A
couple weeks ago I was at the physiotherapy clinic undergoing painful dry
needling to address an injury I sustained at the gym. The physiotherapist,
Lauren (name has been changed), told me that she was planning on purchasing a
condo so she can rent out and collect a small income from it. She said she saw it done on HGTV and it’s something she has been
thinking about for some time.
Real-estate investing is a good idea [bet you didn’t expect me to write
that line in this blog!]. The only
caveat is that the numbers need to make sense.
As
the needles went into me, she explained how she can easily rent out the place
for more than the monthly mortgage costs. “Always a good start” I thought while
enduring excruciating pain.
The
conversation then went something like this:
Joey:
“What about the maintenance fees for the condo?”
Lauren:
“Well, what about them?”
Joey:
“How much are they and did you take that into account”
Lauren:
“No, they’re not much I don’t think. Doesn’t the tenant pay them anyways?”
Joey:
“No, you pay them. Ok, how much is the monthly taxes?”
Lauren:
“Maybe $1500? I don’t really remember”
Joey:
“How much is the insurance for this rental unit? It’s usually more than a
standard homeowner’s policy since tenants are in there”
Lauren:
“I thought the condo board pays that?”
Joey:
“No, you pay that”
Lauren:
“Oh”
Joey:
“What percentage are you allocating for when the unit is empty and for costs
associated with damage caused by tenants”
Lauren:
“Tenants could damage my property?”
Within
a few moments, I realized Lauren had not exactly thought this plan through. This
was a highly-educated person who was thinking of making one of the biggest
financial transactions of her lifetime and she as relying solely on information
she obtained from HGTV. She wanted to
buy in my current area so I already had a good idea what the missing numbers
were. We calculated it all and concluded
that she was going to be losing money
every single month. I thought, well
at least she figured this out before signing on the dotted line.
Then
the bombshell came.
“I
already put the deposit down.”
Real-estate
investing 101
Investing
in real-estate is a great way to build a steady stream of income that could one
day replace the current income you generate from your job and then some. Many financially successful people in the
world have real-estate investments in some form or another. I must have read at
least a dozen or so books on the topic as I’ve always been fascinated by
real-estate investing.
It’s
not an overly complicated process and it goes something like this: you put down
15-25% of the purchase price, you make a few repairs or renovate it to maximize
rental potential, and then you rent it out to a suitable tenant(s). The key is
that the rental income is more than all the associated costs including mortgage
payment, insurance, property taxes, reserves for damages and times the unit is
vacant and all associated maintenance costs. At the end of each month, there
should be a surplus of money known as “cash-flow” which you can use for
yourself or to store away for more property acquisitions down the road.
As
time goes on, you can leverage the property to buy other properties or you can
just sit on it until the mortgage is paid off and collect the rents until you
ready to sell it. Or maybe you’ll redevelop the property into something else
once you raise enough capital. There, I saved you the time and effort of
signing up for a real-estate seminar or reading a book on topic. You’re
welcome.
From
positive to negative
For
the past few years, I’ve been looking at various semi-detached and detached
homes in the Toronto area with the intention of doing some renovations and then
renting it out. Every single property I looked out was a losing proposition.
The only way to make money was to put down 30-40% plus another $50-90k for
renovations, which was an obscene amount of capital and would have put my
entire net worth into one single asset. It’s the equivalent of putting all your
money into one stock, a very high risk and ill-advised strategy. I’ve been burned before betting everything on
one horse and I was not going to repeat history again. But, maybe it was just me and others were
making money?
What
I’m about to tell you may seem shocking to some, even those who attended the
Real-Estate Wealth Expo in Toronto recently and were told real-estate investing
is a viable way to make money in Toronto and to do whatever it takes to buy
real-estate.
Most
“investors” who entered the market in the last 2-4 years are losing big money every month. I don’t
know about you, but investing is about making
money every month, not losing money. When you buy shares in a company,
bonds, preferred shares, ETFs, mutual funds, REITs or any other financial asset,
there is an expectation that your investment will grow via dividends,
distributions, interest and, hopefully, a capital gain. But, would you buy a
financial asset and pay several hundred bucks or even a thousand dollars a
month to hold it? Heck no! What sane, rational investor would do that?
While
gyrating expert Pitbull may have given an inspirational speech on going from
negative to positive at the Real-Estate Wealth Expo in Toronto a couple months
ago, he would have done a better service explaining to the audience how in
reality real-estate investing went from positive to negative. I now welcome you
to the world of Pitbull Voodoo Math.
Minority
Report
John
Pasalis is a real-estate agent and president of Realosophy Realty in Toronto. Mr. Pasalis recently wrote an extensive report
analysing the Toronto and GTA real-estate markets to ascertain why prices have
exploded in the last few years. As you
may not know, real-estate data in Toronto is a closed system. You and I cannot
find out the selling price of a home and what it sold for the last 5 times,
only a realtor with access to the MLS system can (in case you’re wondering,
most other places in the world have an open system).
Mr.
Pasalis wrote an extensive report analyzing all the data and he reached a
startling conclusion: 95% of all real-estate
investors who bought properties with a whopping 35% down payment lost money
every single month in 2016.
Now,
earlier in this post I indicated that real-estate investing usually involves
putting a down payment of 15-25%, which, therefore, means anyone who put down
less than 35% was almost 100% assured of losing money. There are few things in
life that are sure bets – the two big ones being death and taxes. Should we add
Toronto real-estate investing = losing money to that list?
Mr.
Pasalis also noticed something different happening with the market, people were
coming into his office eager to purchase money losing properties because they
wanted to flip them a short time later. These buyers were willing to take out
line of credits and even use their credit cards to pay the monthly difference.
Here is the kicker – in Toronto the average “investor” was losing a monstrous $1,121.00 every single month. Welcome to
peak insanity ladies and gentlemen!
It
takes a lot of chutzpah to write a thorough, well-researched, methodologically
sound report that directly debunks the narrative that some of your peers preach
and will likely ostracize yourself (send me an email if you want a copy). I
would imagine Mr. Pasalis will be cut off the Christmas card list from many of
his colleagues this year because he called a spade a spade.
What
does the industry say about this report?
I
inquired with various industry players on their thoughts on your behalf. As
expected, no one replied to my inquiries. This wasn’t a great shock; if I was a
real-estate agent I would probably have better things to do with my time then
to respond to some shmuck’s questions about a less than favourable report.
So,
I did what most Torontonians do on a Saturday afternoon in the spring, I went
to a whole bunch of open houses.
Hitting
the pavement
I
attended some open houses in the Mt. Pleasant and Eglinton area which is one
the hottest areas in the city right now when it comes to real-estate. Houses
here, as I was told, do not sit for more than 5 days before they are scooped
up.
As
you and I have read in multiple newspapers, magazines and blogs over the past
few months, open houses are apparently mini-circuses where hundreds of people
come in droves to check out the place before making a hasty offer above asking
price. Well, the open houses I attended
were pretty much empty. These were sub $1 million homes – the most desired and
lusted for digs. This was spring time in Toronto, the proclaimed hottest
real-estate market in the world, on a Saturday with beautiful weather and it
was just me and one couple touring the open houses. I say one couple
because we followed each other to the other nearby open houses. At one house, we
gave each other awkward looks when we simultaneously noticed that the upstairs
floors were wobbly; it was a true Kodak moment, I wish you were all there to
see it.
I
spoke to the realtors who were managing these open houses. All were very nice
and knowledgeable individuals. After asking them some basic questions about the
property and developing a good rapport, I casually brought up Mr. Pasalis’
report. The mood instantly went from joyful and friendly to apprehensive and
vigilant. Apparently, they all read it! They all downplayed it and stated I
shouldn’t take anything from it as it was “wrong”. Most realtors declined to
answer any more questions on the topic.
As a lawyer who deposes people on a weekly basis, failing to answer
questions means something was amiss.
One
took the bait, however. “The assumptions made in the report were faulty,” she
stated. I asked if she could explain that and I received a nonsensical answer.
I pushed a little more, “was the math done wrong?” She replied, “well, that I don’t know, but
our office puts little weight on it”. After receiving this politician answer, I
asked the big question, “listen, I understand you don’t agree with it, give me
something, anything, to dispute the findings written here”. I was met with deafening silence. She then
changed the topic to the new appliances put into the home, which were quite
attractive and sparkly I must say.
In
life, when someone doesn’t give you an answer to an important question, it’s
usually because the answer isn’t pretty. For example: if you ask your
significant other “did you cheat on me?” and your partner is silent, odds are
high the answer is not great. Even for the
mundane things in life such as asking a server at a restaurant if a dish is
good and the server is silent, odds are high it’s a crappy dish.
It was at this
very moment that this realtor knew that I knew, and all you reading this blog
now knows, that real-estate investing in Toronto died. It died a painful death
a long time ago. What remains is the high-risk game of speculation and Pitbull Voodoo
Math – losing money every month.
***
When
I initially wrote this blog post, I referred to this wonky math as “Hood Rat
Math”. “Hood Rat” is a pejorative term used to describe inner city persons
engaging in scandalous activities, usually illegal. After eating a large bowl of Reese Peanut
Butter Puffs, and careful reflection, I decided to go with Pitbull Voodoo Math
because it would have been insulting to inner city drug dealers who have a
clear understanding if they are making or losing money at the end of every
month.
All
joking aside, there are now countless people like my physiotherapist, Lauren,
who are losing obscene amounts of money every month on so called real-estate
“investments”. Most are too afraid to admit it for fear of feeling like a
failure and others are adamant that they will time the market perfectly and
make out like bandits. This is the problem when Pitbull’s Voodoo Math has
infected the masses. How long this game of taking out cash advances on credit
cards to pay the monthly losses on these properties is anyone’s guess. All I can say is that it’s a very toxic, high
risk endeavour.
The Greater Fool Theory
The
greater fool theory is probably the simplest concept that
will be discussed in this blog. “I may be a fool by paying X dollars for this
object, but I know there is a greater fool out there who will pay me more for
it”. The object can be anything: tulip bulbs, Nortel stock, beanie babies, oil,
gold, Miami condos, artwork, and even Toronto real-estate. The only thing that
matters is that there is someone out there who is stupider and will pay more
for something than what it’s really worth.
This
game of hot potato or musical chairs, whichever analogy you prefer, works just
fine if there are enough irrational market participants with access to greater
and greater amounts of cheap money. People participating in this game are only
playing to quickly make a buck, not because they believe the object is worth
anywhere close to the price they paid. It’s the definition of Russian roulette
because the last one holding the bag is the true greater fool. He or she is the
one who ends up paying the most for that object that quickly depreciates back
to its true intrinsic value.
Will
you be the greater fool?
