Greater Fool - Authored by Garth Turner - The Troubled Future of Real Estate Book and Weblog - Authored by Garth Turner Fri, 21 Nov 2014 23:36:12 +0000 en-US hourly 1 Trust Fri, 21 Nov 2014 23:36:12 +0000 SONY DSC

Kelly says she’d like to talk with her friends about this stuff, “but they’ve all been suckered into Vancouver area condos and ‘high interest savings accounts’, so that’s obviously no help.”

It’s a common complaint. Where do you go to get some indie thought about investing? After all, the bank’s in the business of selling you stuff. So are the mutual fund sharks. And the credit union. Don’t even think about an insurance or real estate guy. And your parents just want you to be little copies of them, with a mortgage. No wonder so many young people end up being schizophrenics, bouncing between dead-end savings accounts and high-risk, leveraged condo units. Both are really bad choices.

“I kind of feel like an idiot wasting all these years, but I’m an 80’s kid that has actually squirreled away money by renting and not trying to live like a rock star,” says Kelly. “I have a decent job (~60k/yr), no debt and 50k in the bank excluding RRSPs, but I’ve been completely ignorant to investments. I’ve read your posts a few times but I can’t shake this lost in the woods feeling of ETF’s, and I’d rather do it right than get in over my head. What would you suggest for someone like me, that isn’t comfortable going full speed ahead with ETF?”

Kelly says she’s mostly worried about doing this herself. “I know that in starting out I’ll need help, and it will cost a percentage for managing a portfolio, but how do you go about finding someone that is competent in this?”

Well, first let’s discuss timing. Not a day goes by without newbies asking me if this is a good time to invest. Because we all now live on Internet time, when a full day is considered long-term and your Twitter feed never stops, people bounce around from headline to headline. This blog is a perfect example. It’s full of weirdos who ardently believe what just happened (Obama’s speech, ISIS, Ebola, bank layoffs, MH-17, mid-term elections, Fukushima) will alter the entire future. They’re wrong. They bury money, fear risk, buy gold, market-time – and lose.

Kelly’s young. The time horizon is long. And the world will continue to grow while she moves through her life. The doomers almost always end up being incorrect, as the last six years have so richly proven. It happened again this past week.

When growth slows more than people like, they kick it. Since 2008 the large central banks have been quietly coordinating monetary policy, to stave off deflation, support expansion and jobs. On Friday China chewed up interest rates, for example, chopping deposit and lending rates. In Europe the central bank boss, Mario Draghi, was crystal about what he’s got in mind: “We will do what we must to raise inflation and inflation expectations as fast as possible, as our price-stability mandate requires.”

And what does that mean? Cheap money, yes. Plus, central banks buying up assets to create demand and, ultimately, inflation. It’s what the US Fed did for the past four years, before ending its stimulus program in October. The results in America: unemployment went from 10.2% to 5.8%, corporate profits flowered, real estate prices recovered by half and the stock market increased 160%. I have no doubt Europe will be another Cinderella and China will plump, while the US advances its recovery. In other words, all the people waiting on the sidelines since 2008 – waiting for another 2008 – are fools. It ain’t coming.

But there are always risks. Monetary engineering brings volatility, as does the growing mountain of global debt. People overreact. They buy stuff that goes up and run screaming when it falls. This is why you need balance and diversity in any portfolio. The balance is between growth assets (based on stock markets) and safe stuff (called ‘fixed income’). The diversification comes from various assets (like real estate investment trusts, preferred shares, bonds and equity ETFs) and also geography (Canada, the US, international, emerging markets).

Normally, for example, stocks and bonds move in the opposite direction. When the Dow swoons, money flows into the safety of bonds, pushing their prices up while stock values decline. If you own both, you have a built-in hedge, and need not sweat over timing. Finally, all portfolios should be liquid, giving you the flexibility to avoid serious risk if necessary, or jump on a serious opportunity. Five-year GICs are not liquid. Soon neither will be condos.

With fifty grand, Kelly should not be paying an advisor, not giving the bank fat mutual fund fees. She should not be trying to time investments that will stay in place for years, if not decades. And the first place she should invest is inside her TFSA, where all gains will remain free of tax.

The process is simple. Open an online brokerage account. Establish a TFSA and a non-registered (or ‘cash’) account. Transfer your funds. Do what I recommended in a post several weeks ago:

“So divide the TFSA money into five piles, putting equal amounts into ETFs (exchange-traded funds) that mirror (a) the S&P 500, (b) the TSX 60, (c) a basket of preferred shares, (d) real estate investment trusts and (e) a Canadian bond index. You can use iShares products, or Vanguard, BMO exchange-traded funds or others. But these five will give you safe (preferreds and bonds) as well as growth (equities and commercial real estate).”

For example, using iShares, you’d buy XIU (Canadian stocks), XSP (US stocks), XPF (preferreds), XRE (real estate trusts) and XSB (short bonds). As your funds grow, you can add lesser weightings in XEM (emerging markets) or XCS (small-cap Canadian companies). When you get to $150,000 or so, it makes sense to pay someone 1% to manage this growing nestegg, rebalancing it, giving you tax avoidance advice and gaining further diversification.

Of course, this is but an example. There are lots of other exchange-traded funds around, and they’re getting cheaper (even though costs are already a small fraction of what a mutual fund charges). There are also advisors who’ll take on a smaller portfolio, but the fees can be brutal. Besides, you don’t need one.

If you get the right asset allocation and – above all – stop reading damn financial blogs, you’ll soar.

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The temptress Thu, 20 Nov 2014 22:25:58 +0000 BILLS modified

Andrew took his babe to the bank. Like most 24-year-olds, she doesn’t know how to invest. TFSA in cash. High-fee mutual funds. And way too much in GICs. “We went,” he says, “to set up an on-line trading account to give the girly access to low cost index funds and ETFs.”

Perfect. That’s progress. But then TNL@TB turned into a temptress. And war emerged.

“As we were finishing up, I excused myself to take a phone call.  When I came back, no more than ten minutes later, a ‘mortgage specialist’ had joined us.  My GF had disclosed that we currently rent (she left out the part about our all-in housing cost totaling 10% of our gross income).  In the span of ten minutes, the TNL@TB tag team had convinced my GF that buying was not only affordable but was the only logical decision for us to make now that we lived together (throwing money away, building equity, low rates, etc.).  I practically had to fireman carry her out of there but escaped without $400,000 of debt in tow.  Longest ride home of my life.

“I do not believe that Canadian mortgage lenders practice the kind of predatory techniques that we saw in the US leading up to their housing crash.  However, I now realize that the banks have two scripts for TNL@TB.  I was of no interest to them but the reps we dealt with could spot a financial noob from a mile away and seemed to know that they don’t have to convince me of anything. They only need to convince an eager spouse and hormonal housing lust will do the rest.  I am astounded that after two full years of pushing my high liquidity, long-term focused, debt-free,lifestyle on the GF, it took less time than it takes to make a cup of tea to upset the apple cart.  This will be an uphill battle.

“Please keep the blog posts coming.  Our blog dog legion is growing but I will need all the ammo I can get to fight off the all-out assault from TNL@TB.”

Canadian banks have long called mortgages, ‘relationship’ products. Once they’ve you signed up for a home loan, chances swell they’ll get your savings, TFSA and retirement account, plus sell you insurance and flog a mess of mutual funds. Besides, bankers make a spread on every mortgage – and with the amount people borrow these days, they’ll be collecting for decades. Of course, because all mortgages open after five years in Canada, TNL@TB also knows even if interest rates spike in the future, constant renewals mean the bank’s always protected.

And here’s the corker: bankers can fork over a huge amount, at a stupid cheap rate, even if you’re financially hopeless and have saved nothing, because there’s no risk. Thanks to the feds, and CMHC, all high-ratio, high-risk mortgages are backed by the taxpayers. If the kid defaults, the bank still gets paid.

Think about it. Minimal down payments. Borrow from your RRSP. Or Mom. Cheap rates. No risk premium. Federal, provincial and local tax incentives for virgins. And bankers with nothing to lose. No wonder real estate’s become the opiate of the indebted masses, bloating in price. No wonder the people in the bank branch are rabid, aggressive and seductive.

So now we have horny Millennials, average new mortgage borrowing of $10 billion a month, historic heaps of household debt and detached houses costing $1 million apiece in two major cities. Should anyone be surprised what the money-lenders and governments wanted has come to pass?

And yet, CMHC is. Incredible. This week the agency published its annual report, saying it’s now worried houses in Canada cost more than in the States. “This Canadian ‘premium’ could be a cause for concern, because it may indicate that house prices in Canada are overvalued.”

You think?

The feds will be analyzing this, to understand if the giant extra amount it costs Canadians to secure accommodation (Chicago median price for all homes: $188,200; Toronto average price, all properties: $599,658) is temporary, structural or “reflective of relative overvaluation in Canada.” Yes, I know. Like Beyoncé or cold fusion, this is difficult to believe. After all, by taking away the risk that would make bankers think twice about giving $400,000 to a 24-year-old who believes a TFSA is a savings account, CHMC itself is largely to blame. They need to analyze it?

Well, the good news is the agency may be worried, but says there’s no bubble.

So relax. They got this.

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The rich Wed, 19 Nov 2014 22:04:33 +0000 RICH3 modified

If you want to be in the top 1% of income-earners so Millennials can hate you and your divorce turns into hell on wheels, then make $217,000 a year. About two hundred and thirty thousand people qualify. So, 99% of Canadians don’t cut it.

How can this be when a majority of houses in Vancouver and 416 are now worth a million bucks? Hasn’t the real estate boom made all these people rich, too?

Well, there’s a difference between high-income and high-net worth. There are 320,000 people of wealth, defined as families with $1 million investible assets, excluding their principle residence. Houses are not counted because most of them are leveraged, they’re not really liquid, and they act as personal possessions, not investments. At least that’s the way financial guys think, which makes them different from realtors.

As you know, the gap between the rich and the rest is growing faster than yeast. The Occupy kids were exactly right when they flooded onto Wall Street. The middle classes are being hollowed out and the generation of genius kids now being farmed in the basement could be the first one in modern history to be less financially secure than their parents.

They’re pissed, as you might expect. And blame everything. Especially the 1%.

But this could be seriously misplaced anger. At least part of the reason rich people are getting moreso and the middle’s in trouble is where money is deployed. For starters, men (who are as a group wealthier) invest more, while women save more. Given the fact that interest rates have collapsed since 2008, savers have been creamed. The return on bank accounts, GICs, bonds and most fixed-income assets is pitiful. After inflation and taxes, these investors have seen negative numbers.

Also since 2008, the world’s been in an asset bubble. The collapse in interest rates has diverted a torrent of money into things which grow in value and throw off capital gains. Central banks have played their part by flooding economies with cash, trying to stimulate growth and job-creation, which has added to corporate profits, then reflected in healthy stock markets.

Of course, cheap money and an ocean of easy credit have done the same for properties. Canada’s real estate market is a prime example of what happens when you let people without savings buy houses with 3% financing. They pig out. Prices go up. They pig some more. Bigger prices.

But the difference between a guy with a seven-figure portfolio of financial assets and the person owning million-dollar beater house in East Van is debt. Almost always the house is leveraged, while the portfolio is not. Moreover, the returns on a balanced portfolio for the past six years have far eclipsed those enjoyed by a real estate investor, even in Van, 416 or Cowtown.

But there’s more. A US economics professor, in studying the same phenom there, has come to this conclusion: while middle-class people have 63% of their wealth tied up in a single asset (the house), wealthy people have 75% of theirs sunk into investment assets. So, the wealthy have harnessed diversification to actually increase returns and lower risk, while the workies have rolled the dice, gambling that a one-asset strategy will yield financial security. In doing so, they’ve amplified risk.

American families bet on a real estate boom, fuelled by easy credit and rising prices, then lost horribly. After the property market crash of 2007-9, middle-class Americans sold assets in order to pay off debt. The rich were buying. And the gap between them turned into the Grand Canyon.

Professor Ed Wolff also found the wealthy earned double the return on their stock and bond investments as the plebes did on their houses and savings accounts. “The differences reflect the greater share of high-yield investment assets like stocks in the portfolios of the rich and the greater share of housing in the portfolio of the middle class,” he says. “Middle class Americans’ reliance on home values, which still make up two?thirds of their total wealth, and their high levels of mortgage debt have been the main cause of increasing wealth inequality since 2007.”

Will the same experience be repeated here? Of course. Already is.

Real estate values have peaked while the cost of debt can’t go much lower. The easy money’s been made in this asset bubble, as new buyers will discover, unhappily. And, unlike dividend-producing stocks, houses earn nothing and yet have substantial ownership costs. If there’s no yearly capital appreciation, they drain net worth instead of building it. And just wait until mortgage rates normalize.

So, that’s one reason we have rich people. They invest more than they save. They diversify. They’re unhouse-horny. They buy stuff that pays them to own it. They take less risk. They shun debt. And they know it’s not just how much you earn, but what you do with it.

Finally, I know all you metrosexual urban latte-sippers don’t care about a provincial backwater like Saint John, New Brunswick, but add it to the list of places where the housing market is toast. Almost 10% of all homes currently listed for sale are foreclosures.

Says a prominent local realtor: “The last time I saw foreclosures in the numbers I’m seeing was in 1980. That’s when interest rates were at 18 and 21%.”

Imagine what might be coming.

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Parents Tue, 18 Nov 2014 23:11:04 +0000 PARENTS modified

Mortgage brokers made the news yesterday talking about the Bank of Mom (and Dad). More on that in a moment.

The big report that CAAMP turned out also gave us some scary insights into the housing market, which continues to stir loins. Here’s what we know.

So far this year 425,000 properties have sold, and the average price was just over $400,000. (The typical Canadian property is now $419,699, and the median US home price is $209,700.) The aggregate value of these houses was $173 billion.

Where did this giant pile of money come from?

Well, all but 50,000 of those families took out a mortgage, but half of them signed up for a HELOC instead – which is roughly the same thing. In other words, 94% of the buyers arranged financing and just 6% bought with cash. That suggests almost all of the buyers were new to the market, or moving up to more grandiose digs.

How much did they borrow?

The best estimate seems to be $113 billion, which works out to an average of $282,000. That seems reasonable until you layer on this fact: 49% of all of the buyers (or 210,000) so far this year were virgins, who certainly would not have had an average down payment of $120,000.

Of course, some of the move-up buyers carried old mortgages they needed to discharge and replace with new ones, so the brokers figures we added about $90 billion in net new mortgage debt during the time of the study. That’s an average of $10 billion a month – in fresh borrowing.

This is happening as mortgage rates are at record lows, as you know, and when house prices have crested. There\s no doubt whatsoever that when all of these people come to renew their mortgages in two or three or five years, they’ll be paying more. And, as a result, their houses will probably be worth less. It’s hard to fathom the additional risk Canadians are accepting every week, as they gorge on cheap money.

But there’s more to worry about. The wrinklies, say the brokers, are now massively subsidizing their over-educated, under-employed offspring, luring them out of the basement with fat cheques.

The brokers say Mom & Dad are handing off an average of $10,000. In fact, when it comes to down payments, we’re told that half the money is saved and the rest comes from the parents, from another loan or borrowed from an RRSP. So, yes, we’re clearly in an age when most people think nothing of buying real estate with gobs of leverage, since they fully expect prices to go up forever. God help them.

And how about the thinly-veiled message from the mortgage dudes that parents actually have an obligation to get their kids into condos and fat mortgages? Says the association head, Jim Murphy: “I think there are a generation out there of retired people or people getting close to retirement who have a lot of wealth and there will be a transfer of wealth and that is including assistance on their home.”

Transfer of wealth? But all the surveys we’ve seen show that a majority of the Boomers have accumulated jjust a fraction of what will be needed to keep buying thirsty underwear for the next three decades. Fully half say they’ll need to sell their own houses and downsize or rent in order to free up retirement cash. Seventy per cent do not have corporate pensions, after all, and for a lot of Boomers they won’t even see any OAS until they hit 67 – the age when stuff starts falling off you.

So is this largesse just an extension of the helicoptering times we’re now in, or is it a bribe to get the 26-year-olds out of the furnace room? Beats me. (My offspring have cold noses, waggy tails and 10-inch-long hair growing from their butts.)

The other big issue, of course, is what all these gifted down payments may be doing to the real estate market. As you know, the feds killed off long amortization and raised mortgage qualifications in the specific hope of keeping people without money from buying houses they couldn’t really afford. The theory was that would cool sales and ultimately reduce the pressure on prices, once the moist virgins realized that without a wad of savings they simply wouldn’t be able to borrow.

Well, kiss that one goodbye. The kids are loose.

What an interesting life lesson this will be.

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I feel bad Mon, 17 Nov 2014 23:01:28 +0000 BIKER modified

“Canadian homes up 7% at $420,000 from just last month according to CREA press release,” the snippy little blog poster wrote. “How does make you feel Garth T?”

Well, whaddya think? I feel bad. I expected a better quality of criticism. For example, CREA this week announced the average house price increased 0.2%, or $10,900, in October from September, which was lower than the previous month. The year/year gain is in fact 7%, while the Frankenumber increase is 5.5%.

In comparison, inflation is 2.03% and the TSX is ahead 13.57% since this day a year ago. The Dow has added 13.1% and the S&P has swollen 15.86%. So, you can clearly see what low rates and lots of liquidity are doing to asset prices. The big difference is people usually buy stocks (or bonds, or EFTs, or preferreds, or REITs) with available funds. They buy houses with massive gobs of leverage.

I also feel bad for all of the people who think a CREA number is somehow different from the suspect stats thrown out monthly by real estate boards with a penchant for secretly altering sales and price figures. In fact all CREA does is aggregate data from the boards. You know what programmers say. Garbage in, garbage out.

I feel bad for those who think an increase in the average house price means all houses just got more valuable. It ain’t so. As house prices in some markets creep higher, stats are skewed upwards, especially as sales in other, cheaper markets dwindle. The average price comes to be a meaningless barometer of market health.

Never has this been more evident than now. The Canadian housing bubble is a three-city story (soon to be two, if $75 oil hangs around). Higher values in Toronto, Calgary and Vancouver have totally masked what is happening in a majority of cities across the country. For example, sales are falling in Montreal and Halifax while prices are lower in Regina and Ottawa. Detached home sales last month tanked 12% in Edmonton while in tony Oakville the number of deals fell 2.5% while listings rose more than 8%.

I feel bad for those victims of recency, who believe what just happened sets a pattern for what’s to come. While real estate has performed since 2009 (less than financial markets, of course, but still strongly) this isn’t sustainable. Prices cannot increase on the back of swelling debt alone. Without rising incomes and strong economic growth, this will inevitably end in a painful correction.

So I feel bad for those who have been lured in by the no-money-down brokers, the voracious bankers and the unethical condo floggers whose voodoo math promises stellar returns. The over-leveraged will learn it’s just not possible to buy an apartment with $6,500 in cash and then expect 19% annual performance. But right now, nobody’s listening.

I feel bad for the kids getting Hoovered into this stuff, and the wrinklies who will surely watch much of their equity circle the drain. A modest 15% house price correction will thrust a lot of virgins underwater, and turn Boomer houses illiquid. A one-asset strategy is drenched with risk in a world where monetary rules have been turned on their head.

Some argue that financial assets are equally swollen, with the returns pumped up with central bank stimulus and engineered low rates. They’re right. The Canadian economy is a beater right now, and yet the TSX has gained over 11% since January, trouncing real estate, despite a dive in the price of oil. Without a doubt, oceans of money have been flowing into assets looking for decent returns now that safe stuff – like government bonds – pay next to nothing.

The difference between financial assets and real assets, though, is stark. As noted, people buy ETFs with cash. They buy houses with credit. You can exit a falling fund in one second. It can take months, or years, to be rid of a falling property. And in comparison with the huge entry and exit costs for real estate, liquid assets trade virtually free.

So I feel bad for people who don’t get diversification. Sure, you need a place to live. Real estate is fine. I own some. You also need income your whole life, including the decades after your job ends. All of these assets will rise and fall during your lifetime, often enough to alarm. If you have all of your assets in one basket – whether that’s a bungalow or a bond portfolio – the ride will be that much scarier. You can’t control the markets. If they tank just when you need to sell, then risk on.

Too many people come to this pathetic blog to pick a fight because they think I’m anti-house, or to gloat when the realtors have news. What a waste. Every month real estate prices rise is one more month of reprieve for the dearly indebted, yet one month nearer to a greater event.

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The urge Sun, 16 Nov 2014 23:07:53 +0000 FALL modified

“We’re pregnant,” Jim said. I tried to imagine that, and failed.

Just one of those annoying verbal bridges, of course. Margie’s got the bump. Jim’s got the panic. First came the minivan. Then the life insurance. Now the house. Poor Jimmy’s so flummoxed he’s making every mistake in the book. He thinks these are responsible actions when, in effect, he’s creating a more complex, complicated and costly life for his family.

Alas, hormones. They beat the crap out of logic ten times out of ten.

They made an offer on a geriatric bung listed just south of eight hundred. It’s as attractive as a 1978 Oldsmobile, but Jim’s in a panic to buy (the baby’s coming next summer), and convinced this is far cheaper than forking over three grand to rent a similar place.

I did the math. With 20% down (to escape the CMHC premium), including the lost gains from taking almost $200,000 out of their investment account, the monthly cost of ownership is almost $4,900. The premium over renting is north of 60%, plus they’ll have almost $650,000 in debt.

To own rather than rent, that’s $22,800 a year in additional cash flow, or $114,000 over five years – none of it deductible. After sixty months (at 3% variable) they’d add $90,000 to their equity through monthly payments – and still be $24,000 worse off, even with cheap financing. Meanwhile they’re assuming rate risk (variable-rate mortgages will not be 3% in five years), property risk (a 40-year-old house needs serious help) and market risk (real estate is ripe for correction). In other words, this is a losing proposition. Jim’s family will be less wealthy and more indebted – unless house prices continue to climb.

But that’s just one issue. The property he’s after was listed days ago by an unethical agent desperate for an auction. So he priced it low, and bids are being withheld until a week from now. In Jim’s advanced hormonal state he slapped in an offer below the listing price after the agent told him that would likely deter others from following suit. However the opposite’s true. Knowing there’s already paper on the table, other suitors will assume they have to match or exceed the listing price. And Jimmy loses. Which will be the best outcome. But he might rupture.

Well, Jim and Margie’s nesting urge comes at a tough time. Housing in Toronto and Vancouver has reached a point of post-hormonal absurdity. We’ll look back on these days the way we now do the dot-com era, when numby investors paid massive premiums to buy stock in companies without profits – because everyone else was. We know how that turned out.

The latest example is a former beater house in Toronto’s west end that was featured on this pathetic blog a year ago. When 145 Galley Ave was listed it was the hovel of a poor, elderly woman who lived in squalor and disintegration on a street where hipsters now cycle by. No furnace. Missing windows. Leaky roof. Toxic walls from kerosene soot.


Toronto Star photo

The $650,000 asking price turned into a bidding war, and it sold to a flipper for $803,000. He invested $400,000, and it’s now on the market again, 10 months later, for $1.5 million. Most people would call this an excessive, perhaps obscene, gentrification of shelter. But not James McKellar, professor of real estate at York University (I’ll bet you didn’t know they had one). Said he to the Toronto Star: “What we’re going through now is a regeneration of the city, which may be affecting affordability, but where the benefits far outstrip the negatives.”

The benefit is emptying the burbs and intensifying the city core, part of the hipster anti-commute, pro-urban meme now being pushed by media and academia. The negative is housing most people cannot afford, the death of mixed neighbourhoods, and the relentless debtification of our entire society. In addition, plumped, flipped houses bring higher valuations for the entire street, and a relentless climb in property taxes.

Add to that, human nature. The expectation that values will continue to rise, regardless of a stumpy economy or the certainty of higher mortgage rates in years ahead, makes people like Jim and Margie able to justify a bad financial decision. Time, they’re sure, will wipe away any mistake and justify an immediate emotional want.

After all, if prices have gone up for the past five years, will they not go up forever?

Youth is so cute.

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Managing risk Fri, 14 Nov 2014 23:22:29 +0000 BEARS1 modified

She’s early thirties, renting and saving. Big saving. “I, along with my partner have saved approx. $200k over a number of years in the hopes of buying a home with a decent downpayment,” she posted yesterday.

Of course, that makes her special, since saving’s so retro. But she says they want to buy a house when the time is right (not yet), “thus our dollars remain fairly liquid so we can be well positioned to take advantage of opportunities when/if they present themselves.”

But here’s the dilemma:

“I’m torn between making solid long term investments in the financial market and continuing to rent for the next 5+ years, or, staying liquid in preparation for housing prices to fall. I sit in limbo and end up losing on both fronts (no real market exposure = no real upside on my savings). Could you provide some insight as to what you might do if you were in my shoes? If you could discuss proper allocation strategies or parameters – even better!”

Good question. One which most financial advisors get wrong. And most young couples.

First, buying real estate without an adequate down payment means extreme leverage, which brings added risk. No, houses do not go up forever. Therefore, buying with 5% down and twenty-times leverage means a lowly 10% correction in the market would wipe out all your savings. You’d owe more than the property’s worth. If you don’t think that’s possible, come back this time next year. We’ll talk.

Then there’s the CMHC premium, which is north of 3% of the mortgaged amount for a minimal down payment. On a $500,000 mortgage, the cost is almost $16,000. Most people add this to their mortgage, so it gets amortized and effectively doubled over time. Your property then needs to appreciate an extra $30,000 just to break even. Bummer.

In short, a big down is good. This woman gets it. But what sense does it make to keep $200,000 in the tangerine guy’s shorts at 1.3%, when the inflation rate is 2.03% and all of the interest is taxable at your marginal rate? And what if house prices in your hood rise by 5% while you’re saving?

Right. Fail. That money is actually shrinking due to inflation and taxes while you sit on it. Even at double or triple the interest rate, you’re falling further behind. And if you lock the cash into a five-year GIC to boost the return to 2.8% at some godforsaken online Lithuanian steelworkers’ benevolent Manitoba credit union, it’s not available to you should a great house deal materialize in 20 months from now.

So, saving isn’t an option. The NL@TB bank is steering you wrong when she shoves you into a “high-interest savings account” or a cashable GIC. And don’t even think about one of those market-linked puppies.

Instead, invest. But in a fully-liquid portfolio with a system of checks and balances incorporated. That comes in the form of a careful balance between stable, income-producing assets, and things meant to grow. It also arises from diversification, avoiding having too many eggs in one basket.

Regular, terminally bored readers will know I favour 40% safe stuff (a mix of government, corporate, high-yield and inflation-indexed bonds, plus preferred shares) and 60% in growth-oriented assets (some REITs, plus ETFs holding large and small companies in the US, Canada and internationally). The best way for most people to achieve all of this is through low-cost, highly-liquid ETFs (exchange-traded funds). For example, a single asset can deliver a massive amount of diversification (the ETF called XSP holds 500 of the largest US corps; XIU gives you the 60 biggest in Canada).

Now, what about risk?

Novice investors hoping to buy a house in two or five years live in fear that the market will crash the day before they make an offer. This is irrational. The biggest market decline since 2011 happened a month ago when the TSX dropped 10% and the S&P shed 9%. It lasted about three weeks and at the height of the chaos the balanced portfolio was lower by 1%. Yes, a whole 1%. Then it recovered.

Why so little damage? Because as the stock component of the portfolio declined, the fixed-income part (bonds, preferreds) rose, as money flowed into safer assets. That’s exactly what a balanced portfolio is intended to achieve. Meanwhile the preferreds kept on paying dividends, the bonds paid interest and the REITs made regular cash distributions. This balanced portfolio, by the way, earned over 11% last year and delivered 7.3% a year on average over the last decade – which included the 2008-9 bust.

And what if interest rates start to rise? Won’t the value of bonds and preferred shares decline? Yes, they will. But we all know interest costs will increase slowly since the economy is weak. And the moves will be telegraphed well in advance.

Finally, remember the gains made by this portfolio are largely in the form of dividends and capital gains, not interest. So the tax payable on the growth is at a rate 50% lower than the pittance delivered by the orange guy. And if you achieve an average of 7-8% while you wait five years for house prices to correct and risk to fall, your downpayment could increase by half.

So, why wouldn’t you do this?

Because you’re scared, I bet. Then get a smart person to help you, to manage it daily, rebalance, avoid risk and shelter some gains within your TFSA or RRSP. You might just find investing beats the pants off mortgaging your future for a slanty, bug-infested hipster semi. Your father will be devastated.

About the photo: Tim writes: “When I saw the picture featuring the 2 “hunters” who killed a bear I had to send you a note.  The picture is offensive and glorifies the pleasure killing of one of nature’s most beautiful animals. Based on your previous postings I thought you had a lot of compassion for dogs and I presumed that extended to other animals – I guess I was wrong.”

My reply: “I agree. The portrayal is barbaric, and I used it is because it embodies the concept of natural revenge for human cruelty. It is about the consequences of thoughtless actions. The hunters are now the hunted.”

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We’re cool Thu, 13 Nov 2014 20:19:02 +0000 ALMOST 1

Ask most people if they’re middle-class and they’ll answer, sure. Rich people say so. Struggling people say it, too. The truth is the middle’s in serious shape and at this rate, in a generation or two – like the polar ice cap, barn owls or cable TV – it could be gone.

Real estate’s certainly to blame, along with financial stupidity. The masses have gambled on a single-asset strategy and taken on unconscionable debt doing so. Meanwhile most Canadians couldn’t tell you what a preferred share is, how a pension works, or even know they can invest inside a TFSA.

Here are the results, based on StatsCan data and filtered by the Broadbent Institute (yeah, I know. Lots of lefties, but the data is straight.).

  • The top 10% of people by net worth (housing plus investments, less debt) have grown their wealth 42% in the last nine years.
  • But the net worth of the bottom 10% of Canadians has shriveled by 150%. They now owe more than they have, by about five grand.
  • The bottom 50% of the population (that’s the middle class, right?) own 6% of the stuff. The top 10% have 47% of it.

Note this has nothing to do with income, and everything to do with assets. So when we layer on the fact 70% of Canadians have houses, and we’ve just come through a real estate boom, it doesn’t mean everyone’s benefitted – since the bump in equity has been equaled by a surge in debt. Besides, houses don’t pay you to own them. No interest like bonds, distributions like REITs or dividends like equities or preferreds. Real estate also costs a ton of money to buy (witness the double land transfer tax in Toronto) and big commission bucks to sell.

Plus, you have serious overhead with a house – property taxes, condo fees, insurance and maintenance. A portfolio has zero, with the possible exception of an advisor’s fee – which is mostly tax-deductible. Of course, you have to live somewhere, and that’s not free. But the wealthy have learned having too much of your net worth in one asset which pays nothing and costs a lot, is dumb. So, most don’t. And this helps account for the massive divide now opening up between them and the mortgaged plebes.

Let’s also remember this disparity has happened over a period when interest rates have been in the ditch. That’s been to the benefit of the indebted and the detriment of the rich. Cash or near-cash investments earn less than the rate of inflation these days, while mortgages abound in the 2% range. This’s encouraged normally intelligent people to borrow to excess, as if there were no consequences. It really means they’re consuming future net worth to buy assets now. Once rates normalize, those asset values will fall, and the jig will be up.

So, if you think this gap between the wealthy and the struggling is unfair, immoral, destructive and obscene, just wait. It’ll get far worse, and likely have political consequences. Since the wheels came off in 2008, the government’s encouraged people to take on big debt and buy real estate – so politicians here wouldn’t have to spend massively as the Yanks did.

It worked. We bought it.

Next year (says Joe Owe) the feds will have a small surplus. And Canadian families will have record debt. In contrast, Washington still has a fat federal deficit, but the American middle class has paid off more mortgage debt than we have outstanding in the whole country. I’m just not sure Canadians – who think they’re so superior to Americans – understand. In fact, I’m sure they don’t.

This leads me to believe 2015 will be one tough mudder of an annum for the Canadian middle class. Mortgages will cost more by next summer, even if the Bank of Canada thinks the economy’s too weak to jack its key rate. The housing market will continue to lose strength, as is now happening in major regional markets like Montreal, Ottawa and Halifax. Cheap oil will extract a big toll in Alberta. And relentless debt accumulation, without steady income growth, means most families will devote most of their income to staying alive, while saving and investing a pittance.

Meanwhile financial assets look poised to grow far faster than house prices, even in the trendy bits of Toronto or Vancouver. The US recovery’s gaining speed, corporate profits are swelling and Europe’s printing. Since the moment when so many people decided to sell their mutual funds (March of 2009) and buy semis, equity markets have gained 160%. Real estate has also advanced, but on the back of extreme leverage. Worse, most people who have seen their houses rise in value have not cashed in the gain. They expect more. But they’ll soon get less. And so the wealth canyon will widen.

Your friends and neighbours will ignore me, of course. They have a single-asset strategy. They trust bricks, not stocks and think they’re cool.  Too bad.

The greatest accomplishment of any society is the building of a healthy, expanding middle class. But when the top 10% own almost half the stuff, and the rest measure wealth in countertops and crown moldings, it ain’t working.

Richer rich and cheaper houses ahead.

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Conduct unbecoming Wed, 12 Nov 2014 22:56:18 +0000 COUCH modified

Last week Malcolm Melville lost his career. Deservedly so, says the body which polices people in the financial advisory business.

For misappropriating client funds and then providing false statements to some clients, the advisor was tossed out of the industry for life. In any capacity. He was also fined $400,000. Plus he must pay costs of $10,000. Presumably none of this precludes a civil action, or criminal charges.

The agency such people live in fear of is called IIROC, the Investment Industry Regulatory Organization of Canada. It has judicial powers. It conducts unannounced audits. It employs squads of nasty lawyers. It forces every financial firm to spend huge on compliance officers and regimens. And its justice is swift and final.

Of course, most Canadians don’t have financial advisors. Or investment portfolios. But they do own houses, often costing the equivalent of a decade’s labour. Most people use leverage to get real estate, assuming debts they cannot escape to buy assets whose price they cannot control. The risk is every bit as high as deciding you want an RRSP full of stocks and ETFs. But what happens if you fall victim to a rogue agent, or an unscrupulous mortgage broker? Can you be assured these guys will end up dangling the same way Mr. Melville did?

Don’t count on it. This is the wild west of investing, where even convicted bad guys get to keep their jobs.

Bryan Howard is an agent in Alberta, who’s worked for a few firms including Re/Max. Over the past few years he, by his own admission, committed mortgage fraud, falsified documents and forged the signatures of his clients. In fact, this is what the Real Estate Commission of Alberta found:

  • Mr. Howard knowingly or recklessly misrepresented the seller’s name on two listing documents.
  • In two listings, Mr. Howard created false real estate transactions and involved a buyer who had no knowledge of the transactions.
  • Mr. Howard forged signatures on real estate trade documents.
  • Mr. Howard created documents where he set out that someone was the seller of a property when in fact this person was not the property’s legal owner.
  • While Mr. Howard was involved in seven properties he was willfully or recklessly blind to circumstances of mortgage fraud.

“I work in real estate in Calgary,” says a colleague who contacted me yesterday, “and when I saw this I knew I had to send it to you. I am absolutely flabbergasted by the penalty that was given to this industry member by our regulator RECA.”

So what did he get for fraud, forgery and deception?

The regulator has assessed a fine of $39,500 plus costs of $15,000. Bryon Howard will also have to take a course, after a three-month suspension, is good to go. That’s it. Back selling properties.

“The commissions he made on these fraudulent transactions are probably more than the fine,” says the fellow agent. “I am shocked that this individual is not receiving a lifetime suspension for these infractions. It begs the question as to what a person has to do to actually receive a lifetime ban. In terms of being a Realtor and unethical and illegal things that could be done in that position this pretty much takes the cake and the guy gets a slap on the wrist.”

Toothless lapdog real estate regulators are not only in Alberta. They litter the Canadian landscape. For example, the Real Estate Council of BC shocked jaded Vancouverites when it basically ignored a blatant example of media manipulation, false advertising and deliberate misrepresentation than ended up making headlines globally.

MAC Marketing cooked a scheme to purposefully dupe the media, having staffers pose as Chinese buyers of a condo project, then feeding them up to voracious TV cameras. The reporters fell for it (of course), and viewers of several networks were bombarded with viz of horny HAM ladies feasting on Van properties.

The punishment: a $1,250 fine and a 12-day suspension for the company manager. The imposters went unpunished as RECBC said they were unlicensed. In fact, regulations in both BC and Ontario don’t require the dude or babe selling you a condo to be licensed at all. Like I said, this is the wild, wild west. You’re on your own.

Well, govern yourself accordingly.

Get a good agent through referrals, and do some due diligence on him or her. Most real estate regulators offer a search function on their sites, telling you if an agent has ever been suspended, convicted, charged or subject to a disciplinary hearing.

Find an experienced real estate lawyer, and run everything past him or her – including offers and conditions, not just signed deals.

Work with a known broker and large real estate organization with a rep to protect and the resources to make you whole if there is fraud, misrepresentation or unprofessional conduct. The same goes for your mortgage lender. And the risk needle flips to extreme when you’re dealing with a FSBO, who’s regulated by nobody.

Or, rent.

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Lest we Tue, 11 Nov 2014 21:09:10 +0000 NOV 11

Just before 11 am Tuesday I stood in my office to gaze at the horizon, as I have done the last few Remembrance Days. From the 53rd floor I can see forever, across an urban forest to the green and blue beyond. Almost at eye level I could also see the fly past of the WW2 trainers, duck yellow. They thundered ungracefully, powerfully by to remind of wars before drones, when men routinely did the extreme.

As I remembered, I gazed down.

Across the street a new office tower rises. That’s it, above. Forty-five stories over the traffic, workers laid down their tools. A few gazed up at the fat, tough little planes. Others removed their hardhats and bowed their heads. One man clasped his hands and stood silent, on the end of a steel beam.

We did not forget.


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