If you are reading this entry then you are part of my extended circle. We might never meet or… we might swap an email or two… or we might meet at a race. Last week in Penticton
, I was fortunately to meet quite a few new people. If you did then thanks for coming up and saying "hi". The combined effect of everyone greeting me was really positive.
Some of you probably sensed that I wasn't really missing my Tri Forum -- to be honest, I wasn't missing it at all! I appreciated having the extra ten hours per week of time. Still, chatting with a few folks made me come to realize that it is a great vehicle for us to get to know each other a bit. As well, the value received by everyone (including me) is hundreds of times the effort that I put it. The internet provides massive communications leverage when used appropriately.
So the Tri Forum will return, eventually. We're going to rebrand to something like the gForum and get the rotating yin-yang sign in there somehow. I'm leaving that to my web-guy. How long to get it all running? I'm not really sure but it will be coming back -- I need to wean myself off some alternative boards that run the risk of infecting my mind with chaos and noise! Just like big cities, popular sites often reflect the disfunction apparent in many societies (reflecting the fear and lack of self-love of many participants).
Race week was a hoot and I nearly lost my voice from talking so much on Wednesday. M started laying ground rules on me for my own protection. You see, once I get rolling, I am liable to stand around in the sun for hours offering ideas on topics such as run durability and training with power!
Now that more people know what I "do for a living"… I find myself engaged in conversations about investments, property and finance. When my business and triathlon lives were black boxed from each other, I never really had a whole lot of conversational overlap.
Not surprising but very interesting (to me at least) how conversation is guided by association. I need to keep working at listening better because people tell you quite a bit about themselves as soon as they start talking. Five more years and I hope to be much more accomplished.
M has this gift for making people feel comfortable so she does quite a bit of my listening for me. In our relationship, we delegate roles to the person that does them the best -- in that sense we are quite "traditional" in our marriage. Our skills fall clearly into male/female generalizations and we like it that way.
However, with listening, I see the ability to get a real edge on life. Not so much an edge over the competition, but an edge over myself in being able to "see" what's really happening around me (seeing is the first step towards controlling). For me, listening is linked to observation. When I am hearing others quite well -- I am also able to observe myself clearly. This observational skill leads to good emotive control which greatly increases my influence over the world around me. In a sense, we can control people by listening to them.
After a two year break from the Okanagan, I was amazed at all the development that had taken place. I hope that I get a chance to live through another economic cycle where the Fed cuts rates way low following a stock market crash. It all seems so easy in hindsight. Of course, I need to watch my personal “fear of missing out” that we all share. Envy and Sellers’ Remorse are big drivers.
They have a saying in Hong Kong that when your secretary starts writing cheques for IPOs then it is time to exit the market. What I noticed in Penticton was that _everyone_ was talking about property. If you are new to investing then here are some concepts that you might find useful.
Let’s say that I own an apartment that rents out at $1,000 per month. We’ll say that there is no mortgage against the property and my maintenance costs are $2,000 per annum. So I net $10,000 per annum from the property. Further let’s say that I paid $100,000 for the place, so my yield is 10% per annum. In an environment of 4-5% deposit rates that is a nice return. You are getting a great income return on your capital and have the upside for future appreciation.
However, in many markets residential and vacation yields are closer to 5%. So let’s adjust the assumptions a bit and say that I have a mortgage of $80,000; the yield is 5% and the cost of debt is 7%.
Where does that leave us?
$5,000 in rent
$2,000 in expenses
$5,600 of interest
This leaves a net cash outflow of $2,600 or a net yield of -2.6% against value.
I was 80% debt financed so my down payment was $20,000. My return on equity in this case is equal to -13% on equity (ouch).
However, in a property market that is rising by 10% per annum we would have “received” a valuation increase of $10,000. So our net position would be a cash outflow of $2,600 but an asset appreciation of $10,000 – a net move of $7,400 on our equity investment of $20,000 (+37% on equity, yippee).
Further if we manage to convince the bank to stump up some further debt finance against the increased valuation then we won’t even be out of pocket. When inflating valuations combine with high liquidity, it seems like easy money and it is, sort of.
The trouble starts to come when valuations stagnate and/or you get caught with the bank asking you to cover the cash shortfall out of your pocket. In those situations, things can start to look pretty crappy…
Three years rent is $15,000
Three years expenses are $6,000
Three years interest is $16,800
The accumulated cash deficit would be $7,800 (a 39% reduction in our initial investment value – or – a 39% additional increase in exposure).
At a 5% deposit rate, we would have forgone a 16% (compound) interest – the money we could have earned by having the cash in the bank instead of in property. The swing is equal to 55% of our initial investment – on an asset that didn’t move at all over three years. So while we may get our money back in three years – we had to pay 39% holding costs and missed out on 16% interest.
These calculations are interesting to me because often we fail to factor in additional cash calls when we think about an investment. In the second example above, you’d be shelling out each month to cover the deficit – but – the value of the property would not be increasing.
Many people purchase vacation and/or larger primary residences under the assumption that they worst they will do is “hold their value”. In those situations, there is no rental yield on the property so the income gap is even higher. As well, vacation properties are (by definition) non-essential purchases. So our ability to sell is much more volatile.
When we are holding a non-yielding asset that requires maintenance, there is the cash outlay that we have to pay as well as the opportunity cost of the capital being tied up in the asset.
I wanted to lay out a simple example because I was sensing that many people now believe that property investing is a one-way bet, the worst you do is a nil return. In fact, like any depreciating asset – in a downturn you can find yourself locked in and paying money out.
Another common point of view is that it is worth owning any property that we will use ourselves. Well, that depends. I spend quite a bit of money renting properties around the world. The calculation that I do is to compare the total number of nights that I use a property with the capital cost (plus the running costs; plus the hassle) of owning that property year round. If you own then it is tempting to tell yourself that you can always rent it out. But do you really? Most potential renters will want to use it at the same time as you (holiday and peak times). Even if you are renting to friends, tenants are a pain.
Finally, beware that we all have a deep fear of missing out. Hearing about other people making money... Seeing other people own assets… …these things triggers automatic “envy” responses in many of us. So we’re hardwired to want to own “our” assets.
It takes a massive amount of discipline to sit on cash and wait.
Property can be a great investment. I simply get nervous when a see a lot of new people entering a field late in the cycle with an attitude that they can’t lose.
In a flat market, much of the “cost” is hidden from view. Property stagnates more often than it tanks and if you aren’t in a prime-prime location then you can be faced with crystallizing a short term loss or shelling out for a few years through a dip in local conditions.
In my business we have two mantras that we live by. We want to be able to: (a) sell in any market condition; and (b) find tenants in any market condition. This greatly limits the locations where we can invest and means that we pass on seemingly attractive deals in secondary locations. We invest a bit slower but the risk profile of our portfolio is reduced.