Introducing The Financial Uproar Too Much House Equation

Introducing The Financial Uproar Too Much House Equation

Math? Nobody told me there’d be math!

Shut it, italics man. We don’t have time for your shenanigans today.

Rant time. I’m sick of seeing people (including those of us who should damn well know better) consistently justifying buying too much house.

We’ve seen all the same arguments. Moving is expensive. I want my dream home. We’ll grow into it. All that matters is I can easily afford the mortgage. Hey, I need a sex dungeon in my basement.

Okay, maybe not that last one.

Most people can’t afford extra space. It comes down to that. Think about the average home buyer. They take out a fat mortgage which takes them 20 or 25 years to pay. If they do save any money, it’s 10-15% of their income. A lot of them are a few weeks without a paycheque away from being screwed.

Low rates have also pushed our expectations through the roof. People regularly pay 3x or 4x their gross income for property, justifying it by saying “hey, at least I didn’t pay 6x!” It’s the low-tar cigarette argument.

Extra space doesn’t even make economic sense (unless you monetize it, of course). If the average house costs $200 per square foot to put up (which is way too low, btw), a 12×12 spare bedroom costs $28,800 just to build in the first place, never mind furnish, heat, or finance. That spare bedroom that you use five times a year could end up costing $50,000 over the life of a house. It would be way the hell cheaper to foot the bill for your mother-in-law to just stay in a hotel five times a year.

The too much house equation

I’m strictly opposed to people who can’t afford it buying too much house. When I am GOD (and I will be one day, mostly likely on Tuesday), I will forbid it from happening.

How can we determine if someone has too much house? I made up a formula. Don’t worry, Italics Man, there’s hardly any math at all.

It goes like this: if your mortgage is greater than your liquid net worth (which excludes your principal residence), you can’t have too much house. It’s that simple.

The condensed form of the formula is: LNW > Mortgage

I don’t care how much you tell me you’re going to grow into the house. Or that it’s your dream home. Or that you can afford it. The answer is still no if you couldn’t conceivably sell off everything that you own and pay for the place.

(That’s a bad idea, of course, but it does nicely guard against people buying too much house)

People tend to forget that real estate you live in is a pretty crummy investment. You have to spend money each year to maintain it. The government taxes it. You can’t deduct any associated expenses. And it tends to only slightly outperform inflation over time.

And then, people make this investment even worse by buying too much house. It truly boggles the mind.

Buying a house isn’t an investment. It’s nothing more than a big-ass consumer purchase. It’s a big purchase that makes sense in certain markets at certain times, while not making sense other times. Like in Toronto or Vancouver today.

This is the end

We constantly rag on people who buy too many video games or finance vacations, but we cheer people who make a similar mistake with their houses. The fact is the easiest way for the average person with only a small net worth to save more is to cut their fixed expenses, starting with housing.

You might think my too much house formula is too strict. Fine. Loosen it a bit, see if I care. The point is we’re all collectively buying too much house, and it’s killing our ability to save.

This is a Smart Way to Buy a House

This is a Smart Way to Buy a House

When it comes time to buy a house, traditional thinking goes something like this.

“You need a good Realtor guiding you though the whole process. It’ll make buying a house so much easier to have someone you can trust in your corner.”

This doesn’t go over so well in reality. Back when I was a Realtor, I sold some friends a house. They came in with an offer at about 10% under asking. After telling them that wasn’t going to happen, I asked what their bottom line was. And they refused to tell me, saying it would weaken their negotiating stance.

(They ended up buying the place for about 4% under list price. A win, I guess? I dunno.)

A lot of people only begrudgingly use a Realtor when they buy a house. Sure, the average Realtor clearly knows more about houses than a typical home buyer. Even a crummy Realtor is far more knowledgeable than 80% of first time home buyers. Have you met the average home buyer? They’ve got the intelligence of an empty Coke can.

But there are plenty of criticisms towards Realtors, too. Many refuse to show houses that don’t offer full commission. Others will lose enthusiasm about six houses in. Most just care about getting the deal done. And if the deal goes smoothly, the hourly wage often eclipses $1,000 an hour.

What’s a buyer to do? Sure, you could ask around and find a great agent. Or you could do things the easy way and just use the listing agent.

Why use the listing agent? 

I really liked what Reddit user Absolute2014 had to say about the topic.

reddit realtor

(Click vigorously to embiggen)

This strategy is so simple and so brilliant I just had to share it. Well played, Mr. Absolute2014, IF THAT IS YOUR REAL NAME.

It’s clear he’s talking about the Toronto market, but it makes sense no matter where you live. The listing Realtor wants activity. They want showings. And if you show up, they’ve got the potential to show you different places. You probably don’t want to take them up on that, but they don’t know that.

Remember how real estate commissions work. A listing agent negotiates a fee. If a pesky buyers’ agent shows up, they’ve got to split that fee in two. And as one four-year-old once told me, sharing is for suckers. That dinosaur was HIS, DARGBLOOMIT. Yes, I know a four-year-old that talks like a 19th century pirate.

If you exclusively use the listing agent, he isn’t forced to split that fee. I guarantee he’s going to push your offer harder than a competing offer.

Still, do your due diligence

There is one problem with buying a house this way.

The selling agent has to dance a tricky line between representing both the buyer and the seller in such a situation. What they’re supposed to do is try to write up a contract that’s fair to both parties while keeping each side’s confidential information a secret.

Reality doesn’t usually work out like that. Most agents disclose confidential information back and forth all the time. They’re just sly about it.

“I like this house. I’d be willing to pay $225,000 for it.”

“I think a reasonable counter-offer in this situation is $225,000. Jimbo does need to buy a house.”

As long as both the buyer and seller are happy, nobody cares. And the Realtor gets both halves of the commission.

Also keep in mind a selling Realtor may be more inclined to keep certain information about the house private in an attempt to protect the sellers.

Let’s wrap it up

I think this whole strategy is a really smart way to buy a house. I’ve already tried it with one Realtor in town, telling them “if you have any listings where the seller wants out bad, come and talk to me.” I’ll let you kids know how it works out.

How I Invest in REITs

How I Invest in REITs

REITs are awesome. They give you all the benefit of owning real estate without the associated work.

Think about buying a rental property. You’ve got to go out and show the thing, which is pretty much like dating. You make awkward small talk for juuuuuuust long enough to consummate the relationship. And then it’s awkward.

The work isn’t done once you rent the place, either. Your tenant wants things like a working stove and walls without holes in them. You’ve also got to harass them if the rent is late and make sure they actually clean the place when they leave. They never do.

Plus, there’s no return anymore, especially if you live in Toronto or Vancouver. Don’t believe me? Check this out. That house is going to return about as much as an investment in Nortel in 1999.

I’ve also shown you kids how to leverage REITs, which takes away another reason to buy physical property.

There’s just one problem. People don’t know how to invest in REITs. They’re are far different asset class than regular stocks with a bunch of different quirks.

Here’s how I invest in REITs.

Kinds of REITs

Let’s start broad. Here are the different kinds of REITs in Canada:

  • Retail REITs (shopping malls, stand-alone stores, etc.)
  • Office REITs (office towers, usually located in the downtown core)
  • Industrial REITs (warehouses, manufacturing facilities, etc.)
  • Self storage REITs (these don’t exist in Canada, unfortunately)
  • Apartment REITs (they may also own townhouses)
  • Health Care REITs (hospitals, medical offices, retirement homes)
  • Diversified (own a little of many different asset classes)

There are approximately 35 different publicly-traded REITs in Canada and more than 100 in the United States.

The important terms

Before we get into how to invest in REITs, let’s talk a little about how a REIT is different than a plain ol’ corporation.

REITs get special tax status from the feds in exchange for paying out almost all their earnings as distributions to shareholders. As long as they pay 90% of earnings back to shareholders, the REIT itself doesn’t have to pay any taxes.

Canadian REITs are forced to either write-up or write-down the value of their assets each quarter. Most of the time the value of the buildings stay the same, but sometimes they’ll fluctuate. REITs with a lot of Alberta exposure have been writing down assets lately, while those with exposure to Ontario are saying their buildings went up in value.

These adjustments impact earnings. If a REIT earned $10 million after expenses and then wrote down the value of assets by $10 million, it officially earned nothing. But the $10 million loss is just a paper loss; it doesn’t affect cash flow.

REIT investors don’t really pay much attention to earnings. They look at the following terms:

  • Net operating income, which are earnings after all operating expenses have been paid
  • Funds from operations, which is essentially a REIT’s net income
  • Adjusted funds from operations, which equates roughly to a REIT’s free cash flow

Some companies will use a term called normalized funds from operations, which is the same as normalized earnings. It’s income but without all the weird adjustments. The problem with that is normalized funds from operations may exclude stuff that actually impacts the bottom line. Tricky accounting is tricky.

The balance sheet

I normally like to avoid companies with a whole bunch of debt on the balance sheet. That’s not possible in the world of REITs. They will always have debt, and often several different kinds of debt.

Most of the debt will be in the form of mortgages against properties. This is ideal, since a REIT can usually get a mortgage for well under 3%. It’s the cheapest kind of debt.

Other forms of debt may include debentures (those are like bonds but without the pledge of specific collateral), or preferred shares. These will cost anywhere from 5% to about 7%, depending on the REIT’s overall indebtedness. Debentures are preferred because they pay interest (which is an expense) versus dividends (which are paid out of post-earnings cash).

I mostly care about the debt-to-total assets ratio. Most REITs maintain about a 50% debt-to-assets level. but the ratio can go higher. Apartment REITs are the most likely culprits, although I’ve seen REITs in just about every asset class that have too much debt.

The easy way to get the debt-to-assets ratio down is to issue more shares. The problem with that is a debenture might cost a company 5% and the common stock costs 7%.

Dividends

REITs don’t actually issue dividends. They pay distributions instead. The difference becomes pretty important come tax time.

Each distribution is split up into a different number of categories. Some of the payout might be return of capital. Some might be straight investment income. If the REIT has sold a building lately, some might be in the form of capital gains. And so on.

Here’s what you need to know about REIT distributions:

  1. If you want the whole payout, hold it in your TFSA or RRSP
  2. If you hold a REIT in a taxable account, it won’t be taxed as well as a dividend

In terms of a payout ratio, I tend to look at the payout versus adjusted funds from operations. As long as that number is 90% or under, I’m cool. So if a REIT pays out $1.00 per share and earns $1.20, this is good. An 83% payout ratio is pretty normal when investing in REITs.

High yields are common. REIT yields are anywhere from under 4% all the way to above 10%. The general rule of thumb is a higher yield is riskier. Keep that in mind if you’re enticed by a big distribution.

Invest in REITs

When I’m looking to put money in a REIT, I focus on a few different things.

The first is book value. I want discounted assets when I invest in REITs. Most REITs won’t trade above book value because investors know the value of the portfolio is constantly adjusted. I usually don’t get very interested in a REIT unless it trades at 20% under book value.

Morguard REIT (which I wrote about on Monday) trades at 58% of book value.

Next is the payout ratio. Anything above 95% of adjusted funds from operations is at risk of getting cut. One thing to look for is whether the REIT offers a dividend reinvestment plan. If it does and a lot of investors are taking advantage of it, it can lower the cash payout ratio to 80% or even 70%. Cominar REIT is a good example of this.

I also like a management team that owns at least some of the company. Sometimes a REIT will hire a third-party company to manage the assets. This can create issues, especially when it comes to negotiating fees. Internally managed REITs are thought to be the better choice. Most REITs in Canada are internally managed.

Speaking of REITs…

Have you checked out my top stock pick of 2017 yet? It’s a REIT I think has a huge amount of potential. Just give us your email address and you can have the report for free. Scroll down to get started!

Don't Miss our TOP Stock Pick For 2017!

Stumped for investing ideas? Aren't we all. Don't worry, I've got just the thing.

This recent Canadian IPO has everything I look for in a stock. It has huge growth potential; a succulent dividend; a sharp management team; and, perhaps most importantly of all, it comes at a very reasonable price tag because most investors don't even know it exists. 

You're not going to want to miss out on this one. Just click here to get your exclusive FREE report about the stock I'm calling my TOP investing idea for 2017!

That Time I (Accidentally) Helped To Commit Mortgage Fraud

That Time I (Accidentally) Helped To Commit Mortgage Fraud

I can’t believe I haven’t told this story yet. It’s one of my best ones.

The year was 2009. At least I think it was, like y’all can expect me to remember that far back. I can barely remember what I had for breakfast.

I was a terrible real estate agent/mortgage broker. It all came together one year and I made decent money, but the other two years I didn’t make much more than minimum wage. I just didn’t have the killer instinct needed to be a decent agent.

It wasn’t just about networking, which I sucked at (still do, in fact). I wouldn’t even do basic stuff like phone people back if I saw a house they might like. I considered all that stuff to be “slimy used car salesman stuff.”

No wonder I basically starved.

But I did sell quite a few places over the years, including one that ended up being used for some very bad things. Here’s how I was an unwilling participant in mortgage fraud.

It all began…

When one of my office’s female agents decided she didn’t want to deal with a group of guys who phoned her up. They weren’t originally from Canada, and therefore gave her the creeps. Hey, it is small town Alberta we’re talking about here. Casual racism is a thing.

Let me tell you kids something about being a real estate agent. Whenever somebody in your office wants to give you a client or listing, know that the lead is absolute garbage. If it was good, they’d jump on that like a while girl and pumpkin spice *anything*.

But she was nice and I was ambitious, so I took on these guys anyway. They told me they owned a construction company and they were looking to buy a place for about a year while their crew did some work building a new school. The story seemed plausible enough, so I volunteered to take them to a half dozen houses the next day.

We go out to the first place and the lockbox doesn’t actually have a damn key inside. I phone up the Realtor who had it listed, but he’s got no idea what’s going on. So all we can do is look around the outside of the place.

I apologize profusely, but these guys don’t seem to care. They love the place. The price was right, it had plenty of off street parking, and they thought the inside looked great through the windows.

(It turns another Realtor had shown the place and forgot to put the key back. We didn’t find this out until the next day).

We go and view the other five houses, but these guys don’t seem to care. We spend less than five minutes inside each one. They still love the first one. After the last showing, they come back to the office and decide to write up an offer.

This place was listed for $80,000. Remember, I come from a small town with very reasonable real estate values. So this place was cheap, but not overly so when compared to other similar houses. It wasn’t a smoking deal, in other words.

The bottom end of the market was slow, so I encouraged them to come in a little low with their first offer. My warnings fell upon deaf ears. They offered $78,000.

I wasn’t there, but I can only assume this was the seller’s reaction:

crazy-dance

I also had to convince the buyers to add a property inspection clause. Not from a home inspector, but from the guys themselves. Remember, they still hadn’t been inside the place.

When things started getting weird

At this point, this is one of the oddest deals I’ve ever done, but there’s still a reasonable explanation behind everything.

But then it started getting weird.

First, the guys insisted on buying the place through their limited company. Except when I Googled it there was no evidence of this company ever doing anything remotely related to construction. As far as I could tell it was an oilfield services company.

Then they come back and we finally get them in the place. We stayed for about a minute and a half. They didn’t even go into the basement.

They also wouldn’t pick a lawyer. It took them at least a week after conditions were lifted. I googled the guy to find his address and the first result that came up was disciplinary actions taken against him by the Alberta Bar Association.

The biggest red flag was probably when I had to fill out the mandatory Fintrac money laundering form. This was a brand new form (at the time) that forced Realtors to make sure the person we were dealing with was indeed the guy who was buying the place.

When a limited company bought the place all I needed to do was get the info for the guy with signing authority. I presented him with the form and his face went white. You could tell he did not want to sign it.

After a brief conversation in their native language, the lead guy handed over his driver’s license and I recorded all of his info. And then I never saw him again.

The aftermath

A couple of months later I got a phone call from the existing tenant. The seller never bothered to contact him. He hadn’t paid a nickel of rent since they took possession. I thought that was weird, especially considering the intended use of the property. So I gave him the new owner’s phone number.

Which was disconnected.

Probably six months after that I got a call from an appraiser. He was doing some research on the property for the Bank of Montreal, and had some questions. How big was it? What was the condition? And most importantly, what did it sell for?

Here’s what happened. These guys bought the place for $78,000. They then altered the purchase contract to say $220,000 and the feature sheet to say the place was far bigger than it really was. These forged documents were then used to get a $200,000 mortgage.

The lawyer’s job was to inform land titles that these guys did indeed pay $220,000 for the place.

And then they never made a payment. I’d assume they did this a few different times and then buggered off to some country where they can’t be extradited.

Wrapping it up

And that’s how I became an accessory to a major crime. It’s been eight or nine years now, so I think I’m in the clear. In fact, I was never even questioned. I never talked to anyone from BMO directly. And I certainly didn’t talk to any cops.

The lesson? Do your job right, kids. Because I insisted on getting all the proper forms, I was in good shape. I suppose I could have done more when I first had suspicions, but I had no proof of anything. It was all just weird.

Why Rich Dad Poor Dad Haters Have it All Wrong

Why Rich Dad Poor Dad Haters Have it All Wrong

Before we really get going with this blogening, allow me to admit I have a bit of a soft spot for Rich Dad Poor Dad, the controversial book by noted shill Robert T. Kiyosaki. The T stands for Takin’ Your Money, probably.

The first personal finance book I ever read was The Wealthy Barber. The second was Rich Dad Poor Dad, and it was all the motivation I needed. I was going to open my own business and make something of myself, dammit.

Kiyosaki lays it all out there in black and white. The book is filled with invaluable lessons about the basics of ownership, the benefits of working for yourself versus slaving away for (dun dun dun) THE MAN, how the rich buy assets while the poor just waste their money on crap, and so on.

This is pretty basic stuff for me in 2017, but in 1999 I drank all this stuff up. I didn’t really understand it, but I LURVED it.

The problem with Rich Dad Poor Dad

The plot of the book is simple. Kiyosaki has two dads. One is his actual dad while the other is his friend’s dad. The friend’s dad is super successful even though he dropped out of high school, while his real dad struggles despite going to a good university and having a prestigious government job. Rich dad ends up teaching Robert how to become rich. Robert retires young and then writes this book to help out the kids.

There’s just one problem. We’re pretty sure large parts of that story were made up.

Kiyosaki describes his rich dad having a large array of assets in his native Hawaii, owning everything from fancy Waikiki Beach real estate to a fleet of convenience stores. People actually researched it and couldn’t find anyone who fit the description. Kiyosaki has also strongly hinted Rich Dad was a composite character based on a few different people.

Kiyosaki also advocates some unethical stuff in the book, including weaseling out of contracts by putting in clauses that say “subject to partner approval” and to trade stocks on non-public information. He also recommends deducting vacations from your taxes because you were there to look at real estate.

I know somebody in real life who actually does the last thing, btw. It scares the bejesus out of me and I don’t even do it. Don’t do tax fraud, kids.

My favorite part is when Kiyosaki claims his net worth is between $50 and $100 million, “depending on the day.” Because hey, doesn’t everyone’s net worth fluctuate 50% a day?

And then there’s the Rich Dad Academy, where a high-pressure salesperson will teach you everything there is to know about real estate for the low, low price of a couple thousand bucks. The internet is filled with horror stories about Rich Dad education ripping off unsuspecting suckers faster than Scientologists.

OH GOD I’M SORRY PLEASE DON’T SEND LEAH REMINI AFTER ME.

Why it’s still a good book

Back in 2005, Yahoo asked Kiyosaki and a bunch of other experts to pen personal finance articles. I remember reading some of his and they were terrible. They advocated buying gold and avoiding stocks and other questionable things. I’ve also heard his additional books are hot garbage.

But if I was recommending a book for somebody who wants to start their own business or who wanted to get started buying rental property, I’d recommend Rich Dad Poor Dad in a heartbeat.

The average personal finance book teaches somebody how to save and to pick ETFs over mutual funds. It’s the safe way to get rich.

Rich Dad Poor Dad is different. First of all, it’s inspirational as all hell. The story might be made up, but it’s still good. And the lessons presented within are timeless.

I’ve talked to dozens of people over the years who told me how it was Rich Dad Poor Dad that started them on the path of thinking like an investor and not like a consumer. Successful people, too. It’s amazing how many real estate investors love the guy.

The bottom line

Yeah, there are parts of the book that suck, and you can certainly call Kiyosaki’s morals into question once you know about Rich Dad Academy. But there’s a reason why it’s the number one selling personal finance book of all freakin’ time. There’s some good stuff in it.

It’s silly to read something like Rich Dad Poor Dad and proclaim yourself an expert. But something has to get that journey started, and this book has been the kick in the ass millions needed to get started. Maybe we should remember it that way, rather than focusing on the stuff that’s wrong with it.

Don't Miss our TOP Stock Pick For 2017!

Stumped for investing ideas? Aren't we all. Don't worry, I've got just the thing.

This recent Canadian IPO has everything I look for in a stock. It has huge growth potential; a succulent dividend; a sharp management team; and, perhaps most importantly of all, it comes at a very reasonable price tag because most investors don't even know it exists. 

You're not going to want to miss out on this one. Just click here to get your exclusive FREE report about the stock I'm calling my TOP investing idea for 2017!