[AKS]

I am of the understanding that RE investing is purely a longterm investment for positive cashflow, not solely for capital gains, which starts minimally and after 25 years, when one is closer or in retirement, the property is paid in full and the net income from rent will be taxed at a lower marginal rate.

Well, if it's a long term investment, I would probably say it's more do-able for houses in the 905. Houses in Toronto are too expensive or cheaper ones need a lot of maintenance because they're very old. For condos, I don't think it's a good long term investment. Condos are best for capital gains (pre-construction), rent out a few years and sell for profit. (Assuming you have good tenants). I realize there's also possibility of net loss if you purchase too high or if tenant is bad and damages your property. So, buy low, rent for short term cash flow, and sell high after a few years.

For long term investment rental, houses are better I think. But same issue. If you have bad tenants, they could damage your property. Also, if the builder isn't very good, you may have to spend a lot fixing the house. I don't know how much rents in houses go for in the 905 though. Not sure if the earnings will cover all the costs. Downtown is easier to rent out in general, hence condos are better to play with.

 

[vultur09]

Average GTA House Price
Year Price % Increase
1966 $21,360 0.00%
1967 $24,078 12.72%
1968 $26,732 11.02%
1969 $28,929 8.22%
1970 $29,492 1.95%
1971 $30,426 3.17%
1972 $32,513 6.86%
1973 $40,605 24.89%
1974 $52,806 30.05%
1975 $57,581 9.04%
1976 $61,389 6.61%
1977 $64,559 5.16%
1978 $67,333 4.30%
1979 $70,830 5.19%
1980 $75,694 6.87%
1981 $90,203 19.17%
1982 $95,496 5.87%
1983 $101,626 6.42%
1984 $102,318 0.68%
1985 $109,094 6.62%
1986 $138,925 27.34% +
1987 $189,105 36.12% +
1988 $229,635 21.43% +
1989 $273,698 19.19% +
1990 $255,020 -6.82% -
1991 $234,313 -8.12% -
1992 $214,971 -8.25% -
1993 $206,490 -3.95% -
1994 $208,921 1.18%
1995 $203,028 -2.82% -
1996 $198,150 -2.40% -
1997 $211,307 6.64%
1998 $216,815 2.61%
1999 $228,372 5.33%
2000 $243,255 6.52%
2001 $251,508 3.39%
2002 $275,231 9.43%
2003 $293,067 6.48%
2004 $315,231 7.56%
2005 $335,907 6.56%
2006 $351,941 4.77%
2007 $376,236 6.90%
2008 $379,347 0.83%

According to the Toronto Real Estate Board, the average yearly compounded growth of a home in the GTA has been 7.09%. Here’s the raw data:

Hello,

Interesting discussion. Allow me to offer a counter point.

I would strongly argue that the bulk of the GTA housing price appreciation in excess of inflation over this long term period can be strongly attributable to one factor- larger homes. Homes in 2008 are significantly bigger than they were in the 60's and thus the average price would increase too.

True, there have been boom periods of strong housing growth (followed by big busts) but the bulk of that greater than inflation increase is just larger houses. I'm sure someone can pull the stats to show the difference in sizes.

Beyond that, the dramatically lower interest rates can explain the remainder of any increase. That certainly leaves us wondering how prices can truly rise any further when both size and interest rate factors are pretty maxed out.

Ask any successful real estate investor (PM me if you like) what explains his or her success and I bet she's say that she bought income producing property that generated 10% return that's would now probably trade at a 6-7% return and that the income growth did not even keep pace with inflation.

 

[Johnzz]

How does one actually do that? Do you mean take a second mortgage out of the place once it's paid off? Or can one actually just not pay principle and pay interest forever?

Well, if I continue with my $100,000 real estate example from earlier; after 5 years, your property has appreciated 10% (2%X5) and you've paid off $10,000 in principle (roughly $175/mo). So now you have a property worth $110,000 and a mortgage for $70,000 which leaves $40,000 in equity. As long as your bank holds 20% of the properties value ($110,000X0.20=$22,000), they're happy. So you simply request your bank to appraise your property (which they sometimes pay for) and the bank will open up a new line-of-credit linked to your property for $18,000 (110,000-70,000-22,000). You can then use this $18,000 loan as a deposit for another property

Side note: You could also use this new loan to pay down the mortgage on your principle residence (the interest on the $18,000 loan is tax deductible whereas the interest on your principle residence is not).

If you decide to use this new $18K borrowing to purchase another property, you’ll then have 2 appreciating every year. It will only take four year’s time to buy third property, then only three additional years to buy a forth, etc…. In 20 years time, you could easily own 10-15 properties. Of course there's a little more to it then the above example, but this represents the basic framework.

Actually, the correct (and conservative) way to view the above is, your property only holds its value every year while your debt decreases (via inflation). Provided you can comfortably make the interest payment (which depends on the rental income, which depends on the quality of property, etc…) you will profit handsomely. In fact, borrowing to buy any physical asset will work, as long as the asset sheds enough income to support your interest payments (or you’re willing to supplement these payments from your own income). It’s very important to remember, physical assets always hold their value (provided they’re in demand) whereas paper currency always depreciate.

Basically, you’re taking advantage of a system geared towards inflation. The winners are Governments and anyone else borrowing for sensible investment. The losers, in this system, are the investors holding cash which buy less and less each year.

Debt is like gas. Gas can be extremely dangerous, but if understood and used correctly, can perform miraculous things!

Finally, yes, the era we are entering is definately uncertain, which is why I choose to invest in something certain, inflation.

 

[Johnzz]

but my evidence suggests that condos do not maintain their inflation adjusted value and hence don't make much sense as long-term real estate holdings plays.

Ah, the old house vs condo debate.

I like both! But I'd have to add a few points favouring condos.

(1) Yes condos do depreciate, but I’d argue a well built concrete structure is likely to outlive a small timber/plywood structure.

(2) A condo is generally easier to manage then a house (less can go wrong).

(3) There is much less land underneath a condo, but then again, this land is probably worth 100X that of a house outside central Toronto.

(4) The smaller unit size of a condo allows for a much greater pool of renters then that of a single house (which is likely to require renting for $4,000+/month).

(5) The demographic shift toward city centre living. People will wish to save time (who needs that 2 hour commute), save money (as energy costs increase), and retiree’s will wish to live closer to cultural amenities (as personified in pop culture).

I admit, condo investment probably entails a bit more risk then a house, but it also offers much more reward! When it comes to a condominium, location is almost everything. You need to be in an area of limited supply (can’t build any more) and high demand. A good example of this is Yorkville.

Finally, for anyone still sceptical, just look at the old New York apartment buildings built by Rosario Candela in the 1920’s and 30’s. They’re now nearly 90 years old and still, in fact, garner a premium price/sqft due to their quality and specific locations within Manhattan.

 

[vultur09]

It’s very important to remember, physical assets always hold their value (provided they’re in demand) whereas paper currency always depreciate.

Huh? It is dangerous to deal in absolutes. Never do it!

Well, if I continue with my $100,000 real estate example from earlier; after 5 years, your property has appreciated 10% (2%X5) and you've paid off $10,000 in principle (roughly $175/mo). So now you have a property worth $110,000 and a mortgage for $70,000 which leaves $40,000 in equity.

Your appreciation argument is fatally flawed. All works great until this happens:

Ah, but Canada is different than the US right? It's different here! Wrong. The difference is that Canada just socializes the losses upfront with CMHC (aka you and me) assuming the risk.

Your entire Real Estate Wealth 101 argument (so 2002 btw) presupposes continued price growth. It if were that easy everyone would be investing and a bubble would be created. Oh wait, didn't that happen? You need to generate income to compensate for the risks of investing. Our friends at the Bank of Canada made more paper millionaires in real estate than anything else by dramatically lowering the cost of capital. You cannot expect that to continue. So what will drive appreciation now? The answer is income growth and that only comes from a strong and expanding employment base. We are now witnessing the opposite effect.

 

[Johnzz]

So what will drive appreciation now?

You have to think of this differently. What I'm trying to suggest is that, over time (and in general), even if your asset doesn't appreciate, you will profit as your debts depreciate. Do you disagree?

And don't forget inflation, over time, will also push up incomes which help support house prices (Canadian wages were still up 3.5% yoy as of June).

Further more, I'm not professing foolish short term market predictions here. I'm simply providing the basic framework one should use for long term real estate investment given the structure of our financial system.

Focusing too much on the short term, without regarding the overall long term macro picture, brings to mind the old cliché "one can't see the forest for the trees".

 

[Johnzz]

Ah, but Canada is different than the US right? It's different here! Wrong.

Does Canada have the same securitized lending practices as the US? Does Canada have the same interest tax deductibility on principle home mortgages? Does the average Canadian buy a home with zero down and no verified income source as they've done in the US?

Yes, the same indeed.

 

[simuls]

People always seem to go on about how Canadians can't deduct their mortgage interest, but few seem to remember that Americans get hit with capital gains tax on all their properties - including principal residence - which in the case of anyone who bought prior to 2006, means that under the Cdn system, you just experienced a windfall vs the us.

 

[Johnzz]

Americans get hit with capital gains tax on all their properties - including principal residence.

In the US under 26 U.S.C. §121 an individual can exclude up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale.

 

[vultur09]

Interesting summary in today's Globe:

http://www.theglobeandmail.com/repo...very-runs-through-heart-of-us/article1234521/


"House prices are probably already at the bottom of the price trough or close to it - with a 32.5-per-cent average decline since they peaked in mid-2006. According to Yale University economist Robert Shiller (co-founder of the Case-Shiller Index of U.S. house prices), prices have fallen further than they did in the Depression and could remain depressed for years to come. They could, indeed, fall further.

Why so pessimistic a prediction? Prof. Shiller says house prices always return to a historic norm that hasn't changed in more than 100 years; the extraordinary house-price spiral of 2000 to 2006 was an aberration.

For people who think that it's time to buy a house as an investment, Prof. Shiller advises that they aren't a particularly good investment over long periods of time - and a risky investment over short periods of time.

"Do [inflation-adjusted] home prices have a substantial long-term uptrend?" he wrote in 2006. "The [data] suggest not. ... ntil the recent explosion in prices, real home prices in the United States were virtually unchanged from 1890 to the late 1990s." In the exceptional boom of 2000-2006, the average U.S. house price soared by 70 per cent. The price retreat in the past two or three years has merely returned prices to 2003 levels - halfway back toward the 20th century norm.

The historic price norm apparently goes back as far as 17th century Amsterdam, he notes: "The price data shows lots of ups and downs but only the slightest hint of a [permanent] uptrend."

In Norway, house prices have risen annually by a mere 1.3 per cent since 1819. Houses, Prof. Shiller notes, are "a manufactured good," subject to depreciation - which is why you can now buy house price futures on the Chicago Mercantile Exchange to protect yourself from price turbulence ahead. (The least expensive housing over the long term? Prof. Shiller says that historically it's rental housing. In real dollars, rents have fallen by 50 per cent since 1913.)"

 

[TrickyRicky]

Vultur, I would also be curious to see how wages and household incomes changed over the century as well. I suspect we are adapting socially to completely maxed out the capacity of a nuclear family to afford housing. There was a time when a single man could get a job in a factory and support a young family in his early twenties. Look at us now. We have a double income earning couple living at home until well into their 20's, not able to purchase until into there 30's and doing so only with creative financing and down-payment support from their parents. This couple will now expect to be working well past what we would consider retirement age at 65. I see it happening already but I would not be surprised to see more and more people purchasing the immigrant way as family clans, with sibblings and cousins and parents and children purchasing together for co-habitation.

P.S. I don't find single family homes, that is houses with a single unit or family occupant to make particular good sense either.

 

[lead82]

this is already happening in some ethnic gta suburbs. It will become the norm for houses in the future.

 

[Johnzz]

"Do [inflation-adjusted] home prices have a substantial long-term uptrend?" he wrote in 2006. "The [data] suggest not. ...

This is exactly what I’ve been saying as well. I have always assumed in my assumptions that property, over the long term, appreciate no more then inflation (i.e. zero real growth). However, this does not imply it’s a poor investment. What the good professor fails to mention (or understand), is that mortgage debt falls substantially (via inflation) while your property holds its value.

I have made many millions over the years investing in real estate and find it quite amusing when told by an academic “property isn't a particularly good investment over long periods of timeâ€.

In addition, these last ten years in particular have not been some freak occurrence in Toronto (as they were in the US). The average annual gain in the GTA since 1998 has been 6%, less then the 42 year average of 7.09%.

 

[vultur09]

This is exactly what I’ve been saying as well. I have always assumed in my assumptions that property, over the long term, appreciate no more then inflation (i.e. zero real growth). However, this does not imply it’s a poor investment. What the good professor fails to mention (or understand), is that mortgage debt falls substantially (via inflation) while your property holds its value.

I have made many millions over the years investing in real estate and find it quite amusing when told by an academic “property isn't a particularly good investment over long periods of time”.

In addition, these last ten years in particular have not been some freak occurrence in Toronto (as they were in the US). The average annual gain in the GTA since 1998 has been 6%, less then the 42 year average of 7.09%.

I would agree that an investment that returns 6% annually is respectable but it is hardly the path to wealth creation that you've described. Don't discount the role of timing and luck in your success. The entry point is what makes all the difference and we would be having a vastly different discussion if mortgage rates were still 8%.

 

[Johnzz]

I would agree that an investment that returns 6% annually is respectable but it is hardly the path to wealth creation

The notional house price increase does not equate to return on capital.