A rich anthropomorphic dog with a pipe in his mouth once told me “it’s good to own land…. and people”, he was a racist, but the land part always stuck with me. Up until about 3 years ago it was the cornerstone of financial prudence: Buy a house and you’ll never be poor!! It was a fixture in the American Dream ™. “Own land. Own a house. Wear monocles. Mock the pooooooooor.” The dream has lost some of its luster over the last few years with many homebuyers portrayed as either poor naïve idiots who were lured in by the big bad man at the bank with his anti matter NINJA mortgages and his baby blood filled pen, this guy:
"my wallet may or may not be made of face"
Or they were portrayed as lazy entrepreneurs who didn’t want to do real work so they got into the business of flipping homes because real estate never goes down right? The Greater Fool theory is a key piece in any bubble, when asset prices lose all touch with reality and people only buy them knowing that they will be able to sell them to someone else at an even more ridiculous price….sound familiar? Anyways after a monster crash in Real Estate prices in the States (not Canada as this masterful witty article points out), Real Estate is no longer the no brainer it once was. I am here to repair some of damage done to my homeboy RE.
"More like FO real estate eh?" - The Wisecracking Gangster
1. A major problem for equity investors doesn’t apply with Real Estate
I’ve written before about the importance of loooooong term investing and how your portfolio returns can get ripped apart if you get spooked by “IS THIS 1929 AGAIN? NOTABLE ECONOMIST SAYS MARKET PRIMED FOR BUTT EXPANDING CRASH! NO MORE HANDYS FROM HOT CHIXXXX!” type headlines. So you read that, you go running to Questrade, clickity clack a button or two, and boom you are out of the market just in time for the Fed to announce QE Bajillion and melt your face up 4% in a day. Stocks are too liquid for their own good sometimes. With real Estate on the other hand, the biggest safeguard against pulling the trigger to soon is that is bloody hard to get out of your investment.
You can’t exactly go to http://www.sellmyfuckinghouse.com and kablam you’re homeless with some money in your account from a faceless stranger like stocks. No you gotta get a real estate agent (or figure it out yourself), deal with people farting in your abode during open houses, negotiate face to face and play mind games with prospective clients, live and die waiting for offers, move your full size popcorn maker and other assorted garbage out and make sure you find all the panties you flung in the vents from those, 40s, sweatpants and Viagra parties you had. It’s a bitch and the sheer bitchery of it is a huge factor in deciding to sell, which means you are way more likely to hold on to it for a proper amount of time (10+ years) and let it appreciate.
2. People actually look at what they are buying with a house
An offshoot of the factor above is that because it’s so easy to buy stock, people don’t put enough research into it. “Well Jim Cramer threw a squeaky bull toy in the air and did a back flip while bells went off so this shit must be legit” typity type clackity clack, you own a 100 shares of Angela’s Asses. Congratulations. But with a house, man I can’t be so cavalier! I gotta live here for like 20 years! We gotta check out the neighbourhood, figure out where is up and coming, get experts to inspect the foundation and plumbing n stuff, talk it over, fight about it, have makeup real estate fight sex, the process takes MONTHS of due diligence. This is compared to people spending more time deciding which director’s cut of The Dark Night they want to watch first rather than what stocks to buy.
3. Easy and relatively safe leverage
Leverage is another thing that has become a dirty word in the mainstream media. You hear of banks “levering up” 40 to 1, which in laymen’s terms means that for every dollar in the company that belongs to the owners free and clear (equity), there are 40 dollars which are owed to someone else by a certain date (debt). The reason companies do this is as follows: -
- Say Franks Fountain Dr. Pepper Fountains needs 41 dollars of capital to operate.
- If the owners put up the whole 41 dollars and they make a dollar of profit then the owners see a (1 / 41 = 2.4%) return on their investment. Not great, but if they lose money well the owners are pissed, but no one is going to force them into bankruptcy.
- But say instead they borrow 40 of those dollars required for a year and only invest 1 dollar (a.k.a. they are levered 40 to 1) and they still make 1 dollar of profit. Now the owners see a return of (1/1 = 100%) on their investment. A little more gnarly than 2.4%. But if they lose money, they still owe that 40 bucks to the lender at the end of the year and if they can’t pay then they go into bankruptcy and the lender takes all their stuff
GUYNANCE BANKRUPTCY XTRANORMAL INTERLUDE!
- So leverage can increase returns, but also will increase risk proportionally.
Back to real estate, during the shit in 2008, people were levered to infiniti in mortgages. Literally, think about the downpayment on your house as the dollars the investors invested above and your mortgage as the debt. People buying houses with 0 down had NO equity at all invested in their house, you can’t even calculate a leverage ratio for that. Lenders would advertise “0 down low low rate for the first year….what happens after the first year……..a nice warm glass of shut up and sign! That’s what!” and people bought them cause they didn’t care about the long term as they were just planning on selling it anyways. So you buy a house with nothing down and sell it 6 months later for 40 grand higher than you bought it and boom you have an almost infinite return on investment as well. Easy to see why people got so wrapped up in flipping houses eh? But when the market for those houses evaporates as it did, a ton of people are left holding the bag with a mortgage with awful terms (after the sweet teaser rate) and no way to pay them. Cue meltdown.
- “This housing market raps like its parents jerked it” – The Financially Savvy gangster circa 2008.
It did kind of sound like Eric Sermon…. the generic version, you are right fictional 2008 rap man. So reasonable rational people put kinda 10-15% down on their house, enough leverage so that increases in your house value give you a great return, but not so much that the banks get jacked up to do some MOllestin’ toniiiight. Now why is it better to use leverage in an investment like real estate rather than say stocks? Well you can use leverage with stocks (which is called buying them “on margin”), but with stocks they are valued every second, so if your portfolio drops too much the brokerage you bought from gets nervous and says “….scuse me brosef, your portfolio looks like an old alcoholics diaper, you’re gonna need to give us more cash collateral or we’re selling your stocks at a loss and you can GTFO.” It’s called a “margin call” and is one of the major reasons that stock markets drop so dramatically sometimes. Stocks go down, brokers call their clients for more collateral, clients do the thing where they turn their pockets inside out like the monopoly man and make the confused puppy “baroo?” noise, brokers force them to sell their stocks, selling pressure causes stock prices to drop further. With real estate and mortgages, your house is very seldom valued, and margin calls just don’t exist. Imagine your real estate agent rolling up on you in the middle of the night with a 12 gage saying “you need to cough up 20ginos by tomorrow morning or we’re selling two bedrooms essay!” Never happen.
"Forced liquidation only happens from mah dddiiiiiiiiicccck" - The annoyingly fiscally responsible gangster
4. Condo vs. House
Condo’s are cool. You get to be urban and wear deep V neck shirts and go to all the cool downtown coffee stores with no parking and get sweet views from your 45th floor balcony etc etc etc. No one is debating these facts. What is up for debate, and I haven’t made up my mind on this yet, is the fact that when you buy a house you are getting the land that does along with it. No matter how shitty your house is or if it blows up or is infested with panties from previous Boner In Sweatpant Parties, you will always have the land. In a condo…. you own about a square foot of land, and it might be a shitty foot at that. If something goes wrong, there isn’t really a fallback plan or a safe store of value…… but they are cool….. more on this later as I liveblog life changing decisions.
5. What’s the government gon do
Governments love houses and having their citizens live in them. As such, they can either go the “endorsing their institutions to drastically overextend credit to unworthy recipients and keep mortgage rates ridiculously low” route a-la Fanny Mae and Freddie Mac and the US govn’t in the run up to the 2008 crisis (this will be a whooooole nother article at some point), or, more prudently, they can offer various tax incentives to consumers to help them make said house purchases.
In the States, most interest on mortgage payments are tax deductible (meaning they reduce your taxable income and increase your “yessssssssssssssss new piranha tank” refund), however in Canada you have to do some fancy footwork involving asset swapping called The Smith Manoeuvre (not the sex position) in order to get a tax deduction from your interest. Also in the States you can exclude up to US 250K of capital gains (increases in the value of your house) from being taxed when you sell your primary residence as long as you lived there full time for 2 of the past 5 years. Canada you need to have had your house as your primary residence for every year you owned it in order to be exempt from capital gains tax. The one other bone the Canadian government gives you (as opposed to the boners they are often also found delivering) is that it allows you to withdraw up to 25K (50K if you’re shackin up with another baller) from your RRSP tax free for a downpayment. This means you can stuff money into your RRSP tax free (for a Guynance ™ mind devouring knowledge tornado on RRSPs go here), have it grow faster, pull it out (hehe), buy a house, and not have to worry about replacing it in the RRSP for up to 15 years. Great way to grow your down payment savings.
6. Paying rent is making someone else rich, paying a mortgage is making you rich
…….That’s pretty much it….. plus landlords are usually dinks.
Next up: How Canada got it’s ass in gear and got out of debtpocalypse territory in the late 90s.
Till then honkys!
The SRB (a.k.a. The Sergeant of Margin) ….say it out loud it makes sense