[ponyboy]

interesting discussion. I've learned a lot. I bought my first place at 28 when I started my job after grad school; My strategy that has worked out well was to buy a downtown Toronto house that had been subdivided into three apartments ($290K in 2002, probably worth $390 now), one of which I would live in until I decided to start a family and move on to a bigger place. Living in the house made it a lot easier to manage everything. I am now getting ready to move out to a bigger place (renting it for the time being) but am keeping my property as an income property/investment. Criteria I used for purchasing were (1) some documentation that gross annual rents were 10% or more of the purchase price, and (2) some expectation that the rents from the other two units paid all of the expenses while I was living there. You also want to be sure you are getting a competitive mortgage rate and terms, so having your credit history in order and sufficient income is critical. With the exception of a few unpleasant surprises (rents haven't increased in toronto!, dead furnace, leaky roof, insurance premiums up, increasing utilities, one bad tenant), this has worked out pretty well, and I have been able to make a lot of deductions for taxes. However, I also understand that we have been LUCKY with interest rates staying low (I have benefited especially from a variable interest rate mortgage). People with high-ratio mortgages are really gambling with leverage, hoping that appreciation continues while the costs of financing stay the same or decline. When it works out, you seem like a genius, but I think there is a lot of downside risk over the next few years. What are the best inflation-resistant investment choices?

I think what is right depends a lot on the person, your willingness to manage tenants, preferences to high-rises versus homes in neighbourhoods, your handiness for repairs, your organization skills, and also your stage of life. I don't plan on ever selling real estate because I hate the transaction costs, and plan to buy my next house close to my first one so I can manage the easily (and someday my kids can take over some responsibility).

 

[cdr108]

You're missing a key point here ... home buyers do not earn 6% the way an investor in the stock market normally does. That's because it's 6% of the total value of the home, which includes the debt AND equity. If someone puts down $50,000 on a $200,000 home, and in one year it's worth $212,000 and he decides to sell it, well guess what? He makes $12,000 profit on a $50,000 investment, due to the leverage - a 24% return.

All you're talking about is leverage, and the same situation could be used by someone with a margin account if they wished, although the loan value will be lower.

Leverage can be bad and good, ... it all depends on which side of the fence you're on ...
RE/stock markets up > you're happy and think you're a genius, Trump, or Buffett;
markets down > you're sad and owe more than what the 'assets' are worth.

 

[vultur09]

Well said. Leverage works both ways. Just ask Bear Stearns or Lehman Brothers.

 

[daveto]

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%.

I've only just read all the posts in this thread.

Johnnz, my head hurts after reading all of the flawed logic in your various posts. For a real estate millionaire, your ignorance is appalling. Sorry if that sounds harsh, but it is something you need to hear.

Rather than driving myself batty responding to all of your posts trying to convince you, I'm going to focus solely upon the three paragrpahs in the above single post.

First, you claim in the first paragraph above that you always presume zero appreciation above inflation. However in post #12 of this thread you refer to capital appreciation as a certainty and state that your spreadsheet model calculates that 90% of your profits comes from capital appreciation.

Second, you state that you have made many millions over the years investing in real estate (implied Residential)? Was that in the Toronto market during the period 1996-2009? If so, as others have pointed out your investment strategy does indeed yield great returns in an upward market. Also, can you confirm that your millions of profits exclude any capital appreciation (as per your assumptions in the prior paragraph) and in contrast to your comments in post #12?

Three, the 42 year nominal yearly increase of 7% includes an average rate of inflation of 4.5% for a real (net of inflation) yearly increase of 2.5%. Whereas the nominal yearly increase of 6% since 1998 includes an average rate of inflation of 2.1% for a real (net of inflation) yearly increase of 3.9%.
Furthermore, the real (net of inflation) increase from 1967-1998 was 2%, versus the nearly twice as high real increase from 1998-2009 of 3.9%.

Also, the rates of increase you are using are predicated upon using the present prices (which I and others view as peak prices). If you do the same analysis after a possible 20% price correction the results will look very different.

I hope that at least my responses will give you some pause for thought. If you truly are as leveraged as you claim to be, and truly are so certain of the infallibility of your investment model, then you are at grave risk from a possible 20% correction to Toronto prices.

 

[rbt]

First, you claim in the first paragraph above that you always presume zero appreciation above inflation. However in post #12 of this thread you refer to capital appreciation as a certainty and state that your spreadsheet model calculates that 90% of your profits comes from capital appreciation.

This isn't necessarily a problem. If you can find financing for less than the rate of inflation, then it can still work out to be a decent profit. Of course, which inflation rate (housing, CPI, something else?) and is the financing reliable (nothing like a lender backing out on closing day despite prior approval of person and property; or just being late a few days with financing).

 

[vultur09]

This isn't necessarily a problem. If you can find financing for less than the rate of inflation, then it can still work out to be a decent profit.

Unless you're Goldman Sachs you aren't borrowing money at 0% rb,

 

[cdr108]

Unless you're Goldman Sachs you aren't borrowing money at 0% rb,

or get a gov't bailout, courtesy of the taxpayer, when you're losing billions and in negative equity.

 

[Johnzz]

Johnnz, my head hurts after reading all of the flawed logic

My "flawed logic" has performed quite well over the year’s thank you. Call it blind luck, if you wish.

Regarding your confusion, I've made efforts to differentiate between real yield and nominal yield, as well as, capital appreciation vs paper money depreciation. Clearly, I’m not the best person to explain such concepts here.

 

[vultur09]

John,

You've done really well obviously and that's fantastic!

Just one very simple point to consider though- and this applies to you me and everyone in the market- how would your returns and profitability have looked if interest rates were still in the 10% range? I bet not so hot. You clearly have worked hard and made some great decisions but don't discount the role of luck. Without the bank of canada/federal reserve making concerted efforts to prop up the real estate market a tremendous amount of value would never have been created. You might have wisely predicted the 20 year bull market for bonds or you might have just been lucky like so many others. Whichever the case there is just no denying that the cost of money can't fall any further and therefore outsized returns from real estate have only rental growth (ie real demand for real estate) to generate profit. Historically speaking I don't think that rental growth has even kept up with inflation so that really poses a big problem for anyone expecting to profit from this business from this point onward.

 

[Johnzz]

there is just no denying that the cost of money can't fall any further and therefore outsized returns from real estate have only rental growth (ie real demand for real estate) to generate profit.

I’m getting a little tired rehashing the same old arguments here, so this will be my last attempt.

Obviously, the “nominal†cost of money cannot fall much further (below zero), however, this does not mean the “real†cost of borrowing cannot (i.e. inflation increases 5% but mortgage rates only increase 2%, therefore your “real†cost of borrowing is now 3% lower).

I would also be careful assuming “outsized returns from real estate†are no longer possible. The amount of global stimulus injected via monetary/fiscal measures is almost unprecedented in scale and is likely to push inflation well beyond recent averages (whilst mortgage rates are kept relatively low via central bank stimulus). The future risk is that investors begin purchasing “physical†assets in mass as a safe way to preserve wealth. note: I think you've already begun to see this.

Finally, to give you a recent example here in Toronto, only yesterday I noticed a new MLS listing for a condominium unit in Yorkville, identical to one I just bought for $650K in October/08 (except it's 2 floors below mine). This new listing is asking over $1 million. Granted, it hasn’t sold yet (it’s only been listed for 2 days), but surly this hints at some upside capital appreciation (even in today's difficult market).

I’m not saying property investment is a “sure thingâ€. I’m only suggesting that the long term fundamentals (within the global macro framework) highlight real estate as being a great asset class to own right now. In addition, capital appreciation should be your "main", but obviously not your "only" focus (for reasons I've mentioned earlier).

Live long and prosper!

 

[daveto]

I’m getting a little tired rehashing the same old arguments here, so this will be my last attempt.

Obviously, the “nominal” cost of money cannot fall much further (below zero), however, this does not mean the “real” cost of borrowing cannot (i.e. inflation increases 5% but mortgage rates only increase 2%, therefore your “real” cost of borrowing is now 3% lower).

Johnzz, you've been a good sport and I congratulate you on your success.

However, your example above suggests that banks would be lending money for mortgages at less than the rate of inflation, which I think we would all agree is somewhat unlikely. Also, both the nominal and real rates of borrowing are at the lowest point in modern history. While I agree that it is not impossible for real rates to drop further, I think it is hubris to predicate one's investment viability on such an unlikely development

 

[rbt]

Finally, to give you a recent example here in Toronto, only yesterday I noticed a new MLS listing for a condominium unit in Yorkville, identical to one I just bought for $650K in October/08 (except it's 2 floors below mine). This new listing is asking over $1 million.

My neighbor listed for 10% over what they paid in November/2008. Had a minimum of 12 couples looking at it during the first 2 days.

A conditional offer was posted on MLS which fell through shortly after. The listing price has been adjusted UP an additional 3% since then.

 

[Johnzz]

While I agree that it is not impossible for real rates to drop further, I think it is hubris to predicate one's investment viability on such an unlikely development

I do not predicate my investment on real rates falling further. I simply acknowledge the possibility for those who think it impossible.

 

[daveto]

I do not predicate my investment on real rates falling further. I simply acknowledge the possibility for those who think it impossible.

Fair enough. I apologize for putting words in your mouth.