canadian real estate market

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Financial Freedom: What It Takes?

$5,000 a Month

What Will it Take to Create Such Passive Stream of Income?

So you want to be financially free you say? Ok cool. I want to be an astronaut. There is a gap between what I want and what I have. I am about to make you feel uncomfortable by asking straight questions and telling you the things you don’t want to hear.

To begin with – you are currently not “financially” free. Just because you say you want to be free, I assume that you are currently not. 

“No-no. I am free. I just want to have more freedom” – I hear you say.

Alright, let’s define freedom. Merriam-Webster Thesaurus gives two definitions of freedom:

1. The state of being free from the control or power of another
2. The right to act or move freely

According to the first definition, freedom is a state of being. Also, it assumes that there was some sort of power or another person who was trying to control the one. Question: is the controlling force necessary for being or becoming free? If not, then definition should be the following: freedom is a state of being. Much shorter and simpler, isn’t it?

The second definition states that freedom is the right. Alright, what is the “right”? Google defines it as justified, acceptable, true, or correct as a fact.

My next question is: who is the one that justifies and defines what is acceptable, true, and correct? Who has the authority to extend you the right to be free? I personally don’t know anyone authorized to grant the right to be free. However, I know that the judicial system claims to have the right to limit or take away your freedom by putting you in jail or restricting you from doing certain things and being in certain places. So if there is no-one to ask for freedom, do we get it by default, at birth? Or maybe we need to obtain it somehow, somewhere? It’s confusing and neither of two definitions brought clarity into explaining what freedom is. Maybe other sources have better explanations.

Roget’s 21st Century Thesaurus says that freedom is the license to do as one wants and defines the following as the synonyms for it:

So freedom is a license. To be free, I need a license. Again, who is authorized to issue the license to be free? Does anyone know what it looks like? What are the requirements for obtaining one? Does it have an expiry day? How much does it cost? Again, the more I ask, the more questions I get? Let’s move on. Maybe if we try from the opposite end of the spectrum, we will be able to get to the truth.

What is the opposite of freedom? Below are the antonyms for freedom, according to Roget’s 21st Century Thesaurus:

Dependence and captivity… According to this definition, freedom is some sort of independence from some external force or power. Therefore to be free means to be in a state of independence. Let’s leave it as is and not dig deeper because I feel it’s a rabbit hole that has no end to it. Independence.

Impotence, inability, weakness…? This is ridiculous. Are there better ways to describe the lack of freedom? Let’s ask Google, he knows everything:

Financial Independence

Every person has his own magic number that will change everything and unlock the way to a beautiful, stress-free, happy life. Ha-ha… Anyways, let’s say you need about $5,000 /month to live comfortably, cover all your expenses. You strive to create a passive stream of income of $5,000 /month that will require little to no work from you. The money will simply land on your bank account while you lay on a couch and repost on Instagram the quotes about successful success. With this money, you don’t worry about where the next paycheck will come from. You think you outsmarted the entire world around you and the sky is not a limit for you. You figured it all out and now you are able to manage your time only as you decide to. No bosses, nowhere to go, nothing to do, only unless you decide otherwise. That’s cool? Sure it does.

You heard a lot of “success stories” in which people obtained that financial freedom or financial independence I should say, by investing in real estate. People often start their stories remembering the times, when they busted their asses at work, trying to squeeze as much cash as possible from their full-time jobs. Then savvy folks would pour all their savings into the rental properties for the monthly cash flow. By cashflow I mean the income you have left, after the mortgage, taxes, and other operating expenses. You hear a lot of stories like that and it seems that real investment is a way to go. You will need to build a portfolio of rental properties, which generates your passive income. Now you see the path. Pull up the pants, wipe your runny nose, grab the diet Coke – we are going to get FINANCIALLY FREE.

How much time do you think it will take you to set everything up? What did successful stories tell you about the timelines? Let’s see what it takes to build the stream of income that will generate you $5,000 /month.

“People who make $90,000 a year, actually earn more than 87% of the U.S. population.”,

(Keshner, Feb 4, 2019)

Let’s say you are an educated, hard-working middle-class citizen, who annually makes approximately $100K. Day in, day out from 8 to 5 you grind your way to success working the full-time job. Your life is simple, you don’t overspend and have pretty good financial behaviors that allow you to set some money aside. You saved quite a bit and you are ready to step on the real estate investing path. You are about to buy your first property and already feel like a complete success. Life is great and easy, you figured things out. Everything goes as planned. Few months of house hunting and you finally bought your dream house. A bit of renovation, marketing and you have the tenants moved in. The house brings you about $500 a month of hustle-free cash flow. You feel on top of the world, you nailed it. Indeed, that’s great cash flow. To become financially free you only have left $4,500 /month. No problems, just repeat what you’ve done 9 more times and you can retire. The only problem is that you are out of cash after your first purchase. It’s hard to buy a property without a downpayment. Let’s do some napkin math to see how much time it will take to buy 9 more houses and get your freedom license. 

If you are fortunate to live in Canada, please pay 27% taxes on your annual income. Taxes are a whole nother topic, which deserves separate attention. However, stay on the track, we are not getting into taxes here. Deduct the basic expenses from your annual income. They are different for every person (I don’t include the stacks of toilet paper you purchased during COVID-19 pandemic. Let’s keep it as your little secret). Deducting :

  • Food (one person)
  • Entertainment (movies, 1-2 nights out, nothing crazy, really conservative) 
  • Pet (a small dog shares miserable existence next to you)
  • Commute ($7-10 /day)
  • Car insurance payments
  • Rent (So cheap because you try to save money and live in a shithole. It also includes utilities)
  • Travel (Once a year you fly out to a warm country. You work hard, you deserve it (sarcasm))

You don’t buy new clothes, toys, electronics, gadgets. A new iPhone is just a dream you can’t afford. No Christmas or birthday presents to yourself. Cancel Netflix and Spotify subscriptions. No kombucha or Starbuck coffees. No cab rides. You don’t pay for that cute chick at the bar, sorry honey. No new books or journal subscriptions. You don’t get sick. No dental treatment, no out of pocket medical expenses. You live a monk’s life, literally. From 8 to 5, day in – day out. You have a goal and you are committed to achieving it no matter what it takes. You’ve decided that you want to be free and this is the way to get that freedom. The napkin math showed you clearly – 10 houses – $5,000 /month.

A year later you saved $40,000. You look a little tired, but that doesn’t matter. Well done boy! Now let’s put this money to work and buy a second house. You’ve found a beautiful property listed for little over $300K and your ass got lit on fire. You expect to add another $500 to your monthly cash flow. $1,000 a month, doing little to nothing. No kidding, sounds great, let’s pull the trigger on it. A typical down payment is 20%, which equals $60,000 on a $300K house. What a bummer, you can’t buy it, because you have only $40K saved. You will need to work another six months to make up the difference. You realize that it takes approximately a year and a half to put aside enough money to buy a $300,000 property. Don’t forget that you will need to live the monk’s life and say no to anything that you can’t eat. How long do you think it will take to save up enough cash for ten of those $300k properties? Do you think you will still want that freedom by the time you reach it? By the way, how long do you expect to occupy this planet? Silence…

Ha-ha! Exactly! Don’t freak out yet… Such variables, like appreciation rate and investment income will make things look slightly better. Let’s add them to the equation.

According to Remax: “Healthy price increases are expected next year, with the RE/MAX 2020 Housing Market Outlook Report estimating a 3.7 per-cent increase in the average residential sale price.” According to the Royal LePage Market Survey Forecast: “The aggregate price of a home in Canada is forecast to rise 3.2 percent year-over-year to $669,800 in 2020”.  This is a conservative number and it greatly varies, depending on the area of your purchase. We will use it for our financial projections. The number of 3.7% means that the house you purchased for $300,000, next year should increase in price for about $11,100. Will put appreciation to the side for now and run the numbers only including the rental income. 

I assume you are being a good boy and don’t touch the monthly $500 you get from your rental property. You are not selling the house, therefore we don’t account for appreciation and use only the money you saved from the monthly cash flow. Annually the rental generates you $4,380 ($6,000 minus 26.8% tax deductions). This extra cash will save you about 3 months of hard work at your full-time job. You will need to hassle for 16.2 months (70.4 weeks) to save $60,000 of a down payment on your second house. (It’s almost 2 months faster having the cash flow of $500 /month from the first property). 

One year and a little over 4 months, since you’ve become the landlord, you pull the trigger on the second property.  Now, you are the happy owner of two properties which generate you (hopefully) $730 / month ($1,000 /month minus taxes) on top of your annual savings of $40,000. You continue living on the edge of starvation for another year and six weeks to save enough money to purchase your third house. Same deal, $300,000 purchase price, $60k downpayment. Rental income from the two houses you already own allows you to set aside $60,000 a little bit faster. To be exact, 2.7 months faster since the purchase of your first house. Great job, you’ve got the third house. All three properties bring you $13,140 in cash flow annually which correlates to $1,095 /month. It’s been a while since you stepped on this RE journey. Let’s do a quick check-in. How do you feel living the way you did? Because you were able to save $40k every year, I assume life has been very steady for you. No emergencies, no unexpected expenses. You didn’t get sick, nor met a loved one. No kids were born and your parents stayed healthy and well. All your tenants paid on time. No convictions. The vacancy rate is down to zero. No maintenance expenses, whatsoever. What a stress-free life! By the way, how long did it take you to come to this point, where you build such a passive income stream of “whopping” $1,095 /months? 

2nd Home = 16.2 months
3rd Home = 14.8 months

Time Spent = 31 months = 2 years 7 months

For the past 2 years and 7 months, you lived like a monk. Skinny, tired, but determined to make it work. $5k /months is your dream and nothing can stop you. Great! I like the persistence with which you dig yourself into the grave. Now, please sit down for a second and answer the following questions: 

  • With three behind your belt, how many more houses will it take to get you to your goal?
  • How long will it take to obtain those properties if you continue down this path?

Let’s run some numbers:

  • It will take 9 houses to generate almost $40,000 /year of income after paying taxes.
  • Yellow line all the way down indicates the point at which your rental properties generate you $5,110 a month. This will happen 12 years later when you rent out 14 houses. 

Just think about it, it will take you somewhere about 12 years of living like a monk, busting your ass day in – day out at the full-time job to finally get to the point where you can quit. How realistic is it to maintain such a lifestyle? Is it worth it? Are you ready to pursue this for 12 years? What are your thoughts? 

Numbers above don’t include a lot of important things, such as:

  • Renovation/Maintenance Expenses. Houses break, the roof will leak, AC will break, the basement will get flooded. None of those unexpected experiences were included;
  • Evictions. Tenants don’t always pay rent and you will have to deal with courts, late payments, and evictions. Rooms stay unoccupied – rent doesn’t get paid;
  • Life Situations. People want new clothes, people want ice cream from time to time. People get married, get sick, and die. People make babies. People divorce. People lose jobs, people find better jobs. None of those were included in calculations. Not a single calculator in the world can predict and account for the life situations that WILL happen to you;
  • Property management fees. It will be hard to manage 14 houses without some sort of property management assistance. Especially if you are working at your full-time job. Especially if you want to make this income as passive as possible. As a baseline, expect to pay a typical residential property management firm between 8 – 12% of the monthly rental value of the property, plus expenses. Some companies may charge, say, $100 per month flat rate. 10% on your monthly rental income of $5,110 is $511. That’s an extra house for a second… Now you will need 15properties to keep you afloat;
  • House appreciation. Typically, over the years, your house will be worth more than you paid for it. This extra value can be refinanced and put towards the purchase of the next home. It can be a huge help and dramatically speed up the process at which you get to your goal. It is really hard to predict how much the property will cost over time and the further you shoot, the more off you will be;

Over the course of 12 years, you have saved and re-invested $840,000 worth of down payments (14 houses x $60,000) to buy 14 homes. Let’s see how well your investments paid off.

Capitalization Rate

Cap rate is the crucial piece of information that investors use to make their decision. You need to know for two main reasons:

  • Analyze the performance, or expected performance, of your rental properties. For example, if there are three houses in your price range for sale, calculating the expected cap rates for all three can help you determine which is the best investment. 
  • Determine your property’s fair market value (FMV). This is important if you’re selling a property. If you know how your property’s net operating income and the industry average cap rate, you can determine your property’s fair market value. Market value = net operating income / cap rate. 

Cap Rate is the ratio of the property’s net income to its purchase price (or current market value). While the purchase price remains the same, the market value of the house raises year over year and gives more accurate calculations. $500 /month of cash flow results in a cap rate of 7.3%. What’s a good cap rate, you might ask? On the right are the averages according to CBRE’s North America cap rate survey for the first half of 2019. 7.3% is a good investment. Also since we included mortgage repayment into these calculations it can be considered a cash-on-cash return. Mortgage repayment is the variable that differentiates the two. 

Inflation, The Rule of 72, and Home Appreciation 

In light of recent, or I should say current events surrounding the COVID-19 pandemic we begin seeing the combination of inflation and low mortgage rates. What does it mean to real estate investors like us? High compounded rates of home appreciation. As a tenant or a typical consumer – you lose, because increasing rates of inflation are not very helpful for your consumer purchasing power of basic goods and services like food, utilities, gas or transportation prices. However, if you own the property, you should smile, because the best traditional hedge against inflation is, was, and probably always will be – the Real Estate. This is true because home values tend to increase at least as much as the reported annual rates of inflation. Let’s play around with numbers and calculate how soon your investments will double in value. We will use The Rule of 72. The use of it is very simple: you divide the number 72 by an estimate of annual appreciation gains. A home that appreciates at 10% per year (72 divided by 10 = 7.2 years) may double in value every 7.2 years.  Another home that appreciates 7% each year can double in price every 10.2 years during a relatively strong economic time period.  Or, as in our case, home appreciating in value at 3.5% per year is quite likely to double in value every 20.6 years. However the rule of 72 is not 100% precise, it gives a quick glance at the real estate market condition.

As the house owner, you should also be familiar with Compound Interest. It refers to the idea that when you earn interest on an investment, that earned interest is rolled back into the investment and starts to build on itself. Let’s look at an example on the left. We know that the average annual appreciation rate on your house in Ontario, Canada is 3.5%. Therefore we assume that your $300k house appreciates in value by 3.5% at the end of the first year of ownership. You just made $10,500 out of nowhere it’s put into your home’s value. The next year you’re earning 3.5% on the new property value of $310,500. At the end of the following year, you’ll actually earn $10,868, which is $368 more from the previous. Your earning has gone up, even though you haven’t done anything more than just leave the money in place. If you have enough patience and allow the power of compound interest to do its magic, the house you bought for $300k will double in value in about 21 years. 

Inflation is the counterforce and works in the opposite direction. You probably remember as a kid, buying a can of Coke for $0.50? The increase in prices over time is inflation, and it basically means that a dollar today simply does not buy as much as it once did. According to Statista.com, in 2018, the average inflation rate in Canada was approximately 2.24 percent. So let’s use that as the example here. Things don’t look so bright anymore. After keeping your property for 25 years, it will increase in price only by $105,165. Inflation just ate $279,834 of your money…

To make things worse I’ll remind you that you haven’t paid your taxes yet. According to the Government of Canada:  “When you sell your home, you may realize a capital gain. If the property was solely your principal residence for every year you owned it, you do not have to pay tax on the gain. If at any time during the period you owned the property, it was not your principal residence, or solely your principal residence, you might not be able to benefit from the principal residence exemption on all or part of the capital gain that you have to report.” This means that if you are considering selling your principal residence, you can be reassured that you likely won’t have to pay any tax on your home provided that you meet certain conditions. However, if you are considering selling one of your investment properties, the tax implication can be a bit more complicated. There are two streams of income you would need to pay tax on: 

  1. Capital gain. Say you purchase a property for $300,000, and you sell it for $405,165 in 25 years. Capital gain = $405,165 – $300,000 = $105,165. In Canada, 50% of capital gain is taxable, hence 50% of $100,000 is taxable = $52,582. If you own the property in your own personal name, this $52,582 is added on top of your other income and is subject to the marginal tax rate for the respective tax brackets you are in. For example, let’s use the tax rate we used in previous calculations – 26.8%. Hence tax liability is roughly $52,582 x 26.8% = $14,092
  2. Recapture. You are allowed to claim the wear and tear on the property to defer your rental income. The wear and tear are called capital cost allowance. Assume that 90% of the value belongs to the building and 10% of the value belongs to the land, the capital cost of the building is therefore 90% x $300,000 = $270,000.

Where am I getting with all this? 

Conclusions

It will take time. A loooong time to build the income that will support your lifestyle and allow you to retire. And if you start late enough, you might retire around the retirement age. The example used in this study is just one of the ways things might unfold. It is steady but very freaking slow to build your way out of the 8-5 system. Now I am going to ask you:

  • Does it worth spending 12 or even 10 years of your life living only on rice and beans?
  • Do you think, 12 years later, when you get that $5,000 check it will all seem worth the time and effort you put in? 
  • Will you be able to hold on to your full-time job for at least another decade? Or find another boss, who will pay you at least the same salary.

I am pretty sure that those questions got you thinking. Here is a thing, if you want to break free from the hamster’s wheel, you have to get creative! There are ways to speed up your way to the goal of yours. Some, but not all of them are:

  • Reinvest Positive Cash Flow;
  • Re-finance;
  • Keep the full-time job. If you quit your day job early you will lose your steady and secure income stream and lenders may refuse to lend to you because they believe you cannot support the repayments that the loan requires;
  • Tax Advantages of Real Estate Investing. Real estate is one of the most tax-advantaged investments compared to other investments.
    • 1031 exchanges
    • Tax-free or tax-deferred retirement accounts
  • Appreciation;
  • Equity Build-up;
  • Team up with others.
    • Syndications
    • Partnerships

Simply saving every dime won’t get you far… Saving is definitely better than spending, however, it will not make you rich. Don’t spend your cash on stupid stuff, but realize that it’s better to make more, rather than save more. Doesn’t matter how savvy you are, you can not save your way to wealth. In 99% of cases, your full-time job’s salary will be enough only to meet your basic needs. See below the Maslow’s hierarchy of needs:

You will live a pretty comfortable life:

  • Always fed, never hungry;
  • Live in a comfy warm little cave;
  • Healthy, with access to quality medical treatment;
  • Happy in your relationships with friends and family…

Indeed, that’s a great life to live. However, there are a lot of people I know who live such lives, but they don’t seem to be very happy. There are people who are different breeds. Those folks stagnate in the certainty and safety that the modern world brings. They strive for a challenge, they are hungry for achievement. Those people strive in crisis and hardships. When it comes to your life – you are the ultimate decision-maker. 

You decide, either navigate for miles on woods roads or play it safe take a short trail.

E-Book: FINANCIAL FREEDOM. What it takes to get there?Download

References

  1. Keshner, A. (2019, February 4). Most Americans who earn $90,000 a year say they don’t consider themselves rich. Retrieved February 29, 2020, from https://www.marketwatch.com/story/most-americans-who-earn-90000-a-year-say-they-dont-consider-themselves-rich-2019-01-24 
  2. Canadian real estate market to appreciate 3.2% in 2020 reflecting similar price growth in both condo and detached segments. (2019, December 12). Retrieved April 24, 2020, from https://finance.yahoo.com/news/canadian-real-estate-market-appreciate-110000867.html 
  3. Frankel, M. (2020, April 17). What is a Good Cap Rate for an Investment Property? Retrieved April 24, 2020, from https://www.fool.com/millionacres/real-estate-basics/articles/what-good-cap-rate-investment-property/ 
  4. Plecher, H. (2019, October 22). Canada – Inflation rate 1984-2024. Retrieved April 24, 2020, from https://www.statista.com/statistics/271247/inflation-rate-in-canada/ 
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USA Great Depression Rental Housing Market Analysis

RENTS IN THE DISTRICT OF COLUMBIA 
The hearing of June 17, 1932, which appears below, was held prior to the approval by the Senate of Senate Resolution 248, directing an inquiry into the rental situation in the District of Columbia. The record of the following hearing is included herein, however, because of its close relationship to subsequent proceedings under the resolution. 

FRIDAY, JUNE 17, 1932 UNITED STATEs SENATE, CoMMITTEE on THE DISTRICT of Columbia, Washington, D. C.

Mr. BRINKMAN. In a case where a building is mortgaged for $200,000 and the interest is 6 percent, if that interest rate were lowered to 5 percent and some of the excessive commissions charged for renewals every three years on these loans were eliminated, you would have a saving in interest charges and commissions of $2,500 on that loan. The usual rental of a building of that type is about $33,000. You could give the tenants of that building a 7 percent reduction in their rent, without diminishing the return to the owners at all, simply by lowering the interest rate 1 percent. 

Mr. BowTE. Do you mean a building that you would loan $200,000 on would only produce $30,000 a year? 
Mr. WHITEFORD. That is the worst loan I ever heard tell of. 
Mr. BRINKMAN. $33,000. Mr. Bowie. Nine times. 
Mr. WHITEFORD. You talk about vicious loans. I am surprised at how little you know after all your study about this. 
Mr. BRINKMAN. Thank you for the insult.

The Rust firm took in the ‘Clifton Terrace Apartments at $750,000. The income from that property is sufficient to produce a net return of about 13 percent on the investment.

Apartment-House Game

Senator Copeland. Are you familiar with the apartment-house game at all? 
Mr. GoRDON. Fairly well. I know they are all broke. 
Senator Copeland. Well, is your business comparable to theirs? Are they better or worse off than you are? 
Mr. GoRDON. Well, I would say—I can not swear to this—more than half of the apartment houses in Washington have been foreclosed through the inability of the people to carry them. Either the Second or first trusts have been foreclosed and the people lost them. I think that is the best proof that they do not pay. 
Senator CAPPER. Well, were not the most of them financed for a great deal more than they had in them? 
Mr. GoRDON. Some of them, although a few firms here, which you probably know about, did some very wildcat financing, but we don’t account that. That was the exception. Most of our lenders here lend on an apartment house about 60 percent to 65 percent of the actual cash cost of the building and ground. That isn’t bad. Then, this man will have a second trust above that, maybe of 20 percent, and then when a smash comes, he gets squashed. 
Senator CAPPER. The second trust is where the high financing took place? 
Mr. GoRDON. Not necessarily.
Senator Copeland. Your idea and contention is that even though there has been a foreclosure and new owners have taken possession, that with the amount of the investment they have to make, it goes up to the original cost? 
Mr. GoRDON. Well, maybe not that. He takes it over at $150,000. Maybe he will have to spend $15,000 to fix it up, but he may lose that much in vacancies before it is filled up again. Sometimes you have to take these houses and fumigate them with poison to get the bedbugs out. 
Senator KING. What do you allow for deterioration in buildings here per year? 
Mr. GoRDoN. Well, 2 percent or 3 percent. 
Senator KING. In 10 years a building costing $200,000 would deteriorate 20 percent? 
Mr. GoRDON. It may go further than that; and if the neighbourhood goes back, you get hit awful hard. It is a very risky business. 
Senator Copeland. Well, the present investment in an apartment house, according to your figures, is at least 25 percent less than the investment made by the original builder? 
Mr. GoRDON. I would say so, yes; but he hasn’t got a new building and is not getting the same rents, either. Keep your mind fixed on this: One-half of the apartment-house owners have lost their buildings because they would not pay. That is a fact. Look at the Star every evening and you will see big foreclosures all the time. 
Senator CAPPER. Do not the loan companies—the loan companies. are companies—the loan companies who are doing the financing—make the clean-up? They get the money.

House Values

Senator KING. Has there been a reduction in the value of the real estate in Washington during the past few years? 
Mr. GoRDoN. You can build houses now, the actual cost bein about 30 per cent less than you could four or five years ago. Ground has held its own. I am surprised it has, really. In many places vacant ground has gone up a little bit. 
Senator CAPPER. Are conditions in Washington in that respect better than probably any other city in the country? 
Mr. GoRDON, I consider Washington the safest city in the world. 
Senator CAPPER. Is it not due largely to the fact that there is a steady payroll here out of the Government Treasury? 
Mr. GoRDoN. Yes, sir. 
Senator Copeland. And no industrial life.

Construction and building new houses had become 30% cheaper.
During the financial crisis, it is safer to live in non-industrial cities.

Land Value

Senator Copeland. And, as a matter of fact, the present value of the property is probably not half that? 
Mr. GoRdon. No; I would not say that. I would say the building is 30 percent off and the ground has held its own. I think that is it. The ground has held its own. 
Senator Copeland. Then, your judgment is that the average apartment house, thoroughly modern, is worth about 30 percent less? 
Mr. GoRDON. The building; yes. The ground at the same value. The ground has held up very nicely.

Buildings had lost about 30% in value!!! 
However, what is really interesting is that the land price remained the same… Investments in lad are much safer.

Senator Copeland. What about land values? 

Mr. Do YLE. They are off in the majority of cases. There are instances where surrounding improvements naturally are holding or maintaining values, and in some places, they are going up, depending on the use of the particular property. 
Senator Copeland. Has there been anything abnormal in that? 
Mr. Do YLE. Just a general lack of demand caused by general conditions. 
Mr. BRINKMAN. If a building is worth given amount to-day, and if it would cost to reproduce that building 25 percent less than it cost to put it up originally, ought not rents to come down proportionately assuming the building was on a fair rental basis before? You would have a building worth less and you could not sell it on the market for the same price as when it was constructed. Should there not be a reduction of rentals? 
Mr. Doyle. There is no arbitrary situation where the landlord can dictate what he will get out of his property. He has to take what his tenant will pay. That is regulated by supply and demand. 
Mr. BRINKMAN. How much of a reduction should occur? 
Mr. Do YLE. It is not dependent on what costs have gone down, because we have in mind normal conditions and not abnormal conditions. 
Mr. BRINKMAN. You had a good many vacancies at 3901 Connecti cut Avenue, had you not? 
Mr. Do YLE. Yes. Mr. BRINKMAN. You reduced rents substantially, did you not? 
Mr. Doyle. They have been reduced. 
Mr. BRINKMAN. Did you rent a great many of the apartments?
Mr. Do YLE. When we first took it over we did not reduce them as much. Vacancies occurred to some extent afterward. Rents were reduced in the last two months quite materially, and old tenants were given a month’s rent. 
Mr. BRINKMAN. And you were able to rent some of those empty apartments? 
Mr. Doy LE. It has been, through very careful and good management, rented up, and I think it is practically 100 percent rented. They are very reasonable rents, but it pays no return on its cost. 

Construction Costs

Mr. BRINKMAN. How much have apartment building construction costs come down approximately in the last few years? 
Mr. Doyle. Approximately 25 percent. 
Mr. BRINKMAN. Twenty-five or 30 percent, would you say? 
Mr. Do YLE. I said 25. Of course, I am testifying.

The cost of construction reduced by 25%.
It got much cheaper to build, hence it made sense to buy deteriorated houses just for the value of its land. Demolish -> Build a new house.
However, if you wanted to build an apartment house and had to have a first-trust loan of $300,000 or $400,000, I do not think it would be humanly possible to get it. Build for cash?

Mr. WHITEFORD. I would not put a dollar in any building enterprise, and I do not think any other sagacious businessman would.
Senator Copeland. I know you can now build property very much less than you could two or three years ago. I built a building three years ago and another this past summer. My cost on the second building was about one-third less than on the first one. There is not any question about that.

Rents

Mr. WHITEFORD. … we hear these complaints of distress that can not pay any rent. I know of people who are living in houses, in apartments, where they are not paying rent. They can not pay it. There are homeowners who can not keep homes. A man came in my office yesterday and asked me to loan him $200 to pay the little installment of interest due to his home, and it is a nice, great big home worth $20,000 odd. That man is suffering. He is in danger of losing his home for a few hundred dollars, but you can not do it by wishing you could. These property owners are in a jam. They are in difficulties and have their properties on valuations and purchase prices that go back for several years. Many of them are losing them now. Their security is jeopardized, for a lot of these properties are not worth the trust.

A drop of 2.5 percent in rents in Washington between June 1929 and June 1932.

The CHAIRMAN. In looking over Mr. Brinkman’s report I see that the reductions are very small. 
Mr. BRINKMAN. That is correct.
Senator KING. You mean it is to the personal advantage of an owner to take charge of the rental of his own property? 
Mr. BRINKMAN. If I were the owner of the property I would not put it in the hands of a real estate agent, because I would have to pay them 5 percent commission, have to let him manage the property, buy supplies for it; pay in some cases 8 to 10 percent discount on purchases for the property, let them fix the scale of rates, and if a tenant is already a tenant of another member of the Real state Board, they will not accept him as a tenant. I will say it is a disadvantage in many respects for an owner of a property to turn it over to real-estate agents.

In order to reduce operational costs, owners will start managing properties on their own. Not the best time to be in the property management business.

Increase in rents by colored people

Mr. J. C. OLDEN. I represent the Better Citizens Bureau. I have made some further investigations with reference to the reduction of rent during the last week or so. I was to bring that further testimony to Mr. Brinkman, but they said they had closed reports on that matter. I can give the facts to this committee; as far as I have been able to find out in the apartment houses and houses that are rented by colored people there has been an increase in rents in the last three years and in some cases no reduction at all, possibly $2.50 or $3 reduction in an apartment. 
Senator Copeland. Does this cover a good many houses? 
Mr. OLDEN. Practically all the apartment houses rented by the colored in Washington.
Senator KING. Are any of those apartment houses owned by colored people, to which you refer? 
Mr. OLDEN. No; they are owned by white people. Some have white agents and some have colored agents.
Might not be the case in the modern world. I suspect there was much more racism back in the 30th.
Mr. BRINKMAN. Properties are not worth the assessments? 
Mr. WHITEFord. Not to-day, they are not. 
Senator Copeland. I do not know any reason in the world why the landlords of Washington expect they are going to make money when nobody else in the world is doing it. 
Mr. WHITEFoRD. Most of them are not. 
Property owners and landlords, in particular, are losing money.
If you had $500,000 you would not buy a piece of property and pay for it in cash. All large rental properties have trusts or mortgages on them made by an insurance company or trust company. There is no way in heavens world that they can escape paying 5 or 6 percent interest on their trusts and that interest rate was incurred several years ago. When you figure these properties have got to go on and pay that interest if they do not they will lose them.

Cash is King. Save cash, leverage.

Mr. WHITEFORd. The landlord gets to it every six months when he pays his interest. Sixty percent of the assessed value represents a fair mortgage, which is a fair way to approximate it. 
Senator Copeland… What percentage? 
Mr. WHITEFORD. Sixty percent of the assessed value. If that be true, then our figures show the property owner is getting less than 3 percent on his equity. 
Mr. WHITEFORD. Yes; and as Mr. Lusk says, it is less than savings bank interest; it is less than Liberty bond returns. 
Senator Copeland. Do you not think he would be lucky if he got enough to pay carrying charges? 
Mr. WHITEFORd. That is true. When you reduce the rent, you will have people that can not do it which will result in a series of foreclosures in the community.

Only sixty percent of the houses’ value is backed up by mortgage.

It seems to me that the owner and the agents overlook the great opportunity to increase the number of their tenants, and increase their income by reducing the rent. 

Senator Copeland. I will tell you about my experience. I just came from Michigan where I went to see my father. My sister and I own some modest little homes and I asked her how she was getting along with the tenants. She said she cut the rent in two, in each instance, because by doing that she kept the tenant. They could not pay more than that, and if they had moved out because of the rental they had been paying, certainly she could not have rented the property to anybody else, because nobody else would pay it, but by making those reductions houses are occupied. As the chairman said, it seems to me in view of this great crisis, as it is going to be worse after this Congress adjourns, we have got to do something to take care of these people, and the landlords have just got to face the situation. If they do not cooperate they are go ing to lose anyhow, because these people can not the rent. They will have to reduce them or they will move out.

Mr. WHITEFord. We are reducing them. We have shown a lot of reductions, and experience shows it every day. Many of them are losing their property under foreclosure, anyhow, whether they reduce them or not. 
Senator KEAN. In the city of Elizabeth, where I come from, there is a row of apartment houses that used to rent for from $55 to $60 a month. They had been getting it right along, but now they are down to $27. 
Mr. WHITEFORD. If they have any trusts on the property they can not carry them.

Increase the number of their tenants, and increase their income by reducing the rent. How many tenants can you put under one roof? Now there are a lot of regulations that will restrict that.

Reference

United States. Congress. Senate. Committee on the District of Columbia. Subcommittee on Rental Investigation. (1932). Rents in D.C.: hearings before the United States Senate Committee on the District of Columbia, Subcommittee on Rental Investigation, Seventy-Second Congress, second session, on June 17, July 28, Sept. 9, Nov. 10, 30, Dec. 1, 2, 17, 20, 21, 23, 27, 29, 1932. Washington: U.S. G.P.O..

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Money, Credit, and Debt – COVID-19 Inspired

Below is my excerpt accompanied with main takeaways from the study published by Ray Dalio – an American billionaire hedge fund manager and economist, on April 23, 2020. (LinkedIn post)

We shouldn’t rely on governments to protect us financially. 

We should expect most governments to abuse their privileged positions as the creators and users of money and credit.

All countries can print money to give to people to spend or to lend it out.  However, not all money that governments print is of equal value.  

You cannot create more wealth simply by printing more money and creating credit. To create more wealth, one has to be more productive. The relationship between the creation of money and credit and the creation of wealth (actual goods and services) is often confused yet it is the biggest driver of economic cycles. 

Money and credit are stimulative when it’s given out and depressing when it has to be paid back. When the economy is growing too quickly and the government wants to slow it down, they make less money and credit available, causing both to become more expensive. When there is too little growth and central bankers want to stimulate the economy, they make money and credit cheap and plentiful, which encourages people to borrow and invest and/or spend.

The short-term cycles of ups and downs typically last about eight years. These short-term debt cycles add up to long-term debt cycles that typically last about 50 to 75 years. The last big long-term debt cycle, which is the one that we are now in, was designed in 1944 in Bretton Woods, New Hampshire, and was put in place in 1945 when World War II ended. However, these long-term debt cycles take about a lifetime to transpire, unlike the short-term debt cycles that we all experience a number of times in our lifetimes so most people understand better.  When it comes to the long-term debt cycle most people, including most economists, don’t recognize or acknowledge its existence because, to see a number of them in order to understand the mechanics of how they work, one has to look at them operating in a number of countries over many hundreds of years in order to get a good sample size. 

When it is widely perceived that the money and the debt assets that promise to receive money are not good storeholds of wealth, the long-term debt cycle is at its end, and a restructuring of the monetary system has to occur. 

When countries were at war and there was no trust in the intentions or abilities to pay, they could still pay in gold. So gold (and to a lesser extent silver) could be used as both a safe medium of exchange and a safe storehold of wealth.  

A person puts money in a Bank in exchange for interest (profit) -> Bank lends that person’s money to somebody else in exchange for a higher interest (profit) -> Those who borrow the money from the Bank like it because it gives them buying power that they didn’t have. Everyone is happy. 

Trouble approaches when either there isn’t enough income to survive one’s debts or the amount of the claims (i.e., debt assets) that people are holding in the expectation that they can sell them to get money to buy goods and services increases faster than the number of goods and services by an amount that makes the conversion from that debt asset (e.g., that bond) implausible.  

Think of debt as negative earnings and a negative asset that eats up earnings (because earnings have to go to pay it) and eat up other assets (because other assets have to be sold to get the money to pay the debt). When incomes and the values of one’s assets fall, there is a need to cut expenditures and sell off assets to raise the needed cash (to pay the debt). 

When that’s not enough, the following happens:

  1. Debt restructurings where debts and debt burdens are reduced, which is problematic for both the debtor and the creditor because one person’s debts are another’s assets 
  2. Central bank printing money and the central government handing out money and credit to fill in the holes in incomes and balance sheets (which is what is happening now).  It occurs when holders of debt don’t believe that they are going to get adequate returns from it.

When people go to Banks and take the money they invested (for interest) out of it to buy goods and services, the bank has two choices:

  1. Allow that flow of money out of the debt asset (raise interest rates and cause the debt and economic problems to worsen).
  2. Print money. 

An important difference between money and debt. Money is what settles claims—i.e., one pays one’s bills and one is done. Debt is a promise to deliver money.

This Already Happened Before… Several Times

In 1971, on the evening of August 15, when President Nixon spoke to the nation and told the world that the dollar would no longer be tied to gold. This led to stock prices rising. On Sunday evening March 5 President Franklin Roosevelt gave essentially the same speech doing essentially the same thing which yielded essentially the same result over the following months (a devaluation, a big stock market rally, and big gains in the gold price). That happened many times before in many countries, including essentially the same proclamations by the heads of state.  

The coronavirus triggered economic and market downturns around the world, which created holes in incomes and balance sheets, especially for indebted entities that had incomes that suffered from the downturn.

When credit cycles reach their limit, the following events take place:

  • Interest Rates fall down. When there isn’t much room to stimulate by lowering interest rates (or printing money and buying financial assets) the greater the likelihood that there will be a monetary inflation accompanied by economic weakness. Stimulating money and credit growth by lowering interest rates is the first-choice monetary policy of central banks.
  • The government prints more money and creates additional debt. It is both the logical and the classic response for central governments and their central banks to create a lot of debt and print money that will be spent on goods, services, and investment assets to keep the economy moving. That is what was done during the 2008 debt crisis when interest rates could no longer be lowered because they had already hit 0%. As explained that was also done in response to the 1929-32 debt crisis when interest rates had been driven to 0%.  This creating of the debt and money is now happening in amounts that are greater than at any time since World War II. The European Central Bank, the Bank of Japan, and—to a lesser extent—the People’s Bank of China made similar moves.
  • People will shift their wealth into other things. Current money printing increases the chances that money will be printed too aggressively and not used productively so people will stop using it as a storehold of wealth and. They also often move their wealth to other storeholds of wealth like gold, certain types of stocks, and/or somewhere else (like another country that is not having these problems). 
  • People will seek to sell their debt assets and/or borrow money to get into debt that they can pay back with cheap money. 

Such periods of reflation either stimulate another money and credit expansion that finances another economic expansion (which is good for stocks) or devalue money so that it produces monetary inflation (which is good for inflation-hedge assets such as gold). 

  • Economic stress caused by large wealth and values gaps, will lead to higher taxes and fighting between the rich and the poor. The rich move to hard assets and other currencies and other countries. Those countries that are suffering from this flight from their debt, their currency, and their country will want to stop it. Expect governments to try to make it harder to invest in assets like gold (e.g., via outlawing gold transactions and ownership), foreign currencies (via eliminating the ability to transact in them), and foreign countries (via establishing foreign exchange controls to prevent the money from leaving the country).

When there is a large wealth gap, big debt problems, and an economic contraction, there is often fighting within countries and between countries over wealth and power. Also this will lead to domestic and international political changes. 

  • The governments will go back to some form of hard currency (e.g., gold or a hard reserve currency) to rebuild people’s faith in the value of money as a storehold of wealth.
  • People will start selling their assets. To deal with that monetary inflation crisis and break the inflation, the supply of money will get tightened, which will drive interest rates to the highest level “since Jesus Christ”.  Debtors will have to pay much more in debt service at the same time as their incomes and assets fall in value. This will squeeze the debtors and require them to sell assets.

We shouldn’t rely on governments to protect us financially. 

We should expect most governments to abuse their privileged positions as the creators and users of money and credit.

References

  1. Debt buyer (United States). (2017). Retrieved 26 April 2020, from https://en.wikipedia.org/wiki/Debt_buyer_(United_States) 
  2. Chapter 2: Money, Credit, and Debt. (2020). Retrieved 26 April 2020, from https://www.linkedin.com/pulse/money-credit-debt-ray-dalio/?trackingId=SFvpSLUTwhBNNU8641VbRA%3D%3D 
  3. Understanding Devaluation, the Causes, and the Downsides. (2020). Retrieved 26 April 2020, from https://www.investopedia.com/terms/d/devaluation.asp 
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COVID-19: Oil & Stocks

Cheeeeep GAS

You have already noticed that the gas prices went down. Significantly! The first drop started on February 21st (Friday). Nothing critical, a slight fall down which had stopped on February 28th (Friday), exactly in a week. We are witnessing the Oil War – an epic battle between Russia and Saudi Arabia.

  • Why did the fall stop? 
  • Why did it rise back up? Briefly, but it id
  • Did someone regulate it? 
  • Was there events that caused the stall?
  • Is there an economic mechanism for oil price regulation?

Who controls the oil prices?
 OPEC or the Organization of the Petroleum Exporting Countries was formed to negotiate matters concerning oil prices and production.

How does OPEC do it?
OPEC controls oil prices through its pricing-over-volume strategy. … Thus, when there is a glut of oil in the world, OPEC cuts back on its production quotas. When there is less oil, it increases oil prices to maintain stable levels of production.

Why do oil prices fall?
Factories have been idled and thousands of flights canceled around the world as the coronavirus outbreak. People work from home – they drive less. Shrinking demand for jet fuel, gasoline and diesel. And now – the travel ban between the United States and Europe. It’s a nightmare scenario for the oil market.

What cheap oil means?

  • You will benefit from lower oil prices and the resulting decline in gas prices at the pump, especially in the United States where retail markets react more directly to supply and demand.
  • If you work on oil somewhere in the plant in Texas, Louisiana, Oklahoma, New Mexico or North Dakota, you will most likely lose your job.

Warren Buffett talks oil price plunge

Stock are Down

Let’s see what is happening in market by industry:

Every industry has been negatively affected. Some more, some less. I circled the most affected industries. Let’s look closer:

Consumer Discretionary Sector -> Tesla is doing AMAZING

⬆️ Stocks that are on rise:
⬆️ Technology Sector displays growth:

Grocery Stores Industry shows great Performance. Costco stocks went up. People buy food in bulk! Folks also buy drugs, which is totally understandable and clearly observed from the stocks perspective Pharmacy Services & Retail Drugstore Industry Performance.

People play more video games: Gamestop Corp   (GME)

People are being asked to isolate themselves. This is against human nature, therefore people will find other “safe” ways to socialize. Because people won’t socialize as much, they won’t buy a lot of jewelry and accessories. Apparel industry will also see a dip. 

Shares of Signet Jewelers Are Down

Tiffany & Co. (TIF)

So what does the market tell us?
  1. People are scared
  2. When people are scared, they buy food and drugs. In bulk!
  3. Computer companies are on the rise. Particularly Networking and hardware industries
  4. People spend more time at home and play more video games
  5. When people don’t socialize as much, they worry less about the way they look
  6. People won’t go to the grocery stores as much. Online grocery shopping and delivery will grow
  7. People invest in Gold – one of the safest currencies.
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COVID-19: The time of great Opportunities p.1

Up to this day I have not given too much of my attention to all the hype around COVID-19 virus. Up until now, however not because of the virus itself, but economical and social changes it caused directly or indirectly. The changes I witness are monumental. Right this moment we live in a really-really interesting moment. Nothing like this had happened before and we are at the front row of sets in theater of life.

Before I dive into the current state of economy and all the exciting things that’s happening, I need to refresh the memory on some of the basics. To make educated decisions and fair assumptions you have to understand how the economy works. This is the first time I actually went back to the knowledge I obtained at MBA school in my ECON class.

Low Interest Rates

As of March 13, interest rates are historically low. The last time we’ve seen such numbers was in 1991. What does it mean to you, economy and society?

Low interest rates are good for the economy: they stimulate people to buy more. Spending drives the economy. One person’s spending is another person’s income. The more people buy, the more is being produced. The more real estate a person owns, the more willing a bank is to grant the mortgage to that person. (coladerall)

Because interest rates are low, people will start to borrow more money. Borrowing will set us into the short-term debt cycle. This cycle works in phases, and typically lasts 5-8 years. 

The phases are: 

  1. Interest Rates are low.
  2. Spending increases. People buy more stuff. Economy expands
  3. Income Increases. One person’s spending is another person’s income.
  4. Prices go up. Especially its noticeable in the real estate market. Because production of goods could not keep up with the growing demand, prices on existing houses go up. Now more people have money and are wanting to spend them, however it takes time to build the house.
  5. Inflation goes up. This is where the problems begin. 
  6. Interest rates go up. 
  7. People borrow less. Fewer people are now able to borrow.
  8. Spending decreases. People spend less.
  9. Income Decreases. Economic activity decreases
  10. Deflation
  11. Recession 
  12. Lower Interest Rates
  13. Repeat. 

Accessible Credit – Expansion 
Hardly Accessible Credit – Recession

With the new knowledge in mind we can assume and expect house prices to rise. Everything happens in cycles and the short-term debt cycle is just a building block of the long-term debt cycle. Each time The Bank lowers interest rates to stimulate the economy and get back on track, we leave more and more debt behind. Debt burden slowly grows until it’s not. Economic collapse is inevitable in countries with credit. People are not good at spotting long-term patterns and it makes it hard for them to spot, even harder to predict when the next crash comes. It all eventually leads to depression…

Key Takeaways:

  1. House prices will rise
  2. People will buy more
  3. Interest rates will remain low for some time (no need to rush)

The questions are:

  1. Why does the government stimulate the economy by lowering IR?
  2. What will be the lowest interest rate in this cycle and when will it occur?
  3. How long will housing prices be rising for, until we reach the ceiling?

YouTube Video: How The Economy Works by Ray Dalio

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Best Real-Estate Markets to Invest in Rentals | Ontario, Canada

I began my real estate investment journey from picking the market to invest in. My main goal is cash flow. Through my research and speaking with multiple real estate agents I narrowed down my scope of search to 5 markets:

  • Barrie
  • Oshawa
  • Peterborough
  • Windsor
  • Sarnia

Below I share my research and key findings:

Real-estate market analysis, Ontario CanadaDownload
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First-Time Home Buyer Incentive | Canada

Let’s talk real-estate.
Have you heard of the First-Time Home Buyer Incentive?

As a first-time home buyer I got really interested in First-Time Home Buyer Incentive provided by the government of Canada. It was released just over a month ago (September 2nd). Government of Canada plan to spend $1.25 billion over three years for the First-Time Home Buyer Incentive (FTHBI). They designed it to lower new homeowners’ monthly mortgage payments without boosting their down payment costs. Okay… Continue.

What exactly are you being offered?

  • 5% for a first-time buyer’s purchase of a re-sale home 
  • 5% or 10% for a first-time buyer’s purchase of a new construction
  • It is not interest bearing and does not require ongoing repayments.   

It all sounds too good to be true. How much and when do I need to pay back?

You can repay the Incentive at any time in full without a pre-payment penalty. You have to repay the Incentive after 25 years or if the property is sold, whichever happens first. The repayment of the Incentive is based on the property’s fair market value. 

  • You receive a 5% incentive of the home’s purchase price of $200,000, or $10,000.
    If your home value increases to $300,000 your payback would be 5% of the current value or $15,000. 
  • You receive a 10% incentive of the home’s purchase price of $200,000, or $20,000 and your home value decreases to $150,000, your repayment value will be 10% of the current value or $15,000.

A-HA! Now I see where is the catch. Easy money for the government. Here are the few examples to demonstrate how this is beneficial for the government:

Government does not like to lose money and there are some smart people working to make sure it doesn’t happen. Consider that fact and examples above I make the following assumptions:

  • Government anticipates the growth of real estate market over the next several years. It is safe to buy.
  • Government tries to stimulate the new affordable housing development. It is profitable to build. This is a great time to be in construction business.
  • Property prices on the outskirts of GTA real-estate markets are expected to grow. Here is why:
    Total borrowing is limited to 4 times the qualifying income ($120,000 annually x 4 = $480,000). The combined mortgage and Incentive amount cannot exceed four times the total qualifying income.  The amount for the mortgage loan insurance premium is excluded from this calculation. 
    It is almost impossible to find a decent property in Toronto GTA for $480K. You got to expand the scope of search and look further. People will start buying houses in the areas like Barrie, Hamilton, Niagara, Oshawa, Windsor, Brampton etc… Because of increased demand I expect significant raise in house prices in those areas.

For a personalized example, I used the First-Time Home Buyer calculator to see, if qualified, how much money can I save using this incentive. Let’s say you make CAD$100,000 annually and want to buy a house for CAD$440,000 with $40,000 down payment. FTHBI will save you about $120 on monthly payments and $1440 /year respectively.