Blessed by the Potato

It’s been another rough few weeks over here. I have revisions to make to my now-complete first draft, and though there aren’t that many, they’re taking me forever. I had hoped to be done these almost two weeks ago. I seem to have serious issues concentrating (also why there haven’t been many blog posts here), and my stress levels are once again through the roof. But it’ll be over soon (just months now!) and then I can worry about what to do with the rest of my life. To try to get my science groove on I’m even going out to give some rah-rah science! outreach talks at high schools soon, which I hope goes well.

Mother’s day seemed pretty hectic here, with dinners and brunches and last-minute shopping. I ended up getting a new pizza cutter for myself while I was at Caynes. I’m impressed enough with it that I had to give it a quick mini-review: it cuts through pizzas way better than my old ones. That might be because it’s new and sharp, but even then it seems to do a better job than they ever did: I’ve always had to go back-and-forth to get a clean cut, but this did the job in one swipe. It has a rather heavy handle (vs. the cheap plastic or wood handles of my other two), and the blade disc is held securely with no play: the other two both had fairly significant wobble in the roll of the cutter.

I was recently interviewed by a reporter from the Globe & Mail, and had a brief mention in an article as a result… but although it was my website and Potato identity that brought me to his attention, the article had no mention of either. So at least my quasi-secret identity remains safe, and I don’t have to write a tedious “welcome, G&M readers” post. However, if my understanding of comic-book lore is correct, this reporter is now in grave danger, as those who possess the information of a person’s secret identity — especially reporters with privileged sources — are abducted with uncanny regularity: whether by targeted schemes or pure evil happenstance. Fortunately, I believe the last time I updated my arch-nemesis page I selected “the geese who block the bike path by the river” and they are not the hostage-taking sort of villains.

Rob Carrick agrees with my earlier post that TD’s e-series funds are great, but hard to buy. I think it’s really weird that the fund you have to trade online requires faxing/mailing in an application to open an account, but weirder still that people like me have to write third-party user guides on how to actually manage the things.

CC weighed in before I got around to publishing this post, saying that he didn’t find the e-series that hard to set up. I don’t find it that hard from the instructions either, and have helped people set them up… but Wayfare did run into issues, mostly with the branch staff being clueless and trying to sell her on higher-MER funds, and with that conversion step not going through right away. Plus some of the other steps (like withdrawing under the HBP) are a little less clear, as Krystal found out. As much as I love the e-series funds for average investors, something’s not right when the best instruction sets and knowledgeable people are outside of TD. Anyway, I’ll repeat my best advice: use TD Waterhouse.

Deliquencies are rising in Alberta as the housing market there flattens out. I consider it more evidence that delinquencies are a trailing measure, so not very relevant in a discussion on the health of Canada’s housing market, but take it however you want (i.e.: too small to be meaningful at all is also a good way to take it).

A little article on Home Capital Group also points to some more warning signs: “He said the company is being cautious when considering loans that will go toward properties in Vancouver or downtown Toronto, because the markets are showing signs of overheating.”

Canadian Business revamped their website, breaking the RSS feeds and leading to many 404 errors for old links to their articles. The ability to comment also seems to have disappeared. But, I’ve found Larry MacDonald again, and now he seems to be moving towards believing that Vancouver at least, is in a bubble.

I’m a bit late on this, but Freddie Mac actually reported a profit this quarter. The preferreds I own (a very small speculative bet) are actually in the black now by over 30% (given the timeline though, still no better a performance relative than the index). I still don’t expect a final resolution for years yet, and this only suggests that rank insolvency is perhaps not as much of a risk — but political risk still looms large, as it didn’t look like the conservator allowed them to repay any significant portion of the bailout. Despite the recent run-up, they’re still only trading for 10 cents on the dollar, quite a reasonable discount given the return to profitability. Though I was tempted to buy more on the news, I figure I’d hold pat with my thimble-full of exposure. There’s still lots of risk here, and I don’t need to bet any more than I already have.

A short post by Saj Karsan on learning from your history, but not letting randomness influence that. I can’t dig it up now, but Michael James had a similar idea some time ago: a good decision is not necessarily the one that lead to the correct outcome in the way things played out, but one that made the most sense given the information available at the time.

A cute tongue-in-cheek site about the benefits of coal-fired electricity.

Garth Turner is a very polarizing figure. He was a controversial politician, and was one of the early voices to raise a warning about a Canadian housing bubble, getting a book and blog out of the deal. Indeed, I have to credit him for first bringing the idea to my attention; of course, I went out and did my own homework to come to the same conclusion, a step that is not to be skipped. I read his blog Greater Fool pretty much every day, but yet I don’t have it linked in the blog roll on the sidebar. That’s because it’s hard to recommend him: he’s crass, vain, evasive at times, confrontational at others. I read it, but it’s certainly not for everyone. Often, I find myself providing Garth-to-English translations as he glosses over crucial details or makes up his own slang that accumulates after years of daily posts.

Garth is not a personal financial blogger, out to rationally lay out the details of a plan and analyze the ways to optimize it. He’s not some student out to cheerfully converse and debate with the denizens of the internet all hours of the night. He provides brief glimpses of possibilities, and then tells people to go get a qualified financial advisor for details. When pressed, he’s fond of various terse two-word answers: get lost, get real, grow up, come on. I remember about two years ago he had one of those open forum sessions with the Globe where readers send in questions and he answers for an hour and the whole transcript goes up on their website, and he answered someone’s question with a two-word brush-off and I was appalled: it’s one thing to do that on your own site, quite another in a Q&A with the Globe!

But that’s just who Garth is. He talks about the housing situation in emotional terms, and provides some good anecdotes from his readers, but he’s not a details guy. So earlier this week Garth suggested to one reader that he borrow against his paid-off house to invest in a “balanced portfolio (my fav is 40% fixed, 60% growth) making 8% or so […] This is called diversification. It mitigates against having the bulk of your net worth in one asset alone. […] And it’s something nine in ten Canadians would never dream of doing. Which is why only one in a hundred of us have a net worth of a million, while seven in ten own houses.”

Others jumped on this particular advice, the most prominent being Canadian Capitalist saying “This advice is so bad that I don’t even know where to begin.” In the comments, Michael James (who by now you show all recognize as another PF blogger I link to a lot and have great respect for) said: “I’m tired of hearing recommendations to leverage a house for “diversification”. After borrowing against a home to invest in other assets, the home represents exactly the same percentage of net worth that it represented before borrowing. Changes in the home’s value affect net worth in exactly the same proportions whether you have a mortgage or not. The only difference from a risk point of view is the added risk from the new assets. This may or may not be a good strategy, but it is not diversification in the sense of reducing risk.”

And that’s well said. It’s not diversification in the usual sense of reducing risk: borrowing against the house is not the same as selling it, you still have exposure to it if the price goes down. But, as he says, you do get exposure to the new assets, which is part way towards diversification (but with increasing risk because you’re leveraging to do it). I don’t think it’s bad advice in Al’s case, but the issues of leverage — and other details like what a balanced portfolio should be and the issue of whether it makes sense to hold bonds when borrowing to invest — are lacking from Garth’s post. It’s harsh, but not entirely unwarranted criticism.

Then in today’s post, Garth comes out swinging: “Which brings me to this. It’s a column trashing me on the wimpy MoneySense site, written by a young father of three brave enough to be anonymous.”

That brings up a very good question of what it means to be anonymous these days. Is Lady Gaga anonymous? Madonna, Mark Twain, Prince, Robin Hobb? Canadian Capitalist, first off, isn’t anonymous: Ram has had several articles written about him (which are not hard to find on his website), his actual face is his forum avatar. But even if that weren’t the case, is “Canadian Capitalist” anonymous, in this sense? Is “Potato”? Sure, we don’t use our real names, but how much would our “real names” mean, anyway? There’s definitely a distinction between the fleeting anonymity of user213 leaving a comment on Garth’s blog with a dummy email address and then disappearing into the ether never to be seen again, and the pseudo-anonymity of CC or Potato, Gabe or Tycho, Yahtzee: established personas on the intertubes, with consistent messages, accountability (at least as much as if I was blogging with my real name), the ability to be contacted and engaged in dialog with. I publish under both my real name and Potato, and I daresay I’m better known and more widely read as Potato, with a longer track record (going on what, 13 years now of BbtP?). I would be more anonymous if I used my real name.

A name-brand source of information, opinion, ranting, and hilarity.

So I don’t think the “brave enough to be anonymous” ad hominen is warranted or fair. The internet seems to be growing up and moving away from pseudo-anonymity, but it’s still there (just as it is in “real” publishing) and I think it’s important to distinguish between actual anonymity and a nom de plume.

As for the debate itself, I think by now you can see I’m somewhere in the middle: I think that with what we know about Al and his interest in leverage and diversification, borrowing against his home to invest is perhaps a good plan for him (though if he wants to move up and is concerned about a real estate correction, selling and renting a larger place would be an even better plan). Expecting 8% on a diversified portfolio is maybe a little optimistic (and past returns are no guarantee of future outcome), being able to secure a HELOC at 3% will require some good negotiating skills, and it may not make sense to include the safer spectrum of bonds while also borrowing at the same time, but nothing is out of the ballpark there. However, Garth didn’t fully discuss the risks, the limits of the diversification, what he meant by balanced portfolio, etc. Greater Fool is where you go to get the kernel of an idea, an emotional appeal about not shunning risky assets entirely for the illusory safety of a house, or a fun cautionary tale about a couple with ridiculous exposure to real estate. It’s not the place for a detailed financial plan and a rational discussion of the trade-offs involved.

And a final note: I’m generally slightly opposed to leverage, and the bizarre case of holding low-yield fixed income like a savings account or government bonds while also having debt. But it can make sense in some cases. For instance, recently one poster at CMF wanted to try to find a way to maximize her mortgage over-payments to finish it off, but noted that income could be unpredictable and needed a long amortization just in case. To me, that’s an excellent case where it’s safer to maintain the leverage of the mortgage and keep some money in a savings account: if you do run into a rough patch, it’s very difficult to get that overpayment back, you still have to make your regular mortgage payments to keep from facing foreclosure, and you can’t eat your principal. An emergency fund, even if it costs you a bit in interest spread, can be a very handy thing (and in this particular case, she was looking for an open mortgage to really go nuts with the prepayments, but a closed mortgage is so much cheaper that to keep the emergency fund and just pay it at the end wouldn’t cost anything).

I like the note in this story about the advisor making clients check the box “I want to buy low and sell high” or “I want to buy high and sell low.”

Michael Geist had a tonne of UBB-related posts up this last week or two. I haven’t had a chance to read any yet, but I’ll get around to it (and likely posting on it) soon. If you can’t wait, go ahead and read him yourself!

Last time around I briefly mentioned Tokyo Electric Power, with a pointer to Financial Uproar’s take. After that little bump I mentioned, it just tanked. I was surprised by that: my take was that the cleanup costs would be several billion (let’s say $10B), and the liabilities were capped by Japanese law. What transpired was that that last part looks like it may not be true: though there is a law in place to limit liability for “exceptional” natural disasters, and that it would be a no-brainer that the worst quake/tsunami to ever hit Japan would count as “exceptional”, that’s not automatic, and the government is apparently not going to make that declaration. I don’t have expertise in Japanese law to say one way or the other, but I’m anxious to see what happens in court down the road.

Supposedly the reason for that is that, because of the public scrutiny, etc., the politics wouldn’t be very good of letting them partially/mostly off the hook. But no matter what, the lay public is going to have a bee in its bonnet about nuclear plants for some time to come now. If the Japanese government leaves TEPCO out to dry on the liability thing, despite the unprecedented size of the natural disaster and the existing laws, that could send a chill down corporate spines, and that would really sink nuclear power in the country (and possibly, everywhere).

Be sure to check out the comments section of my previous post on REITs vs Condos. Rachelle had some good points about the risks of REITs, and I realized that though I much prefer REITs to condos, I didn’t quite emphasize enough that I’m not hugely keen on either. After all, REITs are only 3% of my portfolio now. I’m not sure under what circumstances I’d go to zero allocation — even in my active portfolio, passive thinking on asset allocation means that, to some extent, I’m willing to risk losses to get exposure to a sector. I also explain further what I meant by “somewhat” interest-rate sensitive (TLDR: less leverage than retail condos, and the effective rates today aren’t as far below “normal” 2007 as CMHC-insured residential rates are, so the correction shouldn’t be as bad).

The Globe had an op-ed on the housing bubble here, saying “signs point to a severe housing correction.” Nothing new to BbtP readers (though he does trot out the hot asian money meme). I think the most remarkable thing about this article is not what it says but the very fact that it not only got published as-is in the Globe, but it was featured prominently rather than buried (or in a point-counter-point pair). If I was in a more optimistic mood, I might say that the big drop-off in sales volume for the 2nd half of March and the uptick in such articles in the MSM finally marked the top… but we’ll have to have passed it by months/years before we can really say where the top was. As always, patience.

A good TED talk on apathy in politics. I like his proposed zoning notice for Toronto. The topic of apathy and politics is perhaps particularly apropos with the current federal election.

Oh, humans, can I ever get you to stop relying so much on your limbic system? On the internet today: “nothing is more horrifying or ignorant than to hear the pro-nuke faction rushing forward to boast, as they are doing these days, that nobody-has-died-yet-from-radiation-at-fukushima.” Yes! Damn them for trying to inject facts and rationality into our Fukushima fear and outrage orgy!

Macquarie research put out a comparison of REITs vs direct (condo) ownership in Toronto and Calgary. The story was picked up by the Globe and others. It’s an interesting comparison, especially the part about leverage, when another article this week warned of the dangers in leverage.

“Unbeknownst to most of these families, their theory of home ownership as a safe, low volatility investment is based on the often-mistaken premise of no or little debt. This is a crucial blind spot because the moment that a large amount of debt is used to buy a home, that safe investment theory goes completely out the window. […] What happens when that family buys that house with just 10 per cent cash down and a 90 per cent mortgage that promises an interest rate of 3 per cent to the bank over the long term? Amazingly, the equity in the house has now become dramatically more risky than before. The equity is now three times as risky as the overall market rather than 30 per cent as risky. This is more risky than an investment in nickel mining stocks or Internet start-ups.”

I was asked after these reports about REITs, and specifically if they’re as risky as the housing market, given my views there. Briefly, a REIT is a real estate investment trust, a type of investment that owns real estate that it rents out. The majority of the cash flow is paid out as a distribution to the investors. I tend to view them as a step up from fixed income: essentially all of the anticipated return will come from the distribution (rather than capital gains), and though that can be cut or expanded depending on circumstances, it should for the most part be stable.

I do invest in REITs (until late last year they were a huge part of my portfolio, but now are down to ~3% as I was selling as the prices appreciated), and don’t think that they’re in for the pain that residential housing is, due to several key reasons.



The first is diversification: both personally and for the REIT. Even if I wasn’t hugely negative on housing, I’d be somewhat uncomfortable having my house be the entirety of my net worth for the better part of a decade. With a REIT, I can get some exposure to real estate without risking it all. Also, the REITs themselves are diversified, holding many buildings all across the country. Even if I think Vancouver and Toronto are bubbles, Canada on the whole is not quite as bad.

The second is the sector: most REITs I invest in lease retail and commercial buildings (plus some industrial and government properties). Even the REITs that invest in residential apartments are not buying individual houses or condos. The housing market has been blown up by speculation and cheap-as-free CMHC financing, but those factors haven’t applied to multifamily residential (i.e.: apartment buildings of 5+ units) or industrial/commercial/retail buildings.

The third is return: REITs are investment vehicles for professionals, run by professionals. Before investing money, a building is evaluated for its investment return, and only its investment return (not how nice the school district is or how grown up you’ll feel buying it or how only scumbags rent or how pretty the countertops are). A common measure of investment return is the cap rate: the rent less the expenses divided by the price. The lowest cap rate I’ve seen on a REIT purchase in the statements I’ve read for the last few years was 5%, but 6-8% is more typical. For residential housing, buyers don’t evaluate it for its investment return (often at all, but certainly not as a top priority) — some people don’t even investigate what their housing alternatives are, and I kid you not, more than one person (on the internet, granted, so trolling is a possibility) didn’t even know that you could rent detached houses/townhouses/anything but apartments — and if they try, don’t typically do a very good job of it (innumeracy at work). In Toronto, a typical residential condo cap rate is something like 2% right now, with gross yields at 5%.

And the fourth is liquidity: if I buy a house and I’m wrong, I’m sunk: up to 10% just in transaction fees, and in a down market it can take a long time to sell (or a big discount). Even if I could recognize a downturn early on (say after only a 5% drop in prices), I’d probably lose 20% by the time I got out, not even accounting for the risk-layering of leverage. For a REIT, transaction fees are the same as for other stocks: small (for the position sizes I take, I try to keep fees to less than 1%). If I’m wrong, I can sell as soon as I decide to — again, if I could recognize a downturn after only a 5% drop in prices, I could get out losing only 5-7% (depending on transaction fees).

The third point in particular explains why I don’t think REITs are as prone to a real estate crash as residential housing: the over-valuation simply isn’t there in the first place. Plus, unlike residential housing speculators, they don’t rely on flipping property to make money: even if property valuations slide, as long as it’s not so far as to threaten the ratios on their loans, the income should continue to flow.

That said, REITs have had a big run up from the financial crisis lows, and since they are leveraged, they are somewhat interest-rate sensitive. They’re not without their own set of risks. For residential REITs, if rents come down due to competition from accidental landlords, they could take a hit. Even if there was zero spill-over from the coming condocalypse to commercial/retail values, REIT pricing could suffer if crowd psychology caused people to jump ship from anything with “real estate” in the name. A downturn in the economy that causes businesses and shops to close means they have higher vacancies, and thus less income.

There’s been some discussion over whether to hold individual REITs or the iShares REIT ETF XRE. XRE has a 0.58% MER, and not a great amount of diversification, with only a few names making up three-quarters of the fund (Riocan alone is a quarter!). For zero MER, one could buy the top one (or two or three) holdings and get the same basic exposure, it’s argued. Though the MER is a touch high for an ETF, it’s still nice to get the diversification… but I personally wouldn’t/didn’t go the XRE route for a different reason entirely: I just don’t like RioCan (REI.UN). It only yields 5.5% (as of today), and that’s with over-distributions (paying out more than cash flow as they hope that future income growth will close the gap). I know yield-chasing for the sake of yield-chasing isn’t a good thing to do, but there are other (smaller, ‘natch) REITs paying substantially more with, IMHO, the same riskiness as RioCan. Either way though, not a bad way to go for a part of your portfolio, especially as a renter without other real estate exposure.

Thesis progress was once again abysmal this week. In fact, yesterday featured negative progress as I got into a discussion with my supervisor about some previous prose that I may now have to rewrite… Can’t wait to be finished this thing. Weight was down: only one pound, so it could just be measurement error, but at least it wasn’t up again!

Patrick of A Loonie Saved has finally put a post up, discussing the P/E-10, which right now is suggesting that the market is over-valued, in contrast to my earlier ambivalence. In the comments, Patrick links to another blog by Saj Karsan that suggests the P/E-10 may be skewed a bit by a large number of share buybacks over the years, and by the effect of two recessions (the -10 part of P/E-10 is supposed to give an idea of P/E over a full business cycle, but the last 10 years catches two bottoms instead of just one).

Harper once again shows he’s a class act.

Now even Paul Krugman is very worried about a Canadian housing bubble. The Economist has an article titled “Bricks and Slaughter”. “An even bigger reason to beware of property is the amount of debt it involves. Most people do not borrow to buy shares and bonds, and if they do, the degree of leverage usually hovers around half the value of the investment. Moreover, when stock prices fall, borrowers can usually get their loan-to-value ratios back into balance by selling some of the shares. By contrast, in many pre-crisis housing markets buyers routinely took on loans worth 90% or more of the value of the property. Most had no way of bringing down their debt short of selling the whole house.”

Michael James has some very sensible advice on looking beyond the next 5 years in the eternal fixed vs variable debate.

There have been a couple good reports on the fox domestication program in Siberia (watching that Nova episode was the source of the current tagline in the masthead: “50 years ago, Soviet scientists set out to…” “That’s how all the best stories start.”), but I haven’t tracked them down on the web to link to them. Here’s National Geographic, Nova Science Now, and Nova: Dogs Decoded.

Wired has a nice article up on why trivial decisions can sometimes seem hard when there’s an abundance of choice. I seem to recall another article from a few years ago on choice paralysis in investing, and that company pension plans were much better utilized when fewer options were presented.

I was feeling a bit down as my thesis progress has been so slow, and what has progressed has seemed to be won at such a high cost. So I took the Sad Panda meme image and made it my avatar on various social networking sites, but then realized it wasn’t sad enough for the PhD thesis woes. So I made it even sadder by turning it greyscale and adding a watercolour painting effect:

Since I don’t know who to credit for the original image, I can’t presume to claim any rights on the derivative, so have at it.