Investment Properties and the Baby Boom
A conversation I recently had with a friend about his parents has been insightful for me about another dimension of the real estate market as the population ages.
First a little background. My friend was born in Asia and immigrated to BC 20 years ago. His parents immigrated about 20 years ago and are professionals educated in Asia. When they arrived in Canada their degrees were not recognized and they spent the subsequent years eking out a living for their family. They bought and sold properties at various times and rented in between over the years, depending upon the needs of the family. Once their kids graduated university about 10 years ago they had a mostly paid-off property and an investment property with reasonable equity, both in the Vancouver area. They did not accrue much else in the way of savings.
Fast-forward to today and the parents are approaching retirement in about 5 years or so. The father has finally had his professional degree recognized and is working but not at a high salary. The mother is not working. On the property front, they sold one of their properties a year ago and are living in the other with a small mortgage, about $200K, that they plan to pay off in 5 years one way or another. They just refinanced at about 3.3% 5 year fixed. They now have about $700K cash in the bank and a mostly paid-off house worth about $500K with five years left until they plan to retire.
Now the conundrum for my friend. They are planning on retiring but do not think they have enough saved up to provide enough income to retire. They now need to put their $700K to work for them and are looking at the current investment environment. They have dabbled for brief spates in other investments but for the past 20 years they have saved most of their money through real estate. With this background in mind, they are now looking at what to invest in. Fixed income is returning little and they see other higher yielding investments as “too risky.” That is, they aren’t comfortable doing it.
Readers can probably sense where this is going. They are thinking of investing their entire savings into an investment property. They are currently looking at a local multi-unit property (8 units or so) for about $1MM, which purports to produce about $70K revenue annually. Subtract expenses and they think they can conservatively clear $25K per year on $500K after mortgage re-payments (which are low in the current rate environment). The revenue is expected to increase roughly with inflation as rents are raised over time, which suits their need for fixed income.
I talked to my friend about arguments whether or not this is a bad idea. Taking a step back, the parents are putting their entire nest egg into a single property, which seems bad. The nominal returns, however, look decent in the current environment for something they consider reasonably low risk. Part of the problem he has arguing with his parents is they can’t seem to fathom the risk they’re taking. It’s hard to explain to someone how he’ll be alright 95% of the time but 5% of the time he’ll be cleaned out. It doesn’t register; the risk seems to be entirely “under their control.”
My friend used the Mark Carney “interest rates will likely go up” argument. Their answer is that worst-case they can downsize their existing paid-off property and refinance to keep the cash flow “acceptable” with a downgrade in lifestyle.
The long and short of it is retirees like my friend’s parents are starting to do the math on retirement and the traditional mix of investments just doesn’t seem to offer the income required to fulfil their expected needs in retirement. Important points:
1. They have to resort to riskier ventures to fund retirement than has been the case in years’ past.
2. The way risk is meted out in real estate is often in chunks. Producing an expected value scenario that makes any sense to them is next to impossible: many of the aggregate risks we know exist with real estate seem remote enough to be fully discounted. The so-called “long-tail” risk is set to zero.
3. Many have put so much of their retirement savings only in real estate it’s hard to leave their comfort zone and make the switch to other investments.
4. Retirees have time on their hands to help offset ongoing investment costs in case of problems.
5. Multi-unit properties, while experiencing a boom in values, appear to produce headline returns that don’t look horrible in the current interest rate environment.
We often wonder who is buying in today’s market and chalk it up to speculators and irrational owner-occupiers. I now know one family who are doing this as a cash flow investment, i.e. not relying on the property’s future value and not planning on living in it. We may step back and call this family crazy for investing but, as the chips lie, given their comfort level with various investment types, and given their ability to handle some of the investment’s inherent risk by sacrificing some of their free time in retirement (and for my lucky friend, their children’s time), the alternatives are deemed inferior.
This post was submitted by jesse.
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January 22nd, 2011 at 11:47 am
It is not worth it. In my experience, commercial properties worth less than 1 million are not good investments. That's because they are too small, their profit margins are too small, and they are too risky. If you have one unit empty out of 8, you already have 12.5% vacancy. That's the whole net income gone. If you need to redo the roof, it's going to cost you 2 years worth of net income. If you want to spend time and money on renovations, you can't because it would eat ut the net income. With bigger properties with bigger revenues there's much more room for vacancy, capital expenditures, and room to still make money if things go wrong. But the most important point is this: the ROI is already fixed at, say, 5%? That ROI defines the value of the property, and the ROI rate is depends on the interest rate (they HAVE to be higher than the mortgage loan rate). So if interest rates go up, you are screwed. Not only the value of the property is butchered, but your ROI will be lower than the interest rate. To me, they are just not worth the risk.
January 18th, 2011 at 5:53 pm
To add what others have already said, Yes the 8 apt unit building is a terrible idea. Aside from the 5% ROI, the (obviously) older building maintenance requirements, collecting rents, dealing with dick nobs and maintaining occupancy; there may be one bright (eeh?) point.
The rent to purchase ratio is 14.29 (purchase price/annual rental income), where most of the GVRD is over 20. The US averaged close to 25 when their bubble collapsed, according to Moody's, 16 is the long-run average.
Thoughts?
January 18th, 2011 at 10:10 am
@serferboy:
But how long can they sustain that belief? How much will they put up with in order to live that belief? Will it come down to living on just enough money to put food on the table, shopping at thrift stores for clothing, owning no car… or even worse? This is an important question, because the level of house poverty that the Asian population of greater van will endure will have a huge influence on the extent to which RE prices can rise. If they will take on three jobs, live three to a room, and pay 80% of their incomes on a mortgage, this bubble has a long, long, long ways to climb yet, and Flaherty's new regulations will have virtually no effect. If Asian parents will pour all their savings and HELOCs into houses for their children, regardless of price, and pressure the children into taking on the huge mortgages… prices will go up and up until the very limits of human endurance are reached.
I am sorry, but if I were a cynical and evil realturd or developer or banker I would rub my hands with glee because one segment of the population is essentially willing to put themselves into slavery and work themselves into an early grave for my benefit, all because of an illogical belief. Kind of like a cult… the cult of real estate… everyone else might as well just rent forever. I hereby declare myself an atheist.
January 17th, 2011 at 11:25 am
@Anonymus:
It is actually very relevant and a big part of the topic. That is why it was put it in there. If you don't like the discussion go somewhere else.
January 17th, 2011 at 11:20 am
@space889:
I think you're a bit unclear on the terminology. An immigrant is someone with PR status. As opposed to someone who is in the country temporarily as a student, temp worker, tourist, etc.
A PR has all the rights and obligations that a citizen has (except for voting and some government jobs) and they are entitled to the same social programs, in all respects, as citizens.
January 17th, 2011 at 10:46 am
Nice to see some changes, but it's too little in my opinion.
Should have gone 25 year amortization, 25% down…wait a minute, didn't the world work that way before?
As an Asian, I completely understand the culture and pressure to buy.
- Doesn't matter if it's a 600K bungalow that would generate rent for $50 a month
- Doesn't matter if you spend all your income on the house and eat KD every night
The parents would still think its a good deal. In their mind, they don't even factor in property tax, vacancy or repairs in the investment/rental equation…all that matters is:
- I can tell friends I own a home
- RE never goes down (except when it goes down)
—————————————————-
On another note, seems like people are comparing RE returns to the 1.5% risk free bank deposit rate now. We've become a culture where RE is RISK FREE!! Awesome!
January 17th, 2011 at 10:33 am
I have another question as well?
How would the 85% max refinance rule affect existing homeowners with less that 15% equity in their house?
January 17th, 2011 at 10:29 am
@Boombust:
Flat prices should drive out the speculative demand that has been estimated as 50% of all purchases. Why would you want to be cash flow negative with flat prices?
January 17th, 2011 at 10:14 am
Best place on meth Says:"The topic includes: First a little background. My friend was born in Asia…bla bla"
Are you that dumb. That is not the topic, their background is irrelevant. They could be Marsians. Their education is irrelevant. it is in the past and it can not be changed. What is relevant is should they sink saved 700k into multi-unit building as retirement cash flow.
January 17th, 2011 at 10:10 am
@Lilypad: I don't think immigrants are automatically granted PR status to qualify for students loans. But let's assume they are. Also I'm not saying no one does it. As you say there are those who do and succeed. I have met some of these mature adult students doing undergrad/grad when I was in university.
However, what % of all immigrants are these people? What are their backgrounds and what risks they take? A lot of the skilled immigrants are not stupid or lazy or got where they were in their home countries if they are the type who like to use excuses to avoid doing something. The simple fact is that when you have 1 or 2 kids to support, monthly rent and bills to pay, and food to put on the table, it is very risky to say hey I need a recognized degree in Canada so I'm going to borrow a ton of money to go to school for 5 years and pay most of my family's living expenses from the loans in the meantime. Sure there are those who do it but the risk is very high and the payoff is generally not worth it. If you are already close to 40 with 2 kids, adding $100K+ in student loans which has pretty high interest rate before you even start steady job is just not the way to go, especally if you don't even have a good prospect of making $20K+ extra/year compared to not going to school.
You may say that's all excuses but I suspect it's something you never had to deal with.
As well, a lot skill immigrants finished school a long time ago (10 or more years), so getting university here to recognize that is also hard. My wife is going through that right now. Some of her friends did take student loans and went to school after they came here in 2000 but what they find is that even with the degree it's hard to find a job, they have to compete for entry level jobs with 20 year olds, there aren't that good career prospects and wage increase, and the debt they incur is also huge and crushing.
For the 20 or early 30 young people with no kids, things might be easier and they can still go for it. But for those with family, borrowing money to go to school for 4 or 5 years with no income during that time is just way to risky, especially if they actually are planning to be honest and pay back the student loans.
January 17th, 2011 at 9:57 am
@Anonymus:
The topic includes:
"First a little background. My friend was born in Asia and immigrated to BC 20 years ago. His parents immigrated about 20 years ago and are professionals educated in Asia. When they arrived in Canada their degrees were not recognized and they spent the subsequent years eking out a living for their family."
January 17th, 2011 at 9:50 am
Patiently Waiting Says: "Check the topic of this thread."
Yes I have read the topic. Topic is about soundness of investing $700.000 in multi-unit building for retirement cash flow.
And now you go and re-read what you are writing about. duh.
January 17th, 2011 at 9:45 am
New Listings 292
Price Changes 62
Sold Listings 119
10294
January 17th, 2011 at 9:42 am
@taylor192: I agree in principle with your suggestions. It is definitely a lot better for immigrant to find out about these stuff before they came to Canada and find to their shock they can't work in their field.
However the problem isn't simply just that some countries training aren't up to Canadian standards. The problem is also with Canadian companies and various professional associations themselves. A lot of qualifications aren't set by Canadian government but by the various professional associations and they don't/aren't willing to recognize foreign degree for fear of competitions and wages dropping. I think the most glaring example I read is that Harvard medical grads don't have their medical degree recognized in Canada and will have to jump through so much hoop and re-education to practice here that most wouldn't even bother. Yet, Canadian medical degrees are easily recognized in US.
Similarly when companies are looking for people to hire, if you don't have Canadian experience but have 20 years of foreign experiences, the foreign experiences generally counts for nothing.
So without changes from company hiring practices recognizing the value of foreign experiences and credentials and acceptance of foreign credentials from professional associations that are based on actual competencies rather than existing member wage protection, there will always be a lot of unused/under-utilized talents in Canada. These talents will either suffer in silences or go to where their talents will be used and appreciated. Thus Canada will continue to suffer brain drain and inability to capitalize on her enormous growth potential.
January 17th, 2011 at 9:39 am
@Anonymus: Check the topic of this thread.