December 08, 2006

• I can't believe that comparing the sale of a million dollar home at an auction versus selling it the traditional way a year ago provides much insightful information. If it were being compared to homes sold a year ago at an auction, then there would certainly be some value. If the seller would have sold the house by selling raffle tickets, would that be a useful comparison, too?
• With the exception of extreme markets like the coasts and perhaps the mountains, the housing market is far less volatile than the stock market. Even taking the extremes into consideration, if people lose 25% on the value of their home, that is far less than they might lose on the stock market in a day. In most communities throughout the US, home values are somewhere between stagnation and creeping upwards, with few communities losing value. Of course, the secret to making money in real estate isn't through primary residence ownership, but from borrowing money to purchase ownership and then getting someone else to pay off the debt (renters).
• Perhaps PigAlien - but (pulling a non numerical stat out of a handy orifice) I would think that most people do not borrow large sums of money to invest in stocks. But they do to invest in a house. Negative equity is not fun. This has been going on for a few months at least - here and here for instance. On a regional basis, new home sales in the West fell 13.6% in September compared to same month last year. Sales dropped 6.6% in the Northeast, 36.6% in the Midwest and 7.9% in the South, the Commerce Department said.
• I wish we could blame the slump on shoddy, unimaginative cookie-cutter construction on absurdly small lots. Then we'd have the answer right there in the bag.
• I meant to add... over the course of 15-30 years, the value of a real estate investment can increase far more than the stock market. For example, if you purchase a $100,000 home today with a $10,000 down payment and rent that home out, after 30 years at a 3% rate of appreciation, the home will be worth $235,000, or 23 times your original investment, in appreciation alone, not counting rental income. If you put that same $10,000 into the stock market at an average long-term appreciation of 10%, it will only be worth $158,000 after 30 years. Again, the real estate investment example does not include rental income, which can multiply the return even greater. On preview, polychrome, people borrow money all of the time to purchase stocks - its called margin. Its what caused the great depression. That aside, losing money is losing money. Whether its borrowed money or money from other accounts, it's still lost. I live in the midwest, and I can tell you prices here have not dropped. It is definitely a buyer's market right now, and prices may be 'softening', but there is not much negative equity.
• I know people borrow money to put in stocks - my point was that it isn't as common as borrowing money to buy real estate. The number of people exposed to a real estate crash, and the degree of their exposure is, I suspect, much greater than would normally be the case with a stock market crash.
• You are correct that it is not as common to purchase stock on the margin as it is to borrow against real estate. However, there really isn't such a thing as a real estate crash. There are areas which are subject to bubbles and these bubbles are fairly predictable. New York, San Francisco and Miami have all gone through real estate bubbles in the past and probably will again in the future. Notwithstanding, the majority of the country see property prices that are relatively stable compared to the stock market. In addition, if a person loses value on his house, he can simply remain in place and eventually it will gain its value back. With stocks, often times the stocks never recover or are delisted and the money is lost forever. In real estate, you don't lose money unless you sell. To put it simply, stock market crashes have devastated the economy in the past, but real estate crashes have not.
• For example, if you purchase a $100,000 home today with a $10,000 down payment and rent that home out, after 30 years at a 3% rate of appreciation, the home will be worth $235,000, or 23 times your original investment, in appreciation alone, not counting rental income. If you put that same $10,000 into the stock market at an average long-term appreciation of 10%, it will only be worth $158,000 after 30 years. Your example is based very much in time (and in space, with respect to location). You've also left out the repayments on the 90K borrowed to buy the house. Or is this covered by the rental income?
• Yes, roryk, the rental income should cover the mortgage payments and also put additional income in your pocket. Some investors purposely lose money for tax writeoffs. In other cases, some investors might break even or have a negative cash flow for a longer term high return. With real estate, the biggest risk is in management. You have to be pro-active and know how to select and manage tenants. The rewards are very high, however. For instance, building on my previous example, if you can rent out a $100,000 house for $700 each month and increase the rent every year by 3%, by the end of 30 years, you will be earning almost $20,000 each year in rental income, while your mortgage payments will still be less than $600 per month (assuming you don't refinance). After you pay off the mortgage entirely, you'll have a $20,000 annual income on a $10,000 investment, not including the asset value. Find me a mutual fund that can give you those kinds of returns. The values I chose are quite conservative. If you are savvy enough, you can watch the values in the neighborhood and when they begin to slow down, trade the house in a 1031 exchange for a house in a neighborhood with more appreciation and avoid any taxes.
• A few too many ifs in your example for my liking though - I realise that you didn't mean to suggest it was, but it's by no means as straight forward as that. For one thing, you have to find a $100,000 property that you can rent for $700 a month. That would be an unusually high rate of return. Yearly returns equivalent to 5% of total rental property value is closer to the long run average return from what I've read elsewhere so that gives something closer to $450 per month. You don't say whether your 3% is real or apparent but if you haven't allowed for inflation then your 3% per year in nominal terms is closer to zero in real terms. Quite why you would compare a 10/90 split for the house without doing something similar for the stocks example eludes me too. Admittedly 10/90 leverage on stocks seems unlikely, but 50/50 isn't. So that is a $20,000 initial stock portfolio, which makes your 30 year return look a lot healthier. BOTH approaches are proven, long term, wealth creation strategies IF you are careful and think things through.
• I wouldn't imagine having renters is clear & free profit... given the tendency for some individuals to damage houses or default on the rent I wonder how this adds up in the long run. Can you keep a rental house in decent shape for 30 years? Some rental neighborhoods I've seen have pretty much gone into the ground and stopped appreciating early on.
• To put it simply, stock market crashes have devastated the economy in the past, but real estate crashes have not. That's true in America, but not true in Japan in the 90s where overvalued real-estate plus a plunge in the Nikkei, created a decade-long recession.
• It is quite easy to find a $100,000 home to rent for $700/month or its equivalent. Paradoxically enough, the highest cash flow neighborhoods are the poorest, which is where the stereotype of the slumlord comes from. Poor people don't have much choice in housing, and often pay as much to rent as people with good credit and jobs pay to own. You might not find a $100,000 house to rent for $700/month, but you will easily find a $100,000 double where you can rent each side for $500/month for a total of $1,000/month. That is easily found in my city. Margin accounts rarely let you get above 50% of your investment. The $10,000 initial investment would translate to a max of $15,000 with margin, not $20,000. In addition, margin accounts charge interest, eating into your returns, as well as no one is paying off the margin amount like a renter pays the mortgage. Also, stocks tend to be much more volatile than real estate. In stocks, you can easily lose 100% of your investment. In real estate, it is very uncommon to lose value, particularly in the long term. If your tenant causes $5,000 in damage, you will make that money back in just a few years. If your stock tanks and the company gets de-listed, that money may be gone forever. Look at the people who invested in Enron... There are expenses associated with rental property that I have not addressed up until now. They are generally quite manageable and range anywhere from 10%-25% depending on your management experience and the housing quality/neighborhood. All of these expenses are tax-deductible, as well as the interest on the mortgage. With stocks, you do not get a tax-deduction, although you might get a deduction on the margin interest, but I am not certain how that works. Lots of quite clever people have figured out ways to reduce expenses to zero. The latest fad is 'rent-to-own'. With rent-to-own, the tenant pays a premium rent for the right to buy the property. In addition, as the potential owner, the tenant agrees to assume all maintenance costs. Because the tenant feels a sense of ownership, they are more likely to take care of the property and to stay longer than a typical tenant. If they end up buying the property, that's just a bonus!
• Since I don't know your city I'll take your word for it though 12% annual return on property investment sounds...ambitious....to me. As an aside, I'm going on 50% of the total investment, not 50% of what you put in. I've seen as low as 20% quoted but that was an outlier. 50% total seems reasonable.
• I think in your argument for rental profit you are counting on the fact that the house is in, and stays in, good condition. The place I'm renting needs a *lot* of work (including a great deal of roof and ceiling repair), and the landlord isn't fixing anything because that would cut into his profit margin. However, this will eventually bite him in the butt because it will make the house unlivable (taking away his rental income) and he'll have to pay a great deal more to fix what could have been only a moderately expensive problem.
• I still don't buy it, but I'm basing that on Ottawa. In Ottawa, if you buy a house to rent it right now, you will lose money. As I stated earlier, it is $1000 cheaper a month to rent our house, which is a very nice 3-bedroom in a good neighbourhood in central Ottawa, than it would be to pay the mortgage and taxes. My wife and I have spent the last 8 months looking for a house to buy, so I have a pretty good idea what prices and rentals are like around here right now. In addition, mortgage intrest is not tax-deductable in Canada. Considering the condition of many of the cheaper homes in Ottawa, you would have to invest a lot into them to bring them up to code as well. Add the cost of maintenance, and it is a mugs game. Now, if you can afford to buy a multiple-unit building, it might be different, but as it stand right now you would be very lucky to break even on renting out a house if you bought it today. It is probably also different if we were willing to commute in from out of town or move to the suburbs or exurbs. But then you have to take into account the monetary, time, and life-quality cost of a long commute, not being walking distance to everything, purchase and up-keep of a second car, etc. There are also all of the added expenses and time commitments of owning and maintaining a house. Long rant short, yes, you can buy, but at what cost and what trade-offs? It is not always such a simple choice.
• Being a successful landlord takes research, work and trial-and-error. So does being a successful investor in the stock market. Unless you buy an index fund and let your money sit there for 30 years, you are going to have to keep a constant eye on your stock, read analyst reports and annual reports. To pick new stocks, you'll have to read lots of papers and periodicals and keep up to date on the latest market trends. You can't just pick a house and expect to make lots of money off of it, just like you can't pick a stock at random and expect it to be a winner. If you put careful research into your real estate investment decision, make wise choices as a landlord and keep your investment in good condition, you will reap far greater benefits with much less risk than the stock market. Both are truly legitimate and successful means for creating wealth. Having the stock market has allowed our economy to grow substantially by making capital easy to obtain for companies both large and small. We need the stock market, and we need people to invest in it. For those who might be so inclined, however, real estate offers an amazing alternative. With real estate, you have a more direct control over what happens with your money. If you invest in your own neighborhood or nearby, you can keep a closer eye on your investment and might even have a better idea of the important market conditions which affect that investment than in a situation like the stock market, which is national, if not global. How many investors put their money into high-risk global funds investing in 3rd world countries promising high returns on the advice of some financial advisor in another state? You put that level of trust into someone you've never met before. With real estate, you can put the money into your own back yard and keep a close eye on it and still achieve the same returns. 12% annual return is not at all difficult to achieve, its very, very easy. If you make an initial investment of $10,000 in a house, you only have to clear $1,200 that year between rent AND appreciation. At 3% appreciation, you'll have a return of 30% alone on the asset value, not including any rental income. The other thing to bear in mind is that I've used a 10% down scenario. There are many lenders right now offering 100% financing on single family homes to investors. Yes, its true! If you put 3% down, which is $3,000, then in your first year at 3% appreciation (which is very conservative), you will have a 100% return on your initial investment! Investing on margin is extremely risky. Again, if your investment loses value, you may not ever get it back and will have lost money you didn't have in the first place. If your home loses value in the short term, it will almost always gain it back in the long run, even if you do nothing.
• Well, in all fairness, fimbulvetr, this post was about the housing bubble in the states, and you're talking about Canada, an entirely different situation. Our economies are linked, but our governments have different social and economic goals. In the states, homeownership is valued and promoted by the state to such an extent that we get all kinds of benefits that you may not get. In addition to the tax deduction for mortgage interest, we also get tax deferrals when changing houses and we don't have to pay capital gains taxes up to a certain amount for our primary residence. Also, although Canada has a much less dense population, it is centered in the cities, which will of course affect property values. Americans prefer to live in suburbs, where housing prices are much more affordable. Remember in real estate - LOCATION, LOCATION, LOCATION.
• PigAlien, if you can get a house for $100,000 and rent it out for $700/month then I'd definitely say go for it. The problem with the whole low-income tenant thing though is making sure you get good tenants. A friend of mine has a small apartment house but unfortunately had a bad apple tenant. The psychological and financial cost of this one individual exceeded the rent she collected. Aside from good references, what can the landlord do to avoid this? Isn't the uncertainty similar to a stock market investment? Just to add to fimbulvetr's comment, single homes in central Ottawa currently start at around $300,000 for <2000 sq ft and run up to $600,000. To carry a mortgage of say, $250,000 on a small house would cost about $1500 a month. You can definitely rent something nice for that. Buying a house here is a mug's game at these prices.
• Comparing a different city and country to where I'm at in the United States is definitely comparing apples and oranges. It might be very difficult to invest in real estate in central Ottawa. I wouldn't really know, as I'm not familiar with Ottawa. I happen to live in an area where real estate is a great investment opportunity (the US Midwest). As for the risk of choosing tenants, there is a risk involved. In one sense, it is like gambling in the stock market. However, you'll lose far less on one bad tenant than you could lose in a few minutes on the stock exchange. A bad tenant can be very emotional for a landlord, but the landlord needs to look at this as a business, not an emotional investment. My best friend lost over $40,000 on a poor stock market investment. That investment has still not recovered after almost 10 years and probably never will. He lost many nights sleep over this horrible experience and still beats himself up over it. Should he? Probably not, but then neither should a landlord who gets a bum tenant. I do know that if this friend of mine had put his money into real estate in a safe, stable location, it would have grown quite a bit by now and probably for no more emotional trouble than he's already suffered. It is much more difficult and admittedly stressful to manage a property that is geographically distant. I know people in New York and California who purchase rental properties in the Midwest and pay someone local to manage them. I don't see any reason why someone couldn't do that in Canada. How affordable are homes 30 minutes outside Ottawa? I honestly don't know, are they expensive or affordable? I'm obviously horrendously biased, but the truth is, for all the people I know who've lost money in real estate, I know far more people who've done well. I seem to know far more people who lost money in the tech crash of the early century than who've lost money in real estate. The people who've had bad experiences in real estate definitely put it down to bad tenants, repairs and general hassle, but even though they got out of real estate, they didn't generally lose much money. Also, the people I know who made their money in the stock market or as small business owners invariably tell me they would love to get into real estate. I have found that once people reach a certain level, they almost always want to get into real estate investing. Its strange, like joining the country club or something. Almost every millionaire I know owns some property somewhere.
• Renting any kind of house for $700/month would be a steal in Toronto. You're looking at a 2 bedroom in a building with no elevator in a crap neighbourhood for that sort of money. That said, buying any kind of house for $100,000 would be a steal in Toronto. But $200,000 is doable, and you could rent it out for $1500/month (which is what friends of mine were paying for a house in Toronto - now they pay $1200/month for just half of a house (3 bedrooms, two in the basement, small living room, kitchen) while the landlord lives above. That landlord is certainly making her money's worth).
• PigAlien: "but the truth is, for all the people I know who've lost money in real estate, I know far more people who've done well." People who lose money tend not to talk about it as much as those who make it. Property can be a good investment. But do your sums first: at the very least, make sure you price in a rental income that includes some void time between tenants, insurance, agent cut if you're going to use a rental agency. Add in the longer term costs of house ownership if you're really intending to do the 'buy a house for life' thing that PigAlien has suggested: new roof at some point, repointing the brickwork, that kind of thing. Over the long term, stocks have given a better return than property. However, the ability to gear your investment in property more easily than in stocks means that return can be multiplied. However, gearing multiplies the downside as well as the upside: get your sums wrong & you'll lose more than your original stake. Do your own research...
• If by 30 minutes outside of Ottawa, you mean 30 minutes beyond the city limits when there is no rush hour traffic, then yes, very affordable. But, being in the Great White North, youse takes yer chances 4-6 months of the year with a commute like that. Plus the roads out there are terrible. No thanks. The other option around here is to move to the Quebec side of the border. Houses there are dirt cheap, and only separated from the city by a river. The river is why people prefer the Ontario side -- the commute over the bridges and then through downtown is hell. The city is set up so that all transportation, including lumber trucks, have to drive through the downtown city streets. There are no other options for crossing the river. There is also that little language and separatist issue with Quebec as well. And higher taxes. At any rate, moving outside of town adds the extra cost of transportation and we would have to get a second car. Plus the time spent in transit. No thanks, I like my walk/bike to work, even in -40C. Quality of life trumps the opportunity to spend hours of my day in a car and overpay for an ugly, poorly built shitbox in the burbs every time.