I had a chance to read Garth Turners sobering take on real estate this month. It's called Greater Fool. Exceptional book by a guy who really knows what he's talking about.
I really like the title choice, it's a concept that very few are familiar with.
From Wikipedia;
The greater fool theory (sometimes the bigger fool theory, also called survivor investing) is the belief held by one who makes a questionable investment.
with the assumption that they will be able to sell it later to "a
bigger fool"; in other words, buying something not because you believe
that it is worth the price, but rather because you believe that you
will be able to sell it to someone else for an even better price.
This book should be a must-read for anyone looking to scoop up more housing in Canada.
There is NO OTHER item/investment/vehicle/derivative/business where the
bank will finance upwards of $500,000 for someone in their
twenties, who makes $60K a year, with as little as $10,000 to put down.
They not only do it for houses, but they encourage it, and even worse - they've made it easy!
Real Estate continues to be the only item that a person with a meager
income, can finance a HUGE sum to purchase with as little as 5% (or
nothing) down. It's madness. Could you imagine the outcome if that was
allowed in the financial markets?
Our have-it-all culture has encouraged home ownership for everyone - handing out cheap mortgages to
anyone that asks. (I was one years ago, at 20 years old with no steady income, I was given a $200K mortgage having only $15,000 to put down. And they say there is no 'subprime' lending in Canada? I call bullshit on that one) I bought my last place with 30% down, and would not consider buying
with less than 25% down in today's market. My neighbor just bought his place with
5% down in May, and on paper; he's already about $50K in the red on his
mortgage because of the slight correction we saw last year.
Something to ponder: If a house built in Langley, BC in 2004 for $200K, on a lot worth $100K,
sold for $399K new, and again for $700K in 2008, and back down to $600K
today.... then what is the real
value? The market and it's greedy speculators all say it can go up in
value every couple of months and be treated like an ATM machine. But
unfortunately the real intrinsic value of that place is still only
about $300K; despite the $600K+ mortgage on it being carried by the most recent
buyers. Eventually, the market WILL correct back to these intrinsic values, resulting in a lot of
very upset homeowners, living in homes with mortgages WAY larger than their
homes value. There is an epidemic of this very situation in the US as we speak. Eventually... the demand softens, and the inventories rise. It won't take much fundamental changes to take a greater Vancouver MLS ad from $799K, down to $499K in a flash.
Our 'bust' is coming. It may not be as bad
considering our fundamentals and immigration policies, but it's coming.
The talking heads from the big Real Estate firms use the media to tell us that there is upswing in the markets in Vancouver
from time to time so that you will unquestionably buy; and buy inflated properties, so
that the mortgages are bigger, and the banks interest payment profits are up. Pretty simple
and effective racket for ensuring $10-$20K in interest every year, per
family goes to the big banks.
Bush heavily promoted this for the US banks in 2004
http://en.wikipedia.org/wiki/Ownership_society
http://www.newsweek.com/id/163451
As a matter of fact, the entire financial meltdown can be pinpointed to one (of many) crucial mistakes made by the US Government: "Fractional Reserve Banking"
Fractional Reserve Banking, simply put, is a scam put in place in 1903 that allows large institutional banks to hold their customers money 12:1. This means that for every $100 you deposit into an account, that bank is able to loan out $1,200, backed only by your $100. (Smell trouble already??)
Lets say the bank pays you 5% interest annually on your savings; you'll receive $5 that year on interest. The bank will then loan out their $1,200 (courtesy of you), charge 10% interest on the loan, and receive $120 in interest that same year, on YOUR MONEY. Bank makes $120, you get $5. This is going on today. The banks are the robbers, and they're robbing from the inside - legally.
Anyway - back to mortgages; in June of 1983 Investment Bankers started packaging together tens-of-thousands of bank owned residential mortgages (just like yours), and started selling them to investors as 'Collateralized Debt Obligations' or CDOs. These CDOs were sold all over the world right up until 2007. Then came along the big, blood-thirsty sharks of the industry; massive Insurance conglomerates. AIG stepped in, as well as Fannie Mae and Freddie Mac and they insured these dangerous derivatives with 'Credit Default Swaps'. They cleverly called them 'swaps' and not 'insurance', as insurance has to be BACKED by something. This is precisely is why AIG crashed when the mortgage market crashed.
What happened, is that the demand for these profitable CDOs skyrocketed, so the banks had to scramble to keep up with demand, by issuing.... get this... more mortgages (lol). See the problem yet? What started to happen, is that the banks started handing out mortgages to anyone with a pulse, on HIGHLY leveraged bank funds (remember they hold one twelfth of what they actually loan out) in an effort to feed the greedy investment banks, getting rich on CDOs. They were finding 'victims' to sign up for mortgages on already-inflated suburban housing, in some cases, requiring no down payment at all.
Banks aren't fools, they are professional at making money. So if they are prepared to give you 300, 400, maybe $500,000 with NO downpayment, then they MUST be making money somewhere, right? When you sign up for a 25 year mortgage, you are essentially promising the bank in excess of $10,000 per year, in interest payments for the rest of your working life - pure profit to them. Not too mention the profits they make by selling your mortgage out the back door to to some investment house pushing 'CDOs'.... Ahhh, home ownership, the American dream eh?
Lets also not forget; rates are dirt cheap right now, I'm sure you can handle $2,000 a month @
2-5% on a small house, but wait until rates go back to 6, 7, 10%. Now try
almost $4,000 a month for that same property. What's going to happen to
the market then? It will shift, and there will inevitably be way more supply than
demand, resulting in huge declines in value when no on can sell....
Just think - what's happened to interest rates after EVERY SINGLE other
recession?.... We are in for a rude awakening, my fellow mortgage victims ;)
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The 'intelligent investors' have to foresee what will happen to home values when rates skyrocket like they did in the 80's. Rates going way up is happening, it's just a matter of when.
That chart is adjusted for inflation, what it's pointing out; is that
homes stuck pretty close to that $100K mark (inflation adjusted for
that day's dollars) for over 100 years ....until 9/11. It's saying that
homes climbed over that 'resistance' line if you will, beyond 120,
130...all the way up to 200, so do you think perhaps there may be a
market 'correction' bringing homes back down to that 100 mark? Cutting
our average prices in half? Do we have realtors, banks and greedy sellers to blame for this?
It's pointing out a scary trend with regards to the value of your house
over say; your income. Your Grandfather probably bought a house for around $5,000 in
the 1940's. Any idea what he made per year in the 40's?
$2,000 a year? $3,000 a year? Probably more.
In 2009, a guy in White Rock, who makes only $90,000 a year, can buy a home for $750K. Easily.
Starting to see what the trend that Turner is pointing out?
50-60 years ago, peoples homes were only worth about 2 years of income. Now, they're worth upwards of 10+
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"Your house is not an asset" -Robert Kiyosaki
Real assets put regular cashflow
into your pocket. If you buy a house, and rent it, creating positive
cashflow, it has become an asset. If you live in it, it is a liability.
This is a reality that 99% of the public are unaware of. It generates capital gains only AFTER it has sold; it is far from
liquid, and it is subject to upwards of $20,000 in expenses at close.
(realtor fees, closing costs etc)
Your home can be considered an investment, however most people that
consider this, have 90+% of their net worth in their home. Extremely
dangerous - a recipe for being wiped out.
Buying land should be considered an investment, however your ownership
should be no more than about 25% of your net worth, as it lags far
behind other investment vehicles in the long term. If you rely on real
estate alone, good luck.
Housing often depreciates, it's land that appreciates. Albeit slowly (when considering 20-30 year charts).
Most people in the lower mainland are highly leveraged on their homes.
Meaning the bank owns a FAR greater share than they do. How can you
even say you "own a home" when a financial corporation holds a loan on
it worth 75% of its value? Who has the controlling share? The whole
'ownership' concept is simply an illusion. Don't believe me? Stop
paying your mortgage and your property tax and watch the city and the bank
fight over who keeps your house. You don't own it, you merely occupy it
and pay for it. You can take a profit when you sell, but it was never
actually yours, unless it was mortgage free.
Real estate doesn't typically put any money in your pocket until you
sell. Therefore it can't be considered an asset. Land is an investment,
but not a true asset until actual capital gains are realized. ie; after
you sell.
Never confuse being 'up X amount of dollars' on paper with actual true 'in your jeans' capital gains.
The whole "I bought my place for xxxK and now it's worth xxxK" is not a
true statement, until a deal is closed. Just because your neighbor sold
for a profit, doesn't make your situation any better UNTIL you sell and
realize the actual gains yourself. Property assessments and historical
sales are indicators, but far from guarantees...
I bought a condo in Downtown Calgary in February of 2006 for $169,000 plus tax. The market exploded upwards, so I listed in May of 2007 for $299,000 after seeing a neighbor make a huge profit. I sold within 48 hours for $306,000 after a flurry of offers. Now that was probably a once-in-a-lifetime boom for such a short period. Fortunately I was able to recognize it and get out at the peak. Those same units are listing for $249,000 today. Do you think the guy that paid 306 for mine is upset? Would I have been upset if I watched the value crawl back down $57K?
....So never try to guess what your real estate is worth, as its all pure BS hype and speculation, UNTIL the NEW BUYER signs on the dotted line. Only THEN can you say what a house is ‘worth’ to a new buyer.
Don’t pay today; what will be higher than tomorrow’s market value. Seek to do just the opposite.
I own a few different baskets of stocks with various brokers. One of
which has a current market value of just under $250K. It pays me, just
under $2,000 every single month. It's done this for years - to the tune
of around $23,000 per year in dividend income. That holding of stocks
was worth about $400K back in May of last year, and only about $200K in
may of 2005 when I bought it. I could have said "I made 200 grand on my
stocks in 3 years!!" But I didn't because I didn't make that amount; the stocks were UP on paper 200
grand, just as houses do from time to time, but I never actually sold
to make the profit. Reason being; they are an income producing asset
to me. They make me money, they are an asset (as well as an investment)
therefore it's not in my best interest to sell them right now, being so
young. Especially since I can wait until it hits 400 again, and sell
then.
Assets create income: Businesses you own, employees you have that make
you more than you pay them, stocks and bonds with dividend yields,
rental complexes that pay more in rent than they suck in expense, tow
trucks that generate more cash than they cost to operate... these are
assets.
Assets put money in your pocket, liabilities take money out. Your house
is a liability UNTIL you sell and walk away with capital gains. It
costs you money every month, it doesn't pay you a dime. (and HELOCS
suck your future potential gains out prematurely, therefore are not
wise to use)
When you're figuring out your net worth, don't put your car, bike,
truck and big screen tv in your asset column, as they are liabilities,
since they drain your net worth, not grow it. It's very important that
people realize this at a young age.
To summarize….In the states right now, houses are trading hands for 250 grand, that
were "formally appraised" at 600 grand less than 2 years ago. Never
fall into the “my xxx is worth xxx” It’s all BS until you SEE THE MONAY.
Most guys that say "my place is worth 1.3" aren't selling, because they
know the market will only bear about $800-$900K right now, not the
inflated price they perceive it to be worth currently.
-B
