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…

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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.

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Go Ahead. Buy a House. (Just not in Toronto or Vancouver)

Go Ahead. Buy a House. (Just not in Toronto or Vancouver)

It was about three and a half years ago that I wrote one of my most popular posts ever, called F— You, I’m Short Your House.

For those of you too lazy to click though, here’s the gist of it. House prices were insane in Toronto and Vancouver and Calgary and a few other markets as well. We were quite obviously in a bubble. Everything pointed to it including price-to-income ratios, price-to-rent ratios, the fact houses were performing much better than inflation, and temporarily low interest rates propping the whole thing up.

So I decided to put my money where my mouth was and used options to short the market. I shorted every Canadian bank (except CIBC for some reason) using long-dated put options. I entered into this trade when the banks were close to a 52-week low. It turns out I wasn’t the only one looking to do this.

After a few months of steady losses and real estate prices in both Toronto and Vancouver continuing their steady march upwards, I threw in the towel and took my loss.

It’s pretty obvious I was wrong with my bubble call. Both Toronto and Vancouver real estate prices are up approximately 50% since I wrote that piece, although growth has been much more muted in most other markets.

Speaking of other markets

I spent a little time looking into this the other day, and in the middle of my research I came to realize something. Most Canadian real estate markets haven’t done that well in the past few years.

Allow me to quote the best researcher I know, myself. From a Tweetstorm shortly before the New Year:

The average price of houses in markets that aren’t Toronto and Vancouver is $361,000. The median family income for Canada (in 2014) is $79,000. Thus, the average house costs 4.6 times income. Yes, this is higher than the traditional average of 3.5 times income, but not excessively so once we factor in record low interest rates.

A similar story appears in many different real estate markets. Values are going down, not up. In fact, over the last two years, the average price of a house has declined in Calgary, Edmonton, Regina, Saskatoon, Thunder Bay, Fredericton, Halifax, and Quebec City. Winnipeg’s home prices are largely flat as well.

Sure, these places aren’t tanking by any means, but they’re also not going up. And some of them are actually pretty darn affordable.

Take Winnipeg as an example. It has an average house price of about $280,000. In 2014 median family income was $79,850 (this was nearly $4,000 higher than in Vancouver, btw). Let’s round that up to $80,000 because I like nice round numbers. I don’t think assuming the average Winnipegger got a $150 raise in the past two years is outrageous.

Thus, the average house in Winnipeg is just 3.5 times what a typical family makes. That puts houses pretty much inline with historical price-to-income ratios despite interest rates being half of what they were just 10 years ago.

In other words, real estate in Winnipeg is quite affordable. Maybe even more affordable than 10 years ago.

The only real problem is you’d have to live in Winnipeg. Yet people do. Willingly!

More examples? Don’t mind if I do

Let’s do similar ratios for some other selected cities:

City Avg Price Avg Income P/I Ratio
Regina $292,100 $96,080 3.04
Edmonton $373,174 $101,470 3.67
Thunder Bay $198,100 $84,350 2.35
Saskatoon $346,371 $93,400 3.70
Quebec City $259,562 $86,100 3.01
St. John $178,673 $76,450 2.33
Halifax $282,700 $84,500 3.34

Some of these cities are downright affordable, with most trading under historical price-to-income ratios. And if you’re making the average salary in Thunder Bay or St. John, paying down the mortgage early should really be a snap.

Let’s compare that to some unaffordable cities.

City Avg Price Avg Income P/I Ratio
Victoria $639,687 $86,430 7.40
Vancouver $895,084 $76,040 11.77
Toronto $776,684 $75,270 10.31
Montreal $366,956 $75,010 4.89
Hamilton/Burlington $510,475 $84,980 6.00

It’s pretty easy to spot the two outliers on that chart, and there are also a few more overvalued markets out there. Hamilton/Burlington has become expensive, and I probably wouldn’t buy a place in Montreal when $1,500 per month can rent you a pretty sweet pad. Do the kids still say pad?

The bottom line

The three largest metros in Canada get all the attention. Everybody wants to live in Toronto, Vancouver, and Montreal. But like I’ve mentioned before, it’s a hell of a lot cheaper to live in smaller places — especially if you do a job that pays the same everywhere.

The anti-buy a house crowd is getting a lot of attention these days. For the most part, these people are onto something. It is cheaper to rent than buy in most markets, especially the expensive ones. But at the same time it’s also quite affordable to buy a place in a lot of medium-sized cities across Canada.

We bought a house at less than two times our household income, which saddled us with a mortgage so reasonable we’ve paid off 33.6% of it in the first six months of having it (and more since). We’d like to be mortgage free by 2019.

There’s nothing wrong with buying a reasonably priced house in an affordable market. The whole country isn’t out of control like Toronto and Vancouver. Like the United States, Canada has a few cities with crazy-high prices and a bunch in the middle that are quite affordable. Stick to the middle of the country when buying a place and you’ll likely do fine.

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4 Easy Ways to Cut Down on Home Maintenance

4 Easy Ways to Cut Down on Home Maintenance

Thanks to Canada’s massive real estate bubble, more and more people are comfortable renting. This is a good thing.

There are a number of advantages to renting. It usually ends up being cheaper, since a renter doesn’t have to worry about maintenance, house insurance, and paying back a mortgage. A renter also has greater flexibility versus a homeowner, which is kinda a big deal in 2016. And renters won’t lose a big bunch of money if the value of Toronto real estate goes down. We’re already seeing Vancouver’s market collapse.

For many renters, home maintenance is the big expense they’re hoping to avoid. The general rule of thumb is home maintenance costs about 1% of the value of the house per year. It doesn’t all happen at once, but eventually you’ll end up spending that much.

I’ve also seen guides that say you’ll spend up to $10,000 per year in house maintenance. That’s not for a mansion either; it’s for a regular house in suburbia.

Using a percentage of value is a really dumb way to estimate home maintenance, at least in my opinion. My house is worth $195,000. The nicest house on my block just sold for $360,000. Will that house magically pay 2x as much for a new fridge, stove, hot water tank, or furnace? Not likely.

If there’s one thing Financial Uproar is all about, it’s shattering rules of thumb. I think many renters have gone too far the other way, and overestimate the value of maintaining a home.

Here are four ways to cut down on your home maintenance costs.

Don’t buy something with problems

I’m amazed how many people are willing to buy a house that has very obvious issues. Especially people who don’t know how to fix anything.

There’s an easy solution to this. Don’t buy stuff with obvious issues.

You don’t need to be a contractor to figure out a lot of this stuff. If the shingles are starting to curl, your house needs a new roof. If the siding looks like ass, it’s either going to need a coat of paint or to be redone. And so on. Most of this stuff is pretty simple.

Most people overestimate the amount of work they’re capable of doing. I think at least 50% of common household jobs can be done by someone with access to Youtube and a decent tool kit. But that doesn’t mean you’re going to do them.

Extend this to look for potential problems, too. A patio won’t need to be replaced as often as a deck, for example.

No cosmetic fixes

Many people spend large amounts of money on their homes replacing perfectly good things that don’t need to be replaced. They’re just dated.

The perfect example of this is the pink bathtub in my parents’ 1960s house. That thing is uglier than Amy Schumer’s face, but they have yet to replace it. And why would they? It still holds water. It doesn’t leak. The tiling around it is barely fading. That thing will be around long after we all die.

It’s probably the only pink tub left in the whole neighborhood. Everyone else has ripped out their tubs and replaced them with something newer, sexier, and less embarrassing when their friends come over.

It’s the same thing with kitchens, paint on the walls, flooring, and a million other things. It’s all getting replaced before it’s broken. Avoid that and you’ll cut down maintenance costs significantly.

Make long-term investments

My old house had a metal roof. I loved that thing. The company that installed the roof told me the shingles came with a 100 year warranty.

My current house has a nice new roof, because we followed rule number one when we bought it. But we have neighbors who are looking to get a new roof. They have two options. They can either shell out $6,000 for a new asphalt roof, or they can spend $10,000 and get a metal one put on.

If they plan to only live in the house another 15 or 20 years, the cheaper option would probably be best. But if it’s a long-term investment, the metal roof will cost far less per year of ownership, even if it costs more today.

Low-end appliances

Fridges can cost anywhere from $500 to $5,000, or even more. And get they all really just do the same thing. They keep your food chilly.

Fancy appliances don’t just cost more. They have more things that can break. I’m convinced this leads to a shorter life.

Think about it this way. Somebody buys a fancy washer that has all sorts of weird settings. One of the settings breaks. Instead of doing without, they go out and buy a new washer. The old one gets dumped to the curb, where it eventually becomes a home for raccoons.

You can buy 10 $500 fridges for the same price as a $5,000 one. Sure, it’s an extreme example, but the point stands. It’s way cheaper over the long-term to replace appliances with cheaper models.