Monday, July 2, 2007

Thank You John Caspar!

I was at a BBQ last night where we got into the real estate is such a great investment BS, again. I was pained to explain how I believed that to be true if you bought two or three years ago, but if like us, you were caught on the outside looking in, RE ain't such a great investment today. I qualified my argument with equities consistently outperform RE. Did I say consistently?

You should have seen the looks on the faces around the table. "You're not telling me that any equity investment you've held has doubled in three years." "Those kinds of stocks are super risky, besides, you'd be looking at only putting really small amounts of money into stocks, it's not like turning $200K into $400K." "Everyone knows RE is the best investment you can make for your family"

Well, apparently everyone forgot to tell Mr. Caspar, a man who actually gets paid to write and seems to me to be somewhat of a misfit in the MSM world: he's balanced in his writing and he doesn't give you a pump job. For that I say thanks, John.

Here's a great new article and a few highlights: (I'll link back to an earlier post done here too, only because they're eerily similar, non?)
in Canada's hottest real estate markets, it's tough to find anyone who isn't an expert

And [RE BULL MARKET] been going on for long enough that real estate as an investment has fallen into the "Everybody Knows…" category. You know: "Everybody knows that real estate is a safe investment", or "Everybody knows that real estate outperforms stocks", or "Everybody knows that you can't get hurt in real estate." Like that.

And as it turns out, the whole story about real estate as an investment isn't quite the same story that Everybody knows.

According to data from the Real Estate Board of Greater Vancouver, in the last thirty years the average price for a detached home had three bear market periods where it took at least two years for prices to recover to their previous high. After prices topped out and corrected in 1981, it took seven years to get back to those 1981 prices. Real estate investors were just getting back to "knowing" how great real estate was when prices peaked and corrected again in early 1990. It was 1992 before prices climbed back to where they were. And then, in early 1995, prices once again started downward. This time, it wasn't until 2003 until the market saw those 1995 prices again. That's right…in very recent history, it took the investment that Everybody believes in eight years to recover from a downturn.

So there it is. Three bears for real estate, with durations of 7, 2 and 8 years. Four bears for Canadian stocks, with durations of 2, 2, 2 and 5 years.

So what were the comparative returns for those two asset classes over those 30 years? Well, based on the data mentioned above, the average detached home in Greater Vancouver went from $80,000 in 1977 to $785,234 in (April) 2007. Wow. Can you believe the average Greater Vancouver home once cost 80 grand? And can you believe it's now nearly 10 times that?! That's a total return of about 882 percent, or an average annual return of nearly 8 percent. Nice!

if you had invested $80,000 in the index in 1977, it would be worth over $2.5 million in April 2007. That's more than 3,000 percent return, or an average of over 12 percent per year. Very handsome. And by the way, if you'd invested the same amount in the U.S. S&P 500 index, you'd have over $3.1 million in Canadian dollars today – a 3,825 percent return, or an average of 13 percent a year.

So, as it turns out, over the long run stocks do rather well compared to real estate. Of course, on an intuitive basis, you'd figure this out anyway, right? Because if Everybody knew they could make more money in the long run by simply owning real estate rather than owning resources companies and financial institutions and industrial firms and telecom companies, they'd never start, run or buy a company. And Everybody knows that's just silly.
What John doesn't point out directly in his article (he uses a period from 1977-2007 or 30 years for his comparison) is that in those thirty years, 11 years were bearish in equities while 17 years were bearish in real estate. In terms of percentages: 37% of the time you looked at your stock portfolio you were losing money during those 30 years while 57% of the time you received your BC Assessment notice your "fail-safe" RE "investment" was worth less than the previous year.

46 comments:

greg said...

The same point I made about the local market recently, pinpointing the ups and downs, much to the disquiet of some folk at Vibrant Victoria.

FarFromHome said...

That was a great article, where do I find more of his writing?
So on that note, we are looking for a home but hoping we can wait for some sort of correction before we get serious about making offers. We have a substantial downpayment and I keep thinking about whether it would be better to go in with 10 or 20% (get rid of CMHC) and invest the rest in stocks rather than plop the big DP on the house. I could always make a balloon payment later, right? Wouldnt it be better to have some money that was growing and not stagnant, even when you add in the interest on a mortgage. Any comments on this appreciated.
Thanks,
Stormy aka farfromhome

hhv said...

FFH,

The way I see it, and I'm certainly no expert, is this: if you can afford to put 20% down AND your mortgage payments/taxes don't use up more than 35% of your after-tax income AND you still have the financial capability to save at least 10% of your income into some kind of investment for retirement (stocks, bonds, RE, whatever is outside your own home) AND you can see yourself happy in the place you purchase for at least 10 years then there is no time like the present to buy.

The time factor should keep your "home-investment" worth more than what you paid for it today despite any downturns... but even if it's not, you can afford it, you aren't relying on it to fund your retirement and regardless of what its worth, you're happy living in it and don't need to move.

Greg, it's always amazing to see the "everyone knows" factor take all the facts out of investing and put all the emotion into their "claims." I don't know anyone capable of reasoning with emotional people. I just wish people would tell me they're really happy living in a home they've bought that they can afford. All my peers who are homeowners all say the same thing: we don't really like our house/neighbourhood but when we finish fixing it up it'll be worth x amount more and then we'll sell it and move to somewhere bigger/nicer/better.

Anonymous said...

"...when we finish fixing it up it'll be worth x amount more and then we'll sell it and move to somewhere bigger/nicer/better."

Why do these people never seem to realize that if their present house jumps in value so will the bigger/nicer/better place, making them no better off in the future than they are now?

VicREBear

JMK said...

It is great for Caspar to point out that Real Estate markets drop and that it is not a double-digit investment. But he loses me when he doesn't include the 6% a year rent brings you on a property for rent. Sure, subtract off a couple of percent for taxes and maintenance, but that still makes your 8% into 12%. He also neglects to mention that the investment income is taxed eventually by at least 25%. Certainly before you can use it for rent.

For Victoria, +4% reduces the number of bear years to 81,82,83,84 and 94, or four out of the last 30.

greg said...

jmk -

check this out -

"In 1981-1982, house prices dropped from $126,776 to $105,023 in a single year - a drop of around 20%. In the early 1980s, it took longer for the market to recover, and houses continued to lose nominal value, eventually dropping almost 35% by 1985. In inflation adjusted terms, it took more than 11 years for prices to recover to the level they reached in 1981 - this finally happened in 1992, when average house prices in the VREB reached $222,415."

Just cause prices moved upward in nominal terms doesn't equal a non-bear market....

greg said...

jmk -

what that means is - if you bought a house in 1981 as a principal residence - it took more than a decade to break even - and that's not including taxes, maintenance etc....

If you don't remember the 80s on the island personally, don't try to deny it, if you were here at the time, you know that's true.

greg said...

Sort of on topic,

I was talking to a friend from Fairfield who bought in the 80s. He figured prices were down a smidgen from last year, and places are taking longer to sell.

He also figured the amount of refinancing in Victoria is a ticking time bomb - only the tip of the iceberg is showing - and interest rates are going to hit some of those people hard.

Can't say I disagreed with him much - mind you, he knows my opinions on this matter, and maybe he was just being agreeable....

JMK said...

Just cause prices moved upward in nominal terms doesn't equal a non-bear market....

Greg,

Those are the real-price bear markets if you add the 4% for rent. If you don't add the 4% for rent, you add slight real losses in 97,98 and 99. Nominal bear markets are only slightly different.

I'm talking about Victoria here. I don't have the Van numbers at hand. You have the Victoria numbers and can easily check all this.

hhv said...

jmk,
"But he loses me when he doesn't include the 6% a year rent brings you on a property for rent. Sure, subtract off a couple of percent for taxes and maintenance, but that still makes your 8% into 12%."

Are you talking about a rental property as an investment? If that's the case, you won't get any arguments from me. If I had $425K in equities, I'd liquidate that quickly, by a house with a suite in it here in town, rent both units and watch my investment give me a consistently good dividend (rent) and long term appreciation of about 6%. I can incoporate that investment as a business and receive favourable tax terms as well. No brainer there. But if I couldn't pay cash for that investment, my margins change significantly and I'd likely keep that money growing tax-deffered/preferential in equities rather than take on a mortgage for a rental property AT TODAYS PRICES.

Regardless, I don't think Caspar is necessarily talking about a rental home. I think he's saying that most people call their own home (the one they live in) their number one investment. He's simply trying to shed some light on some of our societies current false beliefs. Of course there are alternative scenarios, but the vast majority of the EVERYBODY's he's writing about aren't involved or talking about those alternative scenarios.

vg said...

greg,
Good points on the rental part. I don't believe he was talking a second home, he was referring to a principal residence. It's pretty obvious equities surpass real estate and that is just playing the index,what if you played 25% of that at even middle risk stocks,those numbers would be much bigger. You easily would have bought a Microsoft or something similar in there in the early 80's if you were serious about your investments.


hhv,
you are a party pooper aren't ya,lol. I have decided to back off on my comments to friends and family, they know my stance now so I will refrain for the time being til the media is all over the declines,then there will be no holding me back. :)

JMK said...

HHV,

Rent is a return on the investment whether you live in the house or not. In fact it is a better return if you live in the house, as you won't be taxed on this rent as income.

Interest is a cost of investment. Given the same downpayment, it is the same for the $80k house as for the $80k in the TSX, and will impact the returns on those investments identically. Though I am pretty sure that you will get a much better interest rate from your banker if you tell her that you are going to buy a house than if you say you will buy stocks.

If people think that owning a home is a substitute for saving for retirement, then I agree with you and Caspar, they are being foolish. That only works if they think they are going to retire somewhere cheaper than where they presently live.

greg said...

jmk -

btw, where do you get your 4% number for rent - as far as I can tell, most properties in Victoria will not return 4% per year at the current inflated prices.

ie - on a $560,000 house, it is unlikely you could get a 4% return, after subtracting financing costs, maintenance and taxes.

That would equal $1866 month after the aforementioned expenses.

Not happening in Victoria these days - if you doubt it, I suggest you check the rents on Craigslist.

JMK said...

Greg,

I got 6% assuming a 200:1 price to rent ratio (12/200=6%). The calculation in Caspars article was for the last 30 years, and as the bear community is fond of pointing out the present 230 price:rent is historicaly on the high side. If you want to use today's 230:1, then you get 5.2%.

Please feel free to find a $560k house on Craigslist that rents for less than $2k and post a link here (whole house, not just the upper floor). I've looked recently and couldn't find any.

hhv said...

jmk,

I'm assuming your using 'rent' in this case to describe your mortgage payments?

I get your argument that Caspar has "dumbed this down" to not include certain variables that you feel would alter the outcome of the scenario. I disagree that your mortgage payment or rent changes the outcome of the worth of the asset at the end of the time frame used.

Yes you have to pay rent if you don't own. Yes you have to pay rent to yourself if you do. You also have to pay interest and maintenance costs when you choose to own. But the example used here is if you owned a house at $80K in 1977, free and clear, it's now worth 882% more. Similarly, had you had $80K in the S&P 500 index fund your investment grew by 3,825%. That's the simplicity of it. Its the myth busting RE outperforms the stock market argument.

I'll repeat myself, if I could pay cash for a house, collect rent and watch my investment grow at roughly 6% YOY, I'd sooner do that than throw the same money into an equity-based investment. To me, that's a stable cash-based (as in instant cash ROI) investment as opposed to an RRSP. But again, Caspar is not talking about that scenario. He's talking about the average Joe and Jane at the BBQ who claim that "RE outperforms the stock market" when they're using their own home as an example. Who you pay rent to is a big determining factor here. It can be you or your bank.

Today's prices also are a huge factor-both in rent and purchase price. How many RE investors do you know that are out buying properties with 20% down and getting their mortgages paid for by tenants with enough left over to cover their other house-related expenses? I'm guessing not too many.

hhv said...

I'm guessing you won't find many whole houses for rent in this town because tenants in them know exactly how good a deal they have and won't be moving anytime soon. I bet the turnover rate for a whole rental house anywhere in town has dropped dramatically since 2003.

vg said...

Just saw a house for rent on craigslist and Pemberton Homes in Sidney for $1750, 5 bedroom, almost new looking but is built in the 90's I believe,two doors down from a similar house thats for sale for $1.3 million,look it up yourself.

Anonymous said...

Caspar's article is not quite a fair comparison though. It should have compared someone putting $80,000 in the index and someone buying a house outright with $80,000 which the majority of people in 1977 couldn't have done and a lot still can't do today.

S2 aka Harmony

hhv said...

http://victoria.craigslist.org/apa/364272632.html

It's certainly not the norm in terms of rents being asked right now. But that said, neither is a whole house... seems like a lot of luxury condos being advertised on craigslist this week.

vg said...

Any fix ups and maintenance would offset alot of the taxes plus the fixups are only a personal preference if it is basic stuff(no additions)that will reap no big reward when it is sold cause that is considered general updating. All those articles that say a new kitchen etc gets X amount of more dollars are all BS unless you flip it the next day, you keep it a year or two and you are basically the same as all the other houses you are competing against. It means even less so in a declining market,it better have a new kitchen or you will be losing any chance of a quick sale.

greg said...

jmk -

as usual, you obfuscate and twist the facts - go back and look at what I wrote - said, after your expenses (taxes, maintenance, carrying costs) find a house that will return $1866 per month.

I can get that from CIBC with no costs, in a savings account.

Show me a house that will produce the same, after subtracting those expenses.

How about respecting the facts which show it took 11 years to break even in inflation adjusted terms.

As far as more recently, people who bought in 1995 didn't break even until 2003, in inflation adjusted terms, based on the averages provided by VREB and the Bank of Canada numbers for inflation.

hhv said...

S2,

the way I read the article, that is exactly how the comparison works.

vg said...

Thats not the one HHV,the other is much nicer.
I meant for jmk to look it up since he was demanding a link yet picking apart a clear cut case where the numbers don't lie.

JMK said...

HHV,

I'm assuming your using 'rent' in this case to describe your mortgage payments?

No.

You are confusing two different things: financing an investment and return from an investment.

If you needed to borrow from a bank to invest $80k in real estate in 1977, then you also needed to borrow to invest the same amount in the stock market. So, lets follow Caspar's example and leave that asside. It is a cost of the investment and it is the same for both asset classes, more or less.

This cost is irrelevant when comparing the returns as Caspar is doing. What is relevant is that you include all the returns. And Caspar hasn't - he hasn't included the net 6% or so you'd make for rent owning real estate. He also hasn't included all the costs - 2% a year for realestate, and 25% of your cumulative returns for capital gains on your equities.

vg said...

http://victoria.craigslist.org/apa/363218970.html

JMK said...

as usual, you obfuscate and twist the facts - go back and look at what I wrote - said, after your expenses (taxes, maintenance, carrying costs) find a house that will return $1866 per month.

I can get that from CIBC with no costs, in a savings account.


Greg,

Presumably if you can get that from a savings account, your carrying costs are zero since you have at least $560k in the bank (assuming 4% on your savings account).

Taxes and maintenance on your $550k house are $920/month. I'm pretty sure you can do better than that for rent.

greg said...

actually, I can get 4% on any new balance over $5000 at the moment.

So to extend your analogy, regardless of the amount of financing, I can get 4% for my downpayment - and unless my rent is more than carrying costs plus all those other expenses combined - my net on the remainder is the profit vs any other investment.

Finally, my point was very specific - you provide an example where you actually can net 4% IN RENT, on the open market, after subtracting those expenses, and you will have a legtitimate point.

However, of course, given that rents are tied to incomes and are not caught up in an asset bubble - you won't be able to do that.

Let me spell it out again, so you can't pretend to misunderstand - show me a place that nets $1866 in rent after subtracting expenses (your mythical 4%) - well, where is it?

If I had the entire purchase price available in cash and deposited it in that account - that is $22,400 in interest in the first year!

Using your figure for taxes and insurance, the place would have to clear $2786 in rent per year - before maintenance costs were considered - to break even with the bank deposit.

Well? Any likely properties?

greg said...

Whoops - make that $2786 PER MONTH.

JMK said...

Greg,

I see why you think I'm obfuscating - its because you are not reading my posts. I said, very clearly above, that I assumed a 200:1 price to rent for the last 30 years, because the ratio has historically been lower than it is now.

Price to rent is about 230:1 right now, based on places I've seen (again, clearly stated above). That is $2333 a month on a $560k place. A pretty good deal in Sidney aside, I'll stick with that ratio as being representative. If you don't agree with it, you are welcome to make your investment decisions based on whatever ratio you think is appropriate.

It doesn't remove the fact that this net return, whether you think it is 4% or 1%, was not included in Caspar's analysis.

hhv said...

jmk,

"It doesn't remove the fact that this net return, whether you think it is 4% or 1%, was not included in Caspar's analysis."

Caspar's analysis didn't include rents because that wasn't a part of his assumptions. You can throw them in, you can make assumptions that historically the ratio is 200:1 (I'd argue that the economic fundamental used is 150:1) and certainly that changes the outcome. But there aren't that many RE investors out there. Mutual funds, and specifically index-linked mutual funds, are unsophisticated investment products that are cheap to manage and easy to use.

That is why I assume he used them for his comparison and also why he neglected rents, because the average homeowner is not collecting rent.

I'm thinking Caspar's comparison is a bit closer to apples to apples rather than your more sophisticated apples to star-fruit comparison. If your investment strategy is sophisticated enough to include rental properties, then with a bit of homework, you're likely to look seriously at options and investing on margin accounts. If that is the case, you can make significantly more money, significantly faster with significantly more risk.

vg said...

As far as rents go,lately, as in the last few months. craigslist has been distorting the rent rates for what this city will pay. I see alot of rentals that are on there for several months or coming back online a month or so after someone rents it and finds out it is a total ripoff. This past week I have seen several new rentals that are realizing if you want a reliable tenant you better charge realistic prices or you are gonna sit empty,in other words its wake up time for landlord,especially the newbies who got sucked in by the agents who BS'ed them on what their place should rent for. Like all booms there comes a time where people stop paying the outrageous prices wether it's houses,stocks,cars or whatever. We are at this point for real estate.

Anonymous said...

Does anyone have any comments on the June VREB numbers?

S2

JMK said...

That is why I assume he used them for his comparison and also why he neglected rents, because the average homeowner is not collecting rent.

Joe and Jane Bbq are indeed "collecting" the rent, by not paying it to somebody else. It is the simplest and most reliable return on their investment. To leave this return out of a calculation is silly, and has been the point of about 90% of my posts on this blog.

Again, how they finance that investment is another kettle of fish.

greg said...

jmk -

The BBQs are only collecting the rent on the portion of the rent that is not paid to finance the purchase!

The purchase financing (interest) paid to the bank, is no different than rent paid to a landlord - it is gone forever.

If the BBQs paid cash and own their principal home outright - they are not collecting any "rent" for mortgage payments they are not making - their only means to actually receive money, rather than your fictitious "rental benefit", is if they rent out the place - it is what renters pay them, or what they realize when they sell the place.

Simply put, renters are not paying 4% now on current prices - after expenses.

Don't confuse the issue by throwing in a 30 year average.

Nobody cares what average returns savings accounts were making since 30 years ago, and the same goes for rental returns.

Current rents are the most accurate measure of the actual market value of the property if you want to consider it as an income producing investment.

Again, if you find average houses in Victoria renting for over $2800 per month, supply a link.

The problem is - those average houses don't draw that much average rent, after expenses are considered!

greg said...

Here's another scenario for you.

I own my house in Calgary outright. I live there 10 months a year.

I own my condo in Songhees outright. I live there 2 months a year.

Exactly how much rental benefit am I getting for the two properties each year?

I'll give you a hint - the answer is 1 year's worth.

According to your rationale, owning anything outright provides a rental benefit - a car, a CD, an airline ticket, gold bars.

Most people are not corporations who depreciate their personal possessions for accounting purposes.

In the real world, the only gain I can make on these items is when I sell them, or rent them to others.

If you aren't renting it, and you aren't selling it - your rental benefit is a fiction.

Anonymous said...

Since we're on the subject of selling price vs. rents, I'll throw in my weekend anecdote for what it's worth. My wife & I are currently renting a 2 BR house in the Victoria area, but are looking to upsize. We found a listing for a 3BR house, nice neighbourhood, for $1825/mo. On closer inspection, it turned out to be a house that we'd already toured when it was listed for sale last fall (a small "cottage" on a reasonably busy street). It eventually sold for $475,000. We declined to rent, because it was too small for us ... we might as well stay where we are.

Last time I checked, $1825/month would cover payments on a $300,000 mortgage. Either the new owners are planning to subsidize their new tenants, or they made a hefty downpayment on their rental property, with the associated opportunity cost.

JMK said...

Greg,

Don't confuse the issue by throwing in a 30 year average.

Go back and read the article and the thread. The issue in the Caspar article was that over the last 30 years stocks outperform real-estate on a value-only basis. So of course a 30-year average is appropriate.

According to your rationale, owning anything outright provides a rental benefit - a car, a CD, an airline ticket, gold bars.

This isn't a "rationale", it is an obvious fact when it applies to a basic necessity like housing. If you need a car, then owning one provides you with the monetary benefit of not having to rent one. If you flew an airplane every day with 120 of your friends, you'd probably buy one rather than renting the seats (tickets).

If it makes things clearer, go ahead and make the rent a cost to the equities investor rather than a return for the home owner. i.e. subtract 3% from the equity returns. The comparison works out exactly the same.

greg said...

jmk -

I would suggest you reread my posts.

Are you suggesting that investors should be advised of 30 year average returns when the price earnings ratio is currently out of whack, and justify buying anyway on that basis?

I am referring to the fact that your stated return currently is nonsense.

You can't get 4% from housing now, leaving asset appreciation out of the equation.

Why can't you just admit the obvious, instead of twisting it back around?

Why don't you respond with an actual answer to my two property analogy? I'll tell you why - because it blows gigantic holes in your rental model.

JMK said...

Why don't you respond with an actual answer to my two property analogy? I'll tell you why - because it blows gigantic holes in your rental model.

No, its because your analogy makes no sense. I never said that you gain a rental benefit if you leave a house empty. Thats so obviously false I didn't think it required comment. You only gain a benefit if owning a house allows you to avoid paying a rent to someone else.

greg said...

jmk -

stop tap dancing and provide a few current links that will get you the proverbial 4% on the open market.

JMK said...

Greg,

For the third time, 4% was meant to represent an average over the last 30 years. I clearly said above, twice, that I think it is closer to 3% now. If you disagree with that, fine, but please don't challenge me to prove something I never asserted. Strawman and ad-hominem arguments don't really lead to interesting discussions.

greg said...

Well jmk - since that is the first time you have backed down and mentioned a 3% return, don't try to deflect me from questioning your 4% number, after all, it was you who tried to justify real estate purchases currently by looking at 30 years of previous performance.

It was also you who posited the 4% number, taking the 6% return and subtracting 2% for your "costs".

I'm not really interested in arguing about what happened 30 years ago - my point, which is very clear, is that you can't get 4% in the current market, on a rental basis.

Since you have now pretty much conceded the argument, what was the point of introducing the 4% number into an argument about the current market?

While Caspar may have been talking about past performance, I was clearly talking about current and future performance.

If you concede that the best you can do now is 3% - well, that's not nearly as compelling a financial argument going forward, is it?

JMK said...

Greg,

In my 10:10 AM post I say:

If you want to use today's 230:1, then you get 5.2%.

5.2%-2% = 3.2% net benefit.

I never said the net benefit was 4% now, and I never said anything about whether 3% is compelling going forward.

hhv said...

Thanks for the debate on all sides folks... I've thoroughly enjoyed this today and have counted the minutes I've been away from the comp at home. Anyway, I think there have been great insights from multiple angles today... I for one hadn't thought about the meaning of "rent" in terms of something you own. So I thank you for the lessons you've taught me today... keep it up.

greg said...

jmk -

hmm,

so you didn't mention 6% first, and you didn't ascribe 230:1 to the bears' camp?

In the same post you asked me to provide links to listings for houses under $2000. Somebody else did that promptly, but you never did post anything to support your originally stated 6% number.

If you can't find one such link, why are you arguing when people question the number you are assigning to this assumed benefit going forward?

The whole argument began when it was pointed out to you that your assumed return was out of whack, and based on an unrealistic "rental return" in the local market.

If you are conceding that point, and saying 5% before deductions is more realistic, you are getting closer to pricing the "rental benefit" in your calculation properly, but I think you still could go a bit lower.

But if you are telling me you told me that at 10:10 AM, welcome to the bears camp.

Chaylse said...

Well said.