I admit it. I own real estate – my house, my cabin in the woods for seasonal and often illegal debauchery, and investment property. Assertions I’m a masher when it comes to land just aren’t true. In fact, the prospect of acquiring a unique piece of dirt or an irreplaceable structure stirs my loins. The last property I bought was two weeks ago. If you don’t think there aren’t distressed bargains around, you’re not looking.
But because real estate smites me, I can lose perspective like everyone else. That’s why my last post gave a useful rule of thumb about how much to have – especially when it’s your principal residence and your emotions run riot. A Boomer like me should have no mortgage and little more than a third of net worth in property. A 30-something, on the other hand, should have no more than 60% of net worth in a house, and lots of equity. And nobody – of any age – should buy with 5% down.
Let’s be rational. Last year my house paid me nothing. It probably didn’t appreciate in value, either (after all, who wants a place with underground storage tanks and trip wires?). Meanwhile my liquid assets (bonds, preferreds, REITs, exchange-traded funds) returned almost 15%. So far in 2011 – a year of raging oil, earthquakes, melting nukes, revolting Arabs, defaulting Europeans and collapsing US houses – this portfolio’s up an annualized 9%.
What’s more, the financial stuff is liquid. The real estate isn’t. And this brings me to risk.
It will be a very bad idea going forward to have the bulk of your net worth in a house. Not to own a house. Just to think it’s a financial strategy. It’ll be an even worse idea to use a lot of leverage to buy one. Unlike my financial portfolio, sinking your net worth into one property means zero diversification and exposure to a multitude of risks you simply cannot control. What if the economy slides back into recession? Or rates rise? Or the guy next door buys chickens?
Or, in the case of 51 Melrose Avenue, what happens if you just pay too much?
I mention this place since it was featured in the Globe and Mail yesterday. In mid-town Toronto, it was on the market for seven days, had 100 showings and received 12 offers. Listed for $995,000, it sold for $1,162,000. The front lawn is a parking lot and the back yard is 400 square feet of astro turf. The faux mansion beside it has a new front door four feet from the bedroom window and all you see looking out are parked cars. But it’s got granite! Here it is:
The house last changed hands in 2003 for $651,000, which means it doubled in value in eight years, for a 9% appreciation. The question now: will it double in the next decade? Will there be buyers for this so-so house with tepid curb appeal when it’s $2.2 million? If the new owners say, ‘we don’t care!’ then I hope they’re rich. After all, that $1.1 million invested to garner an 8% return would yield almost $90,000 a year – which makes living here cost $7,500 a month (plus property tax of $6,100, plus insurance, maintenance and Krazy Glue for the lawn).
Fact is, with each price acceleration – even in demand areas like Lawrence Park off Yonge Street or Kitsilano in Vancouver – real estate just gets more dangerous. Fraught with far more risk than a 100% liquid stable of financial assets. For example, as of today we suddenly have higher mortgage rates.
The big banks announced yesterday they’re goosing fixed-rate home loans by up to a third of a point, taking the benchmark five-year mortgage to 5.69%. This has happened as stock markets continue to spike, attracting investment capital (the S&P 500 has gained 97% since March of 2009) away from the bond market. That results in falling bond prices as demand wanes, jacking up yields – and resulting in higher borrowing costs for the banks.
Did you see that coming? (BTW, China raised rates for a fourth time overnight.)
This is the kind of risk which can clobber someone who’s blown the wad on a house. As this wretched blog tries to show on a regular basis, the greatest mistake anyone can make when it comes to investing is to shun diversification. In real estate-crazed places like Leaside or Arbutus, it’s a lesson easily forgotten. But not for long.
Often people post here that they consider their homes to be, well, homes. Not investments. So they couldn’t care less if they lose value. But they lie. Today Canadians, on average, have half of all their net worth in one house. In cities like Toronto, Calgary or Winnipeg, it’s likely closer to 70%. In Vancouver, I’d estimate it’s 90%. Never have we gambled so much on a single asset, and seldom have the odds of losing been higher.
So, have real estate if you want. I do.
But if that’s all you own, it’s time to bail.