Baby, we got a bubble!?

[interested]

Just an example as it's how I (luckily) chose to allocate most of my assets. Any saavy investor, Canadian or not, should have much more invested in the U.S. than a small, undiversified market like Canada.

Obviously nobody knows the future, whether it be equities or real estate. I think your earlier point about asset classes moving in tandem (due to excessive liquidity in the market) is spot on. We could easily see real estate and equities fall together just as they have risen together over the past 5 years.

I am not saying that equities are a better investment than real estate going forward (I wish I knew!), but they have been for the past 5 years. This is something that gets lost in this thread sometimes when people talk about great real estate returns have been. They've been great, but most asset classes have been.

My advice for times like these is to diversify and price in risk because it seems most of the market isn't.

Agree 100%.
It is just this that frightens me...people taking on risks they don't appreciate for very little return. Those who lever that risk are going to suffer a lot. The problem is the more conservative investors like me are going to get dragged along for the ride by those excessive risk takers. Alas, there is no way around it however.

 

[CN Tower]

A dollar invested anytime in the past 5 years had a better chance of a good return in the S&P 500 than real estate. Obviously you can cherry pick dates to show whatever you want, but U.S. equities have outperformed Canadian real estate by any reasonable measure over the past 5 years. The point is that people aren't "missing out" on returns in real estate while they wait for a crash. There are plenty of asset classes doing as well or better than Canadian real estate.

In fairness, an investment in any decent piece of Toronto housing in 2009 has appreciated 40%+. Buyers typically leverage housing approx. 3-1. So $1 invested in 2009 is worth approx. $1.40 today on an investment of $.25. That's almost double your money plus a yield of >3%. That has outperformed the S&P over most of 2009 unless you timed it like a demon. Plus most investors simply don't leverage their stock portfolios to any great extent from my experience.

For the risk involved I'll take that piece of Toronto housing over the S&P 500 any day.

 

[interested]

In fairness, an investment in any decent piece of Toronto housing in 2009 has appreciated 40%+. Buyers typically leverage housing approx. 3-1. So $1 invested in 2009 is worth approx. $1.40 today on an investment of $.25. That's almost double your money plus a yield of >3%. That has outperformed the S&P over most of 2009 unless you timed it like a demon. Plus most investors simply don't leverage their stock portfolios to any great extent from my experience.

For the risk involved I'll take that piece of Toronto housing over the S&P 500 any day.

A point CN Tower:
If the market drops, and you are levered at 3:1, your equity drops pretty fast if there is a 20% correction. About 2/3 of your equity is gone. Also, real estate is not liquid, so if there is a drop, it can be difficult to get rid of.
So what has worked well on the way up (leverage) is a real risk on the way down.

 

[cheech10]

No reason you can't leverage stock investments as well...

 

[James]

The "when" is the million dollar question. As with all markets, real estate goes up and it goes down. It rallies and then it corrects. Trying to predict when it corrects is as impossible as predicting exactly when it's going to boom.

The challenge is: how long do you wait and at what correction do you jump into the market? When you do, how many others will be there, also having waited, and now ready to bid on those undervalued properties?

How much appreciation will have gone by before the correction? When the correction happens, will it be enough to offset the wait? Assume the market increases year over year at a rate of 5%. You'd need a 22% correction to make that 5 year wait cost-neutral (in the simplest of terms, of course, as we're not including carrying costs, opportunity cost, inflation, etc.). This means a house currently worth $700,000 would need to drop to $546,000 for that 5-year hold to make sense.

I'm not a real estate pumper nor am I a real estate bear. I just try to approach it in a rational and practical manner.

I think your assumption that you're losing out on returns by not investing now is misguided. You can invest in other asset classes and get a return while you wait for the market to correct. For example, investors were better off in the S&P 500 than most Canadian real estate over the past 5 years. Equity investors are actually ahead of real estate investors, despite the great returns on real estate.

I don't disagree but in my example above, I specifically made a note that I am not including opportunity cost.

Since you mention the stock market, my post above applies as well. Just find and replace the words "real estate", "properties" and "house" with the word "stocks". Timing the market is a very difficult thing to do but we make financial decisions based on risk-to-reward. I was just throwing something out there as food for thought.

 

[cheech10]

But you can't just ignore opportunity cost/carrying costs/inflation (even if you acknowledge that you're ignoring them) because leaving them out skews the comparison. Significantly. Mortgage payment alone will almost always be less than rent, but mortgage payment+property tax+utilities+maintenance+insurance+opportunity cost of down payment+deferred maintenance will frequently be more than rent.

Disclaimer: I'm a house owner, but not a real estate investor. Neither bullish nor bearish on real estate currently.

 

[James]

But you can't just ignore opportunity cost/carrying costs/inflation (even if you acknowledge that you're ignoring them) because leaving them out skews the comparison. Significantly. Mortgage payment alone will almost always be less than rent, but mortgage payment+property tax+utilities+maintenance+insurance+opportunity cost of down payment+deferred maintenance will frequently be more than rent.

Disclaimer: I'm a house owner, but not a real estate investor. Neither bullish nor bearish on real estate currently.

Point taken. I was just trying to prompt some more thought on the notion of the hold strategy. Someone making a financial decision should most definitely factor in all of those key elements.

 

[NorthYorkEd]

But you can't just ignore opportunity cost/carrying costs/inflation (even if you acknowledge that you're ignoring them) because leaving them out skews the comparison. Significantly. Mortgage payment alone will almost always be less than rent, but mortgage payment+property tax+utilities+maintenance+insurance+opportunity cost of down payment+deferred maintenance will frequently be more than rent.

Disclaimer: I'm a house owner, but not a real estate investor. Neither bullish nor bearish on real estate currently.

Exactly. I was also a homeowner (now a renter) and my friends often ask why we pay so much in rent when it is cheaper to "own". When boasting of their "gains", they never factor in inflation, taxes, mortgage interest, or maintenance costs. It's always "We bought this in 2005 for $307,900, and now we could sell for $460,000. We made over $150,000!"

But subtract inflation ($307,900 in 2005 is worth $363,000 in today's dollars), land transfer fees, real estate and lawyer fees, interest paid, property taxes paid, maintenance paid, condo fees paid, etc, the actual realized gain is likely closer to $15-20,000.

This is a new world we are living in. People need to be more mobile and are looking for more efficient and convenient lives. The old model of staying put for a few decades, raising a family while keeping the same job and living in the same town is fading out. People shed jobs and careers and relationships like last year's fashions; they want to live closer to where they work and play, and they want less of a "footprint". Ownership is nothing more than a lifestyle choice, and not the no-brainer it has been historically.

 

[CN Tower]

No reason you can't leverage stock investments as well...

Theoretically I agree with you. However, practically speaking people don't utilize very much leverage in the stock market and it isn't as easily available or cheap. If you buy on margin and the market moves against you the bank will sell your stocks to protect itself. That doesn't happen in the real estate market where property values are not marked to market daily.

If you owned a rental property in 2008 you would have coasted through the financial crisis with little impact and steady cash flow.

If you owned high margined stocked in 2008 you would very likely have been completely wiped out and quite possibly hit with a big tax bill.

That's the difference.


To Interested:

Of course leverage works both ways! But if you have a 5 year fixed rate mortgage on a property and the market adjusts the bank is not calling your loan.

 

[DearSummer]

Theoretically I agree with you. However, practically speaking people don't utilize very much leverage in the stock market and it isn't as easily available or cheap. If you buy on margin and the market moves against you the bank will sell your stocks to protect itself. That doesn't happen in the real estate market where property values are not marked to market daily.

If you owned a rental property in 2008 you would have coasted through the financial crisis with little impact and steady cash flow.

If you owned high margined stocked in 2008 you would very likely have been completely wiped out and quite possibly hit with a big tax bill.

That's the difference.


To Interested:

Of course leverage works both ways! But if you have a 5 year fixed rate mortgage on a property and the market adjusts the bank is not calling your loan.

When you can't make mortgage payments because your rental property is cash flow negative, the bank will take your home.

When interest rates rise and you can't make the new higher payments or qualify, the bank will take your home.

When you lose your job and can't make mortgage payments, the bank will take your home.

When you can't make payments because your property is unoccupied, the bank will take your home.

When you can't make payments because a tenant isn't paying rent, the bank will take your home.

 

[Condo George]

In fairness, an investment in any decent piece of Toronto housing in 2009 has appreciated 40%+. Buyers typically leverage housing approx. 3-1. So $1 invested in 2009 is worth approx. $1.40 today on an investment of $.25. That's almost double your money plus a yield of >3%. That has outperformed the S&P over most of 2009 unless you timed it like a demon. Plus most investors simply don't leverage their stock portfolios to any great extent from my experience.

For the risk involved I'll take that piece of Toronto housing over the S&P 500 any day.

Now your talking! These are the posts that so many here learn from including myself. Keep on sharing your knowledge and insight

 

[Condo George]

Theoretically I agree with you. However, practically speaking people don't utilize very much leverage in the stock market and it isn't as easily available or cheap. If you buy on margin and the market moves against you the bank will sell your stocks to protect itself. That doesn't happen in the real estate market where property values are not marked to market daily.

If you owned a rental property in 2008 you would have coasted through the financial crisis with little impact and steady cash flow.

If you owned high margined stocked in 2008 you would very likely have been completely wiped out and quite possibly hit with a big tax bill.

That's the difference.


To Interested:

Of course leverage works both ways! But if you have a 5 year fixed rate mortgage on a property and the market adjusts the bank is not calling your loan.

agreed

 

[CN Tower]

When you can't make mortgage payments because your rental property is cash flow negative, the bank will take your home.

When interest rates rise and you can't make the new higher payments or qualify, the bank will take your home.

When you lose your job and can't make mortgage payments, the bank will take your home.

When you can't make payments because your property is unoccupied, the bank will take your home.

When you can't make payments because a tenant isn't paying rent, the bank will take your home.

DearSummer, you're not suggesting that there is RISK involved in the world of investing are you?

SHOCKING

p.s. when you are done with your proverbial crystal ball of the future please pass it around. If you knew with any degree of certainly where interest rates were going there would be far more frictionless paths to riches than the (hands) dirty business of owning properties.

 

[DearSummer]

DearSummer, you're not suggesting that there is RISK involved in the world of investing are you?

SHOCKING

p.s. when you are done with your proverbial crystal ball of the future please pass it around. If you knew with any degree of certainly where interest rates were going there would be far more frictionless paths to riches than the (hands) dirty business of owning properties.

Ah I see so it's OK when you identify risks with margin investing but not OK when I identify risks with owning rental estate. Thanks for that.

 

[CN Tower]

Ah I see so it's OK when you identify risks with margin investing but not OK when I identify risks with owning rental estate. Thanks for that.

It appears that you fail to grasp simple concepts of investment. Stocks are volatile and if they are bought on margin and drop significantly the bank will sell your stock. Whereas, if the real estate market corrects and the value of your property drops in value temporarily, just as the stock might, there is no impact on your mortgage. And even if you are unable to service the mortgage you are legally entitled to many months grace period under the law before a lender can ultimately foreclose on its mortgage.

This lesson is free the next one will cost you