…“This anecdote comes courtesy a family friend. A bit of background is perhaps appropriate here. Family immigrated from Asia over 20 years ago and has amassed equity of about $1MM or so. Couple is in their early 60s. Currently they live in a $750K house with basement suite and have about $400K invested in equities and cash. The house has a $200K VR mortgage.
…Last weekend they bought a $1MM 3 year old house which has 4 br up, 3 br down that can be converted to basement suite. They were pre-approved for $800K mortgage. This is based on them renting out part of the house and one of them working. The other is retired.
…They are thinking about selling their existing property (they also are thinking about renting it out if they can’t sell for the price they want). Their plan is, when they retire in a few years, to liquidate the other house and pay off their soon-to-be primary residence’s mortgage. They will be collecting a meagre CPP and OAS, and plan to supplement these with rental income from the basement. …They simply do not want anything to do with equity/security markets. There is little cash flow to be had for low risk these days, so they claim, and previous attempts to make money through stock/bond markets have produced poor results relative to what their peers have amassed in real estate.
…They are also aware of a few friends of theirs who have recently downsized into townhouses/condos from detached dwellings where they were renting out basement suites. It turns out these people were amassing an extra $15-20K per year in undeclared income on their suites that is no longer possible through downsizing and are now ruing the move. So the situation they now face is that they want a way of producing secure income, tax-efficiently — never mind they can get 5-6% tax-efficient divvies — as well as collecting CPP and OAS. They also want the ability to host visiting family in a larger home.
…So there’s an ongoing element of hedging going on in this market, where people are concerned another leg-up in prices will render their desired retirement home unattainable. They are doing the maths now where they can, with such a purchase, eke out a retirement in a comfortable and relatively expansive home with some rental income. After this purchase, in a few years, they will have a few hundred K of liquid savings and purchased a $1MM home.
…This family will not be living well — relatively little income — but they will be stable and comfortable. They do not *have* to sell, so long as their living/medical/repair expenses remain contained. What’s scary isn’t that this family is so heavily invested in real estate, it’s first that their incomes are low enough they will be relying on OAS despite considerable equity. Second they will be spending very little in the years to come, hardly a boon for the local economy by any stretch. One wonders if Vancouver is prepared for the drop in consumption that could befall an increasingly house-poor city in the coming years.“
- jesse, at VREAA, 10 Oct 2011 4:48pm
So:
Couple in early 60′s.
Current home: $750K market value, $200K VR mortgage (plan to sell “in a few years”, but, for foreseeable future, holding.)
Second home: $1 Million market value, $800K mortgage
Other investments: $200K equities/cash ($400k minus $200K downpayment on second home).
Net-worth: $950K
RE being carried: $1.75 Million
Percentage of net-worth in RE: 184%
Thoughts:
1. Thanks for the remarkable story, jesse.
2. The couple have 184% of their net-worth in RE at a time in their lives when they should probably have no more than 35%-40% therein. These guys are buying more when they should be scaling down. This act is a bizarre product of the psychological climate regarding RE in this town.
3. If RE prices drop 25%, they lose almost half of their total net-worth; a drop of 50%, and this couple are almost completely wiped out. They likely see the chance of any significant price drops as being non-existent. If they lose 50-100% of their net-worth, they will be emotionally devastated; it will colour the rest of their lives. They will never recover. They are playing with far bigger stakes than they imagine. [note to fred - that's 'stakes', not 'steaks' -ed.]
4. They are speculators; they are speculating heavily that prices will remain strong. But they would likely be shocked and perhaps offended to hear anyone describe them as speculators. They don’t realize it but they are gambling, as sure as if they took their money and went to a casino, and put it all on Red. In fact, a successful professional gambler would likely calculate that the casino option is a better bet than holding this position in Vancouver RE. Professional gamblers understand risk; this couple do not.
- vreaa
What I heard is that they’re planning on consolidating RE holdings into one property, either right away by quick sale of current residence, or in a few years when they are in full retirement should they not be able to sell the property for desired price. Their worst-case scenario at that point is selling at a loss and downsizing.
This is the endgame of being house poor. When we see people pay way more for certain low-density properties than rental value they are in effect paying higher carrying costs for future capital gain. This is rational. But when it comes time to realise those cap gains and looking at the lifestyle shift that results by “downsizing”, it’s not always so easy.
Okay, so, if they sell quickly, they’ll reduce their exposure and their risk.
Even then, however (assuming they sell at $750K):
Net-worth: $950K
Value of home: $1 Million
They would still have about 100% of their net-worth in RE, and they would still be severely hobbled by a significant pullback.
If they manage to sell and close off any outstanding debt, they may not care too much if the value decreases. They are hedging — albeit poorly — and stability of tenure is more important to them than cash flow. I can’t make this up.
If they leave their current residence and live for more than a year in the new one before selling, do they have to pay capital gains on the first house?
They’ll probably try to weasel out of those taxes too. If the feds ever wise up there’s going to be a world of hurt for many property owners in Vancouver.
I hope they land in jail.
nice you of to provide your financial management services vreaa. I’m sure there must be some naive saps out there that buy you bullshit.
Ideally I’d like to be invested 100% in real estate in a bull market and 0% in a bear market. But life doesn’t work that way since we all need a home to live in and most don’t panic and sell at the slightest negative news.
I’m sure with your years of financial planning experience you can advise us as to the correct %’s to invest in each sector, as if it were as simple as slicing up a pie. But again, life doesn’t work that way
BTW, since you’re 0% invested in real estate then your bank account with 20 bucks in it means you have 100% cash; is that advisable?
Keep it in the real world vreaa, that’s where most of us have to live our lives
Keep it kind, Hardy. If you find errors in another’s logic, point them out in a rational way without bitter sarcasm. Vreaa’s comments and analysis are rational and compassionate. Let’s hope some readers act to avoid the financial potholes in the real estate road. The couple discussed in the post have not diversified their investments and are gambling on a future increase in real estate prices. Financial planning for the real world recognizes bear and bull markets of different assets at different times – and diversifies accordingly.
Vreaa, Jesse and other contributors – thank you for the ongoing posts. I enjoy the site and visit daily.
vreaa is living in a dream world and wants others to join him
Weak effort, son. I’ll give you a Mulligan.
As a general rule, don’t ever invest 100% of all capitol in one type of investment.
Okay, so Hardy believes I’m not in “the real world” and diablo is convinced I’m “in a dream world”.
I would love to be a fly on the wall when prices do what they are inevitably going to do (fall out of bed) and you guys suddenly wake up screaming and find out that it’s YOU who have both been dreaming (“dreamin’ the Vancouver RE dream”, that is)… but, my wanting to witness that is in itself a dream, as you’ll both have simply disappeared at that point… ‘poof’… like ephemeral apparitions…
BTW, Hardy -> We note from your post that you acknowledge that there is such a thing as a “real estate bear market”.
If they exist, how would one prepare for the possibility of one occurring?
And, hey, we notice that you dole out “financial advice” as readily as the next guy.
Vreaa,
One of these days the shit is going to hit the fan (probably soon) and guys like Hardy who are all in real estate are going to be hurting. I too have told people not to buy. I even consult with a real estate agent to help her buy a income property (one that pays her, not the other way round) she’s actually more than 100% in real estate because her income depends on it as well.
The satisfaction that you were right, will be far outweighed by the sadness of so many people being completely financially decimated. It’s like they have blinders on they can’t see that our situation is similar to the US at all.
Honestly, I too can see the catastrophe coming as I observe people “investing” in a way that is the furthest thing from “investment” you’ve ever seen. From my vantage point I can see who’s selling and who’s buying and when you can see an exodus of long term landlords cashing out like I’ve seen…it doesn’t bode well for the market. These are smart guys and they’ve been around the block more than once. Right now they are sitting in all cash just waiting to buy. I have tons of these guys on my rolodex. They won’t buy if they can’t make money and they’re not buying right now.
One of the very skilled commercial real estate agents, a guy with 20 years experience, is starving to death because he also has a rolodex full of people who won’t buy because they can’t make money at these prices.
So keep going you are absolutely on the right track and when the wall tumbles down, I guarantee that Hardy won’t come back and tell you you were correct.
Totally ludicrous.
Here in Nova Scotia we are seeing RE slowing down. I am bicoastal and run my business in NS and am still wrapping up my business here in Vancouver. Things are getting ugly everywhere. My Boomer friends are wising up and are selling their toys, cutting vacations, they don’t go out as much and they will run their current vehicle into the ground.
The numbers our accountant ran for me proved to me at least, that we are in a Depression, much like 1920-1 and again in 1929. Sadly, this will be much worse. The folks in the Thirties had gardens and pulled together.
Sales of guns and ammo in the States tell you where this is all heading.
I sure hope I am wrong. BTW the AC jet from Hfx to YVR was not full.
In any case – Merry Christmas, and hope 2012 is not the disaster I fear.