February 19, 2021 | Feelings

It doesn’t take long reading comments here to understand we’re obsessed with real estate. Yes, even when the whole raison d’être of this pathetic blog is balance. These days that’s a quaint, dusty notion. Everybody wants all-in on something. It could be GameStop. Or crypto. But usually, for the bulk of Canadians, it’s a house.

The virus made this a compelling strategy. But the pandemic will end. This year. So it’s worth understanding why our emotions have been so hoodwinked by the idea of owning property. Like with Alex. We’ll do him in a few minutes.

First, why do we think as we do about the infallibility of houses? After all, financial assets (like equities) have a vastly better long-term performance. And they’re liquid. Cash flow. You can sell in a keystoke with no realtors, open houses or deplorables poking through your bathroom. No property tax. No condo fees, insurance, utilities, gutters to clean or furnaces to fix. No land transfer tax when buying. No giant commission to sell. Yes, you can live there. But renting is a way better deal. So why are we smitten?

Well, Covid has made people want space. Cheap mortgages have reduced the cost of debt. WFH has fostered nesting. Got it. But these (as stated) are temporary things. People walking into seven-figure mortgages – all too common – and heaping their net worth into a house should be careful. The future might yield some surprises.

Anyway, here’s why real estate makes us lose our minds and 70% of Millennials crave some.

First, the media – mainstream and social – is all over this. Houses are stable, safe and profitable. Stocks (and financial stuff) are risky, volatile and dangerous. When real estate goes up fast it’s a good-news story. When stocks hit a new record high, it’s the prelude to a crash. The bias is palpable. Look at TV’s love affair with flippers.

Second, your parents. They’re hopeless. And, sadly, this is where a ton of people garner all their financial advice – from moms & dads who grew up in a period of insane inflation and economic expansion and blindly rode a one-trick pony into retirement. Buy a house, they always say. Worked for us. And so money illiteracy is passed on.

Third, the costs of housing are always suppressed by the industry while the benefits are exaggerated. No surprise there. Canada has hundreds of thousands of realtors now, all surviving on commission. They’re paid to sell assets, not be your pal. They’ll seldom tell you that throwing all you’ve got into a house means no diversification, and therefore enhanced risk. The costs of ownership, or closing fees, are almost never discussed when buying. Nor will the typical realtor remind you that 1.5% mortgages are doomed or that cities decimated by the virus will be jacking taxes (property, and transfer) or creating new ones (vacancy).

Of course, you can live in real estate. It generally increases in value over time. There’s a big tax break if you sell for a profit, but no ability to write off the significant costs of ownership. Renting is still a huge winner in terms of cash flow, confirmed by the fact that more than 50% of landlords subsidize tenants and are in negative cash flow. Meanwhile governments have become way more renter-friendly, as evidenced by no-eviction rules during the pandemic, rent controls and regulatory bodies tilted against owners.

In short, there are reasons to buy. Reasons not to buy. Renters aren’t losers. Owners take more risk and don’t always win. And in retirement everybody needs steady cash flow far more than they need to own a roof. You can always rent accommodation. You cannot rent an income. Because real estate – at today’s nosebleed levels, especially – involves taking on a whack of debt, job loss, sickness or other reversals can be life-altering events when there’s a mortgage in the balance. Finally, don’t think our virus-addled world will stay this way, in which FOMO is pandemic-induced. Houses can get illiquid. You sure don’t want that happening in the year you need to cash in to finance a layoff or quit your job.

But, nobody cares. Everybody wants a house now. The more they cost, the bigger the want. Alex, too.

He’s 39, single, a government worker, DB pension with an income of $100,000 and four hundred saved in liquid assets. So far, so good. “I’m very frugal,” he says. That allows him to save three thousand a month, since the rent on his current apartment is pretty cheap – $1,500 a month.

Of course he’s hot for a condo. In Delta (a relatively distant Van suburb) for $500,000. The plan is to use $100,000 from his investments and take on a $400,000 loan, keeping a liquid portfolio. “So with a mortgage my monthly payments would be $1,600 plus $400 strata. Of course can’t forget insurance and couple other bills of, I guess, $500. I would be paying about $1k more than my current rent and I’d still be contributing $2k a month to my portfolio.”

Why? “Benefits to buying would be twice as much space and closer to work. It would also get my parents and friends off my back. Feel free to unleash the blog dogs at me.”

If Alex were my kid, I’d mention the following.

He now has $400,000 in assets and zero debt. His rent is so affordable that he’s saving over 30% of gross pay while building a defined benefit pension. The guy is on his way to having at least $2 million (at an annual 6% return) by age 55. That means he can retire early with an annual DB payment of at least $50,000, plus the ability to pull another $120,000 from his portfolio, while renting a villa in Tuscany. Risks include potential market corrections and dying early from bliss.

If he buys, the mortgage payment, strata fees, property taxes and insurance, plus the lost opportunity cost of investing $100,000 will be $2,800 a month. Over five years that’s a premium-to-rent of more than $80,000. Add in the commission when selling ($25,000) and the condo needs to appreciate substantially for him to break even. Risks include rising mortgage rates and falling condo values, potential lack of liquidity and mobility, special assessments on the condo and maybe getting married and being talked into a $2 million house and hideously costly children.

But real estate is about feelings. Bah.

Garth Turner February 19th, 2021

Posted In: The Greater Fool

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