Tuesday, March 13, 2007

How Do You Think of Housing?

In an effort to further the ongoing discussion that we've been having here and over on Victoria's Truth and the one that is also happening on the Alberta Bubble, I offer you these thoughts to pick apart:

About ten years ago, I started reading financial books. I was poor, had poor spending habits, and like most people my age, watched many peers 'benefit' from investments in the stock and real estate markets. I wanted to know what they were doing that I wasn't. I now know that the 'benefits' that many claimed, were either temporary of false, but that's beside the point.

In the late 90s, we were caught up with the tech market and the dot.com bubble. Hindsight being 20/20, we learned that much of the money made, didn't exist and was based purely on emotion and speculation.

Beginning in 2001, we've watched an unprecedented global RE market run-up to levels that can't possibly be sustainable unless incomes catch-up. Yes, our employment levels are the best they've been in a long time, but how about our income levels? There is a growing gap between rich and poor. Less people are rich and more people are poor. These are generalizations that I have no desire to define, but the fact remains that the middle class that emerged out of the baby boom generation is not a trend that is repeating itself, and how affluent those individuals are depends very much on the types of investments they hold and the performance of the market.

So what is an investment? Many of us consider our biggest investment (or asset) to be our home(s). Is this true? h/t Alberta Bubble

A few of the many books I read about money and investing were written by Robert Kiyosaki of Rich Dad Poor Dad fame. He is not the be-all end-all undisputed guru of business and investments, he has his detractors certainly, but like him and his ideas or not, he's fairly successful and has some rules that other financial people use too.

One of those rules is don't look at the house you live in as an asset as long as the bank owns it and you are paying for it. So the trick to turning your home into an asset is getting someone else to pay for it. Build a suite, build two, generate enough rents from those suites to cover your mortgage, insurance, taxes, inflation, and the whole other myriad of costs associated with your house and you have an asset. Otherwise, your bank has the asset, and you have the liability.

But we have to live somewhere. We're better off owning than renting aren't we?

I see two situations where you are better off owning your residence: you can afford it and still have extra money to invest in 'real' investments that do better than the approximate 5.25% real rate of return in real estate over the past 25 years; and a repeat of the above where you get someone else to pay a significant part of your mortgage. Note that the 'real' rate of return doesn't account for inflation.

Yesterday, Prairie Boy described a situation (much better than I ever have too) that we have looked at MANY times in the past couple of months: namely the mortgage helper. Here's what we've come up with so far (and I reserve the right to change my mind on this because really I am a novice on the whole issue): When your $1000-$1200 'mortgage helper' occupies 40-50% of your home, and doesn't pay dollar for dollar (eg 45-50% of your mortgage + other expenses) then you are actually subsidizing someone else's living costs, even if it's just over the short term until the fundamentals change. To consider the 'mortgage helper' an investment, it should be covering more like 55-60% of your mortgage for 40-45% of your square footage.

So when do the fundamentals change? Either the property value comes down or the rent goes up. Can you get more than $1200 a month for a two or three bed suite in your house? Sure, but then the value of that house is much bigger than the $400,000 places we're looking at. I'm guessing the market value of the suite in this place, and its a big suite, would be $1000-$1100/month depending on how much you invest in making it look really nice and trendy for the trustafarian students at UVic who want it all and want it now.

Let me try and bring this all back together and wrap it up so that this post doesn't turn into an essay. The house you live in is not an asset until its paid for. The faster you pay it off, the more of an asset it will be, especially if it has a 'mortgage helper' that turns into an income. The myth of home as your number one asset is propagated by our attachments to the old-world classical liberal ideas of private property ownership and property rights. We have to break the ties to our ideas of needing to own a home in order to practice the smart fundamentals of money management that defines an asset as something that generates an income for you and not an income for your bank.

We also need a place to live. Renting is less costly and more restrictive personaly than owning. Owning provides more personal freedom at a much greater cost in this market. I still remember those adds from 3-4 years ago that showed you how owning your apartment condo WAS cheaper than renting; we don't see those adds so much these days. Perhaps we'll wait until we see them again before we buy.

I'll close this off with the best definition of wealth I have ever found: "The number of days you can survive, without physically working (or anyone else in your household physically working) and still maintain your standard of living.... Ultimately it is not how much money you make that matters, but how much money you keep and how long that money works for you." (R. Kiyosaki in Rich Dad's Cashflow Quadrant)

1 comment:

JMK said...

Hi, great blog and interesting post...

I ran the nubers for myself recently, and found it is still much better to buy than rent in Victoria so long as I hold on for at least 6 years. This was all done plugging in numbers on a rent vs own calculator and using historic rates of return on RE, the indexes, and inflation. You've got to remember your rent will go up, and your mortgage will stay the same.

Of course historic rates aren't necessarily whats going to happen. If the RE market dips, then the numbers are off. But I don't have a crystal ball, and the correlation between RE and the stock market isn't a bad one. So its not clear that for that time horizon my money would be any better off in stocks.

And, despite what the bears say, the real estate market in Victoria is not necessarily the same as Winnipeg. Desireable coastal cities in North America have seen much better RE returns than the 5.25% you quote for all of Canada. Victoria's return has been 6.1% between 1978 and 2001. I remember reading that California has seen above 10% almost state wide over decades. Affordability is far worse in San Diego, San Francisco, Seattle, and Vancouver than here, all because they are great places to live. More than ever, people are willing to pay for that.

Cheers, Jody