Silly Math for Speculators

If I had a nickel for every time I had to endure some property investor telling me about how much money they made, I’d have enough to buy a condo in Phoenix. But just for fun I decided to run some numbers on a stereotypical flipper and what conditions s/he would require to make a “profit” on a flip. Before beginning, remember the mindset: opportunity cost stays in the textbook — what is being measured is whether or not the flipper has more money in a year than when he bought. So we can calculate the approximate profit of a flipper, assuming he bought a year ago and sold today. The profit reaped is therefore:

Profit = Sales Price – Purchase Price – Interest – Expenses + Rent – Sales Fees

Sales Price – Purchase Price = Pi*(1+a),  (where Pi is purchase price and a is annual appreciation)

Rent-Expenses = Pi*CR, (where CR is the cap rate (generously about 5%))

Sales fees = Pi*f, (where f is the sales fees from a sale (say about 3%))

Interest = Pi*LTV*i, (where LTV is the loan-to-value ratio and i is the mortgage rate)

It is approximated, for simplicity, the loan is interest-only (which is reasonable with a 35 year am). We sub:

Profit = Pi*(a + CR – f – LTV*i)

To achieve a positive return, a+CR-f-i*LTV > 0; solving for a,

a> LTV*i – CR + f

So we have a required capital appreciation to ensure the flipper makes money on paper, a huge psychological barrier needed to elicit a sale. We can plot appreciation versus LTV for various interest rates, assuming 5% cap rate and 3% closing costs:

So what do the numbers mean? Well at current interest rates of 4%, a flipper requires capital appreciation of 1.3% to ensure he doesn’t lose money. I ran the numbers with a 3% cap rate (typical of some detached dwellings and some condos):

And assuming the flipper keeps the unit vacant:

If the unit is at 3% cap, the 20-1 leveraged flipper requires a 3.8% annual appreciation; when the unit is held vacant, this increases to 7%.

This cursory exercise shows how leverage with low earnings requires continued capital appreciation to stave off a paper loss, a case made clear when analyzing the simple case of a flipper with a 1 year tenure under various scenarios. When interest rates go up, the required capital appreciation increases at a time when we expect increasing costs of capital to weigh heavily on upward price movement. With high leverage, interestingly, it is an absolute necessity to have prices increase, even for those with variable rate mortgages at around 2%.

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patriotz
9 years ago

@last line:

What's so good about it? Kinsley is saying that fundamentals (e.g. price, interest rates, implicitly rental value) don't matter as long as you can afford to buy. As VHB put it, he can afford a $10,000 pencil, but that doesn't mean it's a good idea to buy one.

I very much regard buying a house as an investment decision, which is exactly why I'm not buying. I can get a much better return on my money somewhere else.

last line
last line
9 years ago

and the last line of the article is the best:

“Home buying is an incredibly important decision,” says Karen Kinsley, CEO of CMHC. “It should be your home first and an investment second. It doesn’t matter if mortgage rates are 21 per cent or three per cent. The bottom line is you’ve got to make sure you can afford what are getting into.”

Anonymous
Anonymous
9 years ago

http://www.globalnews.ca/story.html?id=4245937 Some financial analysts warn that the dramatic, decade-long run-up in house prices reported Tuesday by Re/Max (house prices climbed an average of 6.82 per cent every year from January 2000 to December 2010) will become a distant memory in the years ahead, possibly even calling into question the post-war mantra that buying real estate is a sure-fire investment. Scotia Capital economists Derek Holt and Gorica Djeric said in a note: "This reaffirms our view that the Canadian housing market, which led the country out of the recession, will moderate through 2011, acting as a drag on the economy." "Even though mortgage interest rates are expected to rise later this year, they will still be within short reach of current levels and remain supportive for housing market activity,” says Crea’s Chief economist Gregory Klump. “Strengthening economic fundamentals will keep the… Read more »

SDBound
SDBound
9 years ago

@john:

I'm sorry john but you sound like someone who watches too much programming on CNN. Many large companies have heathcare coverage included. At my employer you even get to "bank" your health benefits dollars. Instead of billing $300 on glasses every year, I can put that allocation aside and get laser eye correction paid for later on.

Joshua
Joshua
9 years ago

@americanwhoknowsbetter: I'm American too, assmunch. Doesn't mean I enjoy aircraft carriers and F16's.

And that's Dr. Snowflake to you.

Anonymous
Anonymous
9 years ago

@Anonymous:

Please google people with small penis to confirm what kind of people have the smallest penis.

……

Home buyers?

Globello
Globello
9 years ago

Robert Shiller, Financial Post and Edmonton Journal, Feb 8, 2011:

"Canada looks to be headed for a big drop in house prices.

Calgary and VANCOUVER are the biggest possible bubbles in Canada."

Kinda surprised that nobody has picked up on this.

Extremely rich Van h
Extremely rich Van h
9 years ago

@Anonymous:

It doesn't matter as long as their hole are stuffed with Chinese money that's all they and Canada concern

Brown Cow
Brown Cow
9 years ago

Although East Indians have the smallest penis. We know how to use it well.

Anonymous
Anonymous
9 years ago

@Anonymous:

Please google people with small penis to confirm what kind of people have the smallest penis.

americanwhoknowsbett
americanwhoknowsbett
9 years ago

"The marine base bothers me."

Well, aren't you just a precious little snowflake.

john
john
9 years ago

@SDBound 33

Each to his own. Remember you're not just moving to San Diego; you're moving to America, where even their most left-wing Democrats are to the right of our Tories. No health care. The death penalty. Crazy gun laws. Crazy right vs left battle going on all the time. Crazy religious nuts everywhere. Nice enough for a visit but I'd rather rent in Canada than buy in America, which is what I'm doing right now.

Bubba
Bubba
9 years ago

I walked around the Olympic Village 2 weeks ago.

Aquilini offerd to buy it ????

At 75% off its still a rip off….kick the tires befiore you even comment. Its pure shite…..and BTW the warranty is probably long gone.

The lobby doors to each strata building are UNlocked….they are so desperate for customers.

Go and prove me wrong.

My predicition is Mayor Moonbeam wants the price to absolutely tank so they can turn this $ Billion dollar fiasco into social housing….

Bubba
Bubba
9 years ago

Re Cloverdale Antiques mall.

" sigh"

I remember when tht mall had the BC car museum…then the vindictive 1990's NDP Gov't auctioned off the entire collection.

Cloverdale area is a hot bed for antiques…like the auto mall model

Was in Cloverdale this week and see Red Barn antiques is down to the old building.

The antique mall was cool.

I don't know WTF the landlord is thinking….I'm gonna bet they will regret the antique mall leaving..bet it stays empty a loooonnnggg time.

F*ck the greedy pricks

Bubba
Bubba
9 years ago

I'm really happy for meth man.

After getting 1000K over list of one of his 20 Drummond Drive homes….he was able to bang one of those HGTV broads who pimped up one of his mansions to flip, thus drive up the average sales price.

Then he donated proceeds to unmarried Mothers fund..to help them get a start

The meth man need on Order of C ……man..vote up if you agree, I have lots of connections (+ air miles ) to make it a slam dunk.

painted turtle
painted turtle
9 years ago

: Good guess!!! Jeff signed the sale papers today. However, he resisted slightly the realtor and went for a less expansive, but ground floor, condo unit.

Jeff has been seeing that Realtor "friend" for month at the local pub, and little by little, that realtor turned a happy renter into

a potential buyer… The details of the story remind me of someone being manipulated by a drug dealer.

Best place on meth
Best place on meth
9 years ago

@Anonymous:

Excellent. Higher interest rates hurt Vancouver the most.

The higher, the better.

Anonymous
Anonymous
9 years ago

Flaherty warns of even higher mortgage rates after this week's jump

http://ca.finance.yahoo.com/news/Flaherty-warns-e

Anonymous
Anonymous
9 years ago

B.C. most financially vulnerable province: TD

"[The] vulnerability index is not a predictor of the future," TD economists Craig Alexander, Derek Burleton and Diana Petramala said in the report. "[But] based on our analysis, we find that households in British Columbia, Alberta, Ontario and Saskatchewan are the most vulnerable," they said.

http://www.cbc.ca/canada/british-columbia/story/2

Bubba
Bubba
9 years ago

114 Anonymous

6 inches is this big

> <

Anonymous
Anonymous
9 years ago

@Extremely rich Van house owner.:

……

@Kosta:

Chinese are rich enough to bang all white girls in the world man.

……

Wonder if the grils would notice they're getting banged?

Anonymous
Anonymous
9 years ago

@Patiently Waiting:

………

Speaking of media whores, did anyone else watch Global news tonight? Some realshits filled a helicopter with rich Asians and flew over White Rock.

……………….

Maybe they were showing them a new place they could jump from when the market tanks in a few months?

Bubba
Bubba
9 years ago

Boombust Says:

February 9th, 2011 at 6:37 pm

“Speaking of media whores, did anyone else watch Global news tonight?”

Yup. Saw it. Then I immediately switched to CTV. Also, I can’t stand that Chris Gailus’ accent

======

Suggestion:

Call him 'Gay l' ass"

WTF is the Global gig from Richmond Oval the Olympic village

If you get too close to a black hole..you get sucked in

bwahahaahahahhahahahahahaahaaaaaaaaaaaa