Clients started to talk to me about real estate. For example, it would have been in the early 2000s when, for the first time but not the last, one client informed me that he’d bought a condo in Montreal so that his daughter could attend McGill. That was a surprise to me, as I would never have considered that as an investment.
So I decided to examine the merits of owning a residence for a university student. Many questions came to mind. How long does it take to complete a degree program? What if the student drops out? How does the student keep up the maintenance of a house such as shovelling snow in the winter and cutting the lawn in the summer while attending university? What happens when the toilet stops working? Don’t students just need a room to sleep because they spend almost all their hours at class or studying or partying? Aren’t students supposed to be focusing on their studies, having fun, and meeting new and interesting people? Perhaps they might want to change their study program that would require a change in universities?
I could think of many potential problems that would argue against the idea of buying real estate for such a short period of time in a city away from the home base. How much does it cost, for instance, to buy and sell a condo or a home? In a short period of four years the cost of real estate commissions and legal fees and repairs that always seem to be required would negate any potential gain, I thought. Isn’t real estate close to a major university expensive?
Of course, I am biased. I am in the business of managing portfolio investments in the publicly traded bond and stock markets. I would have been thinking that the money invested in the house would be better invested with us in our portfolio management service. So I gently challenged those people on their investment choices in buying additional housing to rent to students. I was wondering (usually only to myself ) why they would opt for such a bad investment choice as real estate and forego the chance to add to their investment portfolio with my team. Business considerations aside, though, I was genuinely puzzled by this new trend. So I asked them, “Why?”
The answer came back in several different forms but the simplest version was this: “Real estate is a good safe investment and it always goes up in value.”
When I threw out the idea that renting a condo or a house for the student would make more sense because of the short period of use in a typical university experience, the answer came back without any hesitation: “Why pay rent when I (or my child) could be building equity in a home? Why pay the landlord’s mortgage for him?” In addition, some of them would add that they wanted their child at university to experience homeownership and to get into the housing market “as soon as possible.”
I was surprised by this change. My experience had made me much less likely to believe in real estate as an investment. Just a few years earlier (1995), home values in Edmonton and Calgary and elsewhere in Canada were at rock bottom. Prices had declined or had, at best, no growth for the previous fifteen years going back to the 1980 peak. People had been waiting more than ten years just to break even on their homes.
Our family home purchased in 1990 for $300,000 was sold ten years later after a full year on the market, at the same price. Offers to purchase for any houses in that elevated price bracket (at the time) were scarce. Finally, when we’d almost given up hope of selling, we received an offer for the 1990 price before paying real estate commissions. We accepted the offer quickly, although it wasn’t a happy time.
We were selling for no gain after ten years but the financial impact was much worse. We had done several renovations and upgrades at a total cost of about $50,000. To adjust for inflation one should add about 2 percent per year to the purchase price; about $60,000. So that makes about $110,000 lost on a $300,000 investment in ten years. So to break even before the interest cost of the mortgage (at 13 percent) we would have to sell for more than $410,000.
After that experience, I was convinced that housing was a bad investment. I knew that we could have put that money into government bonds or the stock market instead. The interest rate on risk-free Government of Canada bonds when we bought the house was about 9 percent. So annual income would have been about $27,000, for a total of $270,000 over ten years: a loss of $110,000, or income of $270,000?
So I couldn’t understand how this new positive attitude toward real estate investing had developed so quickly. Had somebody put something in the water supply that made people high on real estate?
About the same time, I had another client decide to cash in his RRSP to use as a down payment to buy rental properties as an investment program. He was a realtor, so I could understand that he would be interested in that, but to cash in an RRSP? That meant paying full income tax on the proceeds on the withdrawals. Nobody ever does that. That’s sacrilege for a Canadian. I failed to dissuade him and he’s done very well as he was buying up properties when a basic house could still be found for less than $150,000. Now he owns about fifteen houses and they are all “cash-flow positive,” as the saying goes. Of course, he has a lot of debt attached to those properties too.
In a conversation that happened shortly after the housing crash in the United States, a client in his seventies, whose wife had passed away, was trying to decide what to do about the family cottage, which he believed was very valuable. He wanted to transfer the cottage to one of his children. He hired an appraiser and found that the price had dropped substantially from the peak value reached a decade earlier. He was clinging to the idea that this property would be a legacy for his children. I asked him why he felt it was better to transfer it than just sell it on the market, and he said: “Real estate always goes up in value.” He had just finished telling me about the appraisal five minutes earlier. I challenged him by pointing out that the appraisal showed a substantial drop in value. “Oh that,” he said. “That’s just temporary. In the long run real estate always go up.”
More signs of a substantial change in thinking kept coming. More than one client decided to move to the West Coast, a common decision for Edmontonians as the seven months of winter start to weigh on older bodies. For those who wish to stay in Canada, a popular destination has been the Gulf Islands in British Columbia, especially Salt Spring Island, as a retirement lifestyle choice. When one client announced a move there and the associated withdrawal of funds to pay for the purchase of a house, I suggested that renting for a year would be a good idea in order to see how she would like the climate. She would have none of it. “If I don’t buy now I’ll never be able to afford to buy a place there.”
Clients would take money out of their investment accounts for real estate purchases, especially U.S. snowbirds. More than once I met with a couple, at their request, to discuss the pros and cons of buying a retirement home in Arizona, California, or Florida. At the end of the meeting I thought that I had succeeded in convincing them that renting, initially at least, made much more sense than buying. The next morning, however, I would see a withdrawal request from that same client for the amount of their U.S. property purchase. My arguments were too weak in the face of an unquenchable thirst to buy more and more real estate.
Sometimes real estate-related decisions resulted in unintended consequences. One of my clients, a widow, decided she couldn’t live in the big, rambling house that she and her recently deceased husband had enjoyed for many years. The maintenance work required was beyond her and the secluded location of the house on a large plot of land made her nervous about security. She knew that because of the size of the property it would take a long time to sell so she decided to buy a condo in the centre of the city. When she applied for a mortgage to buy the condo she was turned down. It turned out she had co-signed a loan for one of her children to buy a home one year earlier. The bank wasn’t prepared to lend her any more money as she was retired and a widow. When she told me the story, after the fact, I realized that real estate exposure might extend beyond the properties that I knew about. I had no idea she had co-signed on a mortgage for one of her children.
I began asking my clients about how much help they’d given children and grandchildren to buy into the housing market. To my surprise, parental help was more widespread than I would have guessed. Sometimes it was a gift of cash for a down payment (preferable), or a loan (not bad); it could be co-signing a loan