicted the tech market crashed, and author of Irrational Exuberance.

Someone ought to hand this guy some mouthwash, eh?

These days, Vancouverites are rushing into the housing market like there is no tomorrow. With prices doubling over the past 5 years, it’s no wonder that our greatest fear is being priced out forever. While every homeowner is celebrating the brisk market in harmony, critics like Prof. Sheller are in an immensely unpopular position. Nevertheless, there are always two sides to a story, and listening to these critics gives us a well-balanced discussion. We don’t want our biases to blindside our views, right?

If you believe that the long-term health of our housing market is resting on solid foundations, consider these 2 arguments:

• Despite prices doubling over the past 5 years, rents are still trailing by a wide margin. This is irrational. Contrary to popular belief, price increases do not signify housing demand; rents do. It’s all about the rents. Over the long-run, rents are the engine driving prices higher. Renters bid to put roofs over their heads. Buyers, on the other hand, look at the rear mirror and speculate the good times ahead. If prices keep sprinting ahead at this pace, can you imagine renting a $2 million house for a paltry $3,000?
• According to data from RBC, the affordability measure for a detached Vancouver bungalow is 68.5%. It means over 2/3rd of a family’s pre-tax income goes toward housing expenses. To put this in perspective, Toronto’s affordability measure is 42.6%; Calgary 40.9%; Montreal 35.3%; Ottawa 30.0%; the entire Canada 39.4%. This places Vancouver on a commanding first place as the most unaffordable city in Canada. Unless you can double your household salaries in 5 years, we’re unlikely to see the double-digit growth that we’re accustomed to.

This post doesn’t predict a bubble burst, but tries to lower homeowners’ expectations to an attainable level. Only buy when you’re ready, and don’t let anyone persuade you into borrowing a high-ratio mortgage. Paying today’s top dollars will not recoup your lost opportunities. In my view, the easy money has already been made.

Further Reading
- According to GVRD, a benchmark house is sold for $682k in March; townhome $428k; apartment $349k. If the market doubles again in 5 years, it’s impossible for a young family to afford a starter home (apartment) at $698k.