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Sep 3, 2019

All Things Different Vol. 2

by Bob Carter

Bob CarterIn my last column, I reintroduced myself to Canadian MoneySaver readers and reminded you of my Beat the Dow days, writing for the magazine back in the 1990s. I promised you the details of how my wife and I rebuilt our family finances from the financial abyss, including the good, the bad and the ugly.

We chose to invest in residential real estate because we truly believed our risk in this vehicle to be no more or less than any other asset class or individual security and in most cases, safer.

The madness behind our logic was simple:

  1. We had equity in our home that afforded us the freedom to invest.
  2. Tapping into this equity would create additional tax deductions for the interest expense on the amounts we used to create the necessary down payments (20% of the purchase price) without impacting our daily cashflow needs.
  3. Securing good clients (we call them “clients” as opposed to “tenants” as we feel these families are more than just a rent cheque) to provide the funds we needed to cover all the carrying costs of our investment without having to reach into our own pockets.
  4. We were driven to build long-term retirement cashflow and believed that income stream was as important to building capital gains in the public markets.

We were prepared to take a patient approach and commit to no less than a 5-year time horizon on any one investment and an overall long-term strategy of 30 years. We started about 8 years ago and have kept this time horizon in view ever since we signed our first deal. To say we hadn’t thought about cashing out and running would be a stretch, although we never did.

We started by joining the Real Estate Investment Network and attending workshops, reading real estate investment magazines and checking out any and all credible sources. We spoke to friends and even family members who gave us everything from negative rebukes to strong support. In fact, several friends were quite open to sharing their own positive real estate investing experiences. It occurred to us that we might be late to the party. But we pressed on thinking the best time to invest would have been 10 years ago and the second-best time was right there and then.

Hmm—where else have we all heard that before?

We also sought the advice of a strong and long-term oriented investment coach and were very lucky to find one located in Alberta. I was interested in that market as there were, and to this day, are no rent controls. The business-first mentality of that market appealed to us and has, for the most part, worked in our favour. We now realize we may have missed out on even greater returns by not investing in Ontario, closer to home. C’est la vie.

Our investment coach convinced us that with the right structures in place, we could operate truly at arms-length. This would require the services of a realtor, versed in real estate investing and not just the “sale and purchase” of properties common to most real estate agents. We would also need a good property manager. It was made clear to us that a property manager who is not themselves a real estate investor has no skin in the game and hence no understanding of the stresses and challenges you might face down the road. Empathy and understanding are huge means of support and we were especially lucky to find the best property management firm in the Greater Edmonton area. Finally, we were advised to build a personal “Board of Directors” to help keep us on track and provide additional business advice.

This Board includes a mortgage specialist who (like our realtor) understands the investor market versus one who helps you find the funds to purchase your family home. There is a world of difference when it comes to understanding the way to finance investment deals, the right banks, the order of mortgages to be sought and a whole host of strategies to help you maximize your ability to secure as many deals as you are comfortable holding. Naturally, our Board also includes our chartered accountant (also a real estate investor) and lawyer to help us execute transactions etc.

But it remains our coach who helps us stay on track and avoid markets that do not represent strong opportunities for long-term, low touch, reasonable rates of return. We purchased most of our property (read properties) through our coach— BUT—not every property — which brings us to our first “learning experience”..

Five years ago, I read about a new, up and coming investor market which looked great on paper. I travelled to the city out west to tour the building site and learn more about this “community of the future”. We read articles, listened to speakers and heard from local politicians and public officials who all stressed the strength of the market. There was a growing population, a strong housing-starts statistic and a buzz about town that reminded me a great deal of what I saw in Grand Prairie and Fort MacMurray some 15 years prior. I read economic reports and thought I had done everything right—until it all went wrong.

This project was a “new build”. The townhomes and condos did not yet exist, although zoning and site services were well in place before we made our commitment. Now, investing in the new build market can be a very solid and successful strategy; not so for us.

The market looked to be well diversified with several different industries employing a strong labour force. These included energy, agriculture, forestry and wood products manufacturing. There was evidence of net in-migration and strong local birth numbers that all suggested a great place to live and invest. Unfortunately, this market just happened to be located in British Columbia and in the second year of our mandate (while the unit’s construction was just being completed) the province elected a New Democratic Party (NDP)/Green Party coalition government.

Support for the investment community and a negative stand on energy markets (both oil and gas and hydroelectric infrastructure) threw out all the good news we had relied upon when we made our decision to commit to the venture.

The lesson we learned was that we had invested in a market that was too small to survive any perceived political instability. While our other units were also located in the West, the markets we selected just outside of Edmonton were in a much stronger and resilient position economically, to withstand Alberta’s election of their own NDP government.

This is not to say that the election of any government of any stripe is necessarily a bad thing. Shock and disruption however can be. We learned that market size, in addition to socioeconomic and demographic trends, can be a great arbiter of your ability to withstand bad news rather than any first impressions you might have touring a job site. Hint: they all look great.

Today, we limit our investing to mid-sized and larger-sized markets and pay attention to the employment situation, income standards and a variety of additional screening tools that suggest market strength and viability for the long-term commitments we seek to make.

But we are not rocket scientists nor are we blessed with Warren Buffet-like analytical skills and we can always be wrong again!

The good news is that the market in British Columbia has started to stabilize, and the syndicate property manager is doing a wonderful job of maintaining the property with a relatively low vacancy rate. While we are adding several hundreds of dollars per month out-of-pocket in order to cover costs, the numbers still make sense. We are strongly cash-flow positive in our other market which seems to net things out nicely, so in total we are in the black at the end of each month.

I’ll close this month’s column by sharing an opinion I always find amusing. It seems when I open an investment magazine or newspaper to read about some retail investment advisor who says investing in real estate is a mugs-game-best-avoided and that the returns from real estate investing over the long term have never equalled the returns made in the public market.

I think these articles and arguments, while amusing to read, miss one key point. When investing in real estate, you select the property that can help you find the best long-term clients who pay you to cover your costs. Someone else is helping you purchase that investment. If selected well, your properties may not cost you a dime as the available rent might cover all costs. In a sense, you have manufactured your own positive returns that measure well in excess of any public market vehicle, unless you’ve been lucky enough to find the latest penny-stock lottery winner.

We understand that there are risks that the markets may fail but take comfort in the fact that there has seldom been a 10-year rolling period in which Canadian real estate exhibited negative returns. Notice I haven’t said a word about price appreciation up until just now. I may have just implied it in my 10-year rolling stat mentioned above. We base our long-term stats on price appreciation of no more than 3% in our strongest markets. In a sense, that very modest target proves the market-pundit’s point, unless you consider the true power of real estate investing. A mortgage pay-down “trickle-up strategy” of wealth creation (where someone else is doing the heavy lifting) is one of the best vehicles to get my wife and I to the end game we have in mind.

In another ten years, I’ll be 69. At that point, we will have paid down most, if not all of our mortgages and have the flexibility of adding to our public and private pension and retirement savings with the cash flow from our rental properties and will look for something else, or maybe we’ll just sit tight and collect rent.

Bob Carter,