Blessed by the Potato

Wayfare sent me an interesting, thought-provoking article in the Toronto star “Sizzlers and Fizzlers”. I shouldn’t say article, it really doesn’t have much writing to it, no analysis or commentary. It’s an interesting factoid. The PDF with what juicy information there is is here. The headline number is that in the last 40 years, Toronto real estate was up 1250% (since 1969), compared to the TSX being up 1244%. This implies that real estate was just as good if not a better investment over the long term than the stock market (once you factor in carrying costs, stocks look like the better place to keep your money, but then you can really leverage the hell out of real estate).

That really put the tingles to my scientist senses* (like Spidey senses, but for nerds… though Peter Parker was a bit of dweeb himself), since this does not jive with just about everything else I’ve read. It makes me want to look deeper into the methods to see how these conclusions came about; it sets off my Saganist “extrodinary claims require extraordinary proof” alarm.

* – Humorous aside, we were talking today in the lab about curious results, including one study that exposed subjects to a 13-hour and 18-hour exposure period every day. Explaining where they found their 31-hour days would have made for a much more interesting paper.

Just about everything else I’ve read, which is more general and not specific to Toronto, puts the compound inflation-adjusted rate of return for housing at about 1% or so (so the nominal rate should be 3-5%). So to see the 6.9% figure in this article (the same as stocks) was a little baffling. Is Toronto really that special? Was all that other stuff about long term trends I read wrong?

Unfortunately, the article does not give anywhere near enough information to say for sure. There are some inconsistencies though. First off, their numbers for the stock market look to be about right, in terms of the nominal prices over the years, but don’t look to include the return from dividends, which should improve the stock market figures by a fair margin. I also have to wonder if the choice of starting year in 1969 could affect things, since the 70’s were a rough decade for stocks — would the picture look different starting from 1959 or 1979? (I don’t actually know, but it makes me wonder) Some areas (and Toronto’s overall average) have not, in inflation-adjusted terms, come back to their 1989 peaks yet, and my dad was saying not too long ago that the housing boom had just recently brought their house back up to that point. Naturally, some areas have been hotter than others. Surprisingly, Willowdale (C-14) was one of the very coldest areas in the study, which just doesn’t agree with the fact that it’s such a desirable neighbourhood. Was it just simply already a wealthy, desirable neighbourhood in 1968, so when the data started in 1969 there wasn’t a whole lot of up left to go? I doubt that, since it used to be, from the perspective of a kid growing up there, a “normal middle class” neighbourhood, and is now full of, well, rich people and condos. The average home price there according to the PDF, $390,520, is almost exactly the same as the overall Toronto average at $390,839 (but it was a good deal above average at the 1989 peak, hence the underperformance). However, a quick trip to MLS will show that the lowest non-condominum asking price is $420k, so how the average got to be $390k in a neighbourhood full of million dollar homes is completely beyond me. The lowest price for a condo is in the $160k range, so it’s possible that all the new condo development in the area is really bringing down the average. But what does that mean for the overall study then? North York’s condo buildup started just a little bit ahead of a lot of other areas, so is the fact that what must be a large number of these units are now being flipped and bringing the average of “resale” homes down disproportionately hurting that area? Likewise, are the people who recently sold their SFHs in the “gentrifying” areas like Leslieville to developers for gagillions of dollars bringing the average way, way up because the condos built on those sites haven’t had a chance to be flipped yet? Since they’re using average values and not medians, are a few $25 million dollar homes in a few areas really skewing the results? Do these results in any way have bearing on the reality of owning a home in Toronto over the past 40 years? Do they offer any insight for what might be in store in the future?? Disturbingly, some of these questions suggest that, for example Willowdale, might have performed even better than the factoid’s already generous rate of return. Or, that the really great returns will come from places that are presently farmland, and not areas that currently look good. Or, that it was a really good idea to own real estate in the 70’s and 80’s, and a really bad one in the 90’s, with the 00’s being a bit of a wash, so far.

The study seems to have enough holes that I’m not going to reject my earlier information that suggests that housing, in general, underperforms the stock market. It is possible that Toronto was a special exception in the last 40 years compared to the overall averages of US (and more rarely for data discussion, Canadian) real estate. After all, in the last 40 years Toronto went from being a backwater city up in, you know, Canada, to being a world-class metropolitan city. Toronto had a huge boom in building and real estate in the 70’s: that’s when almost all of the recognizable downtown was built up: First Canada Place, Royal Bank Plaza, the CN Tower, etc. Two-thirds of those impressive 40-year real estate returns were due to gains in the 70’s and 80’s (yes, it’s cherry-picking at a market peak, but in the second 20 years of this study, housing only returned 2% nominal straight-line returns per year, with negative growth when adjusting for inflation). In just the last 10 years the suburbs have expanded so much some people have started calling them the exurbs, another period of massive growth for Toronto, and also what turned out to be another real estate bubble in the States. So while the headline 40-year overall nominal return number is attention-grabbing, especially next to the very similar number for the nominal TSX return, I’m not convinced that a house is the best place to put my money.

I put the link up on the right, but I also just have to give it a direct mention here to give it the attention it deserves. It’s a Joss Whedon production with Neil Patrick Harris starring as Dr. Horrible, a quirky, shy, evil mad scientist who’s trying to pull off a major heist to get into the evil league of evil when he runs afoul of his nemesis, Captain Hammer (played by Nathan Fillion, of Firefly fame). It’s hilarious and awesome and I want to buy the feature-length movie now (please: make the feature-length movie, pleeeeeease). Go watch it, it’s only like 13 minutes per act, and at the moment there are only two acts up (it looks like the 3rd act will finish it off).

Netbug, of course, found it (how, I do not know) and sent the link on to me, so of course props to him. And naturally, both our MSN quotes at the moment are from it…

The stock market is in the pits at the moment, and I’m seeing values everywhere. I started the year with a bit of cash on the sidelines, and bought in on the downward slide. Now I’m tapped out in terms of cash, but think it’s probably a good idea to keep buying more (not necessarily right away, just a month after my last buy-in, but through the rest of this year and next). Of course, I can’t buy without more cash… or can I? By borrowing money to invest, I can keep buying more stocks/ETFs. If the market is getting close to the bottom and ready to turn around, I could increase my returns substantially. This is known as leveraging.

If I buy $100 worth of stock with $50 of my own money, and $50 of borrowed money, and then next week the stock is up to $110 and I sell, then I’ve effectively doubled my return: I’ve made $10, bringing me to $60 after I pay off the loan, but only needed $50 of my own money to invest. By the stock going up 10%, my return went up 20%.

It’s this magnification effect of leverage that made buying a home such a great investment over the last several years: with 20% or even 0% down, you could grab a home, and even modest increases in price would lead to you walking away with a tasty handful of cash, because you could leverage yourself to a very large degree with a mortgage.

Of course, leverage cuts the other way, too. If my stock went down to $90 instead, and I had to sell there, I’d pay off the $50 loan and find I was only left with $40 — a 10% decline in the stock lead to a 20% decline in my wealth. To lose everything, that stock would “only” have to go from $100 to $50 (a feat CIBC amongst others has managed recently). If it went bankrupt and went to $0 before I could sell, I’d end up with nothing and owe the bank $50, doubling my potential loss from the $50 I had in cash to invest in the first place.

So leveraging is a way to increase your returns, both positive and negative, at the cost of increased risk. I’ve avoided leveraging so far because it just didn’t fit with my risk appetite. Lately I’ve been thinking more and more about it, and am considering whether a 5% leverage (buying $100 of stock with $95 of my own cash and $5 of the bank’s money in the form of a loan) would work for me. In addition to potentially goosing my returns, it might also help me build up my credit rating. On the other hand, the financial markets are a mess right now, so that risk aspect is very clear.

When buying on margin like this, the risk can be magnified even more by what’s known as a margin call. You see, if you buy your leveraged positions with a margin account at your broker (as opposed to taking out a general loan or home equity line of credit), then there are rules as to how much money they can loan you — you must have skin in the game. For example, if the limit is that you must front the cash for 50% of the price of the stock, then you need to keep that much equity handy. You could, for example, put in $60 and borrow $40 to buy $100 of stock. As long as things are going up, then all is hunky dory. However, if a stock goes down to below the threshold then you will have to either provide more cash so that the value of your loan doesn’t go over the limit, or your brokerage will forcibly sell some of your stocks to cover. So if your $100 of stock goes to $80, then your $40 loan is 50% of the value of your holdings. If the stock goes lower to $79, then you are borrowing too much for the equity you have. You will have to immediately (maybe, if you’re a good customer, the brokerage will give you 3 days) provide cash or sell shares to cover the difference. That can really hurt, not only because the leverage has increased your downside risk, but also because the forced sale means you don’t even have the option of waiting out a downturn — your shares will be sold and you won’t participate in any rebound, if it occurs. These margin calls are part of what sometimes drives the stock market to overshoot and oversell a stock — if the stock starts dropping and enough investors find that they don’t meet their margin requirements, they can be forced to sell something, driving it yet further down.

My examples here are quite simplistic — you will naturally have to pay interest on that loan, whether it is from your broker or a separate loan or line of credit. This interest will reduce your bonus gains a bit, and increase the amount you have to pay on the downside. Margin accounts from a broker are generally “interest only”, which keeps the cost of maintaining the leverage low, whereas you’re generally expected to pay back at least part of the principal back with a traditional loan a bank (not sure about a HELOC, I think that is flexible so it can be interest-only if you want it to be). Borrowing to invest, as long as your investments produce income, should make the interest tax-deductible, but I am not a tax expert and in fact this means very little to me given my tax bill as a grad student.

So what are your thoughts on margin and leveraging? I thought I was fairly pessimistic, at least relative to what I was hearing in the media, about what this year had in store back in January. Then things started to get into my value ranges and I started buying. Now things are a fair bit lower than I estimated the bottom would come, so perhaps things will turn around, or at the very least we might see a dead cat bounce. Do you think I should take on the risk of leverage to try to wring some performance out of this market? For a margin account, TD presently charges 5.75% interest to buy Canadian stocks. There are a number of companies out there that are presently paying out that much in distributions or dividends, so I could buy one and have the payments cover the interest while I wait for capital appreciation. On the other hand, the market might continue to go down and down for years to come, and being leveraged would just magnify my losses. That interest rate is also variable, and could go up at any time: possibly quite soon given the fears of inflation lately, adding to the risk. What do you think? Do you have any thoughts on a margin account versus an investment loan or line of credit? To start you off, here are two posts by Canadian Capitalist, Thicken My Wallet on leverage.

You ever have that nightmare, the one where you miss the first day of school? Yeah, today’s the second time that’s happened to me. The first was the special JBO tutorial in 3rd year that they only seemed to tell the physiology students about (it was a joint class and all of the physicists, IIRC, missed the first one). And now today I missed my first intro to CCPM class because I… simply forgot. Didn’t even think it was starting in July for some reason. D’oh!

A wedding is supposed to be many things. A family reunion, a chance for your parents to show you off, and of course indulging a certain someone’s princess complex fantasy. But it’s also supposed to be a grand old party where the special couple gets to call the shots, and get all their dear old friends and family out in their finery to rock the night away. So it was really sad to see everyone, on a saturday night, play the “old” card and quit the wedding early the night before last. Sure, the new parents have a decent excuse, since it’s tough being away from (or keeping) a youngster to that late at night, and I’m sure even the ones who were getting sloppy drunk on the open bar came up with some kind of excuse for cutting out early — some before midnight even! Even some of the people in the wedding party were heading off for bed before the end of the night, which was scheduled for 1 am. I don’t know what is up with that. It was not so very long ago that we started a night out (or in) at 1 am. Shit happens, and it’s usually ok if one or two people have to leave early for whatever reason. However, somehow everyone left early, and that starts to look bad.

Not only did this put a bit of a damper on the giant celebratory party thing but it also meant that there was a constant trickle of people leaving all through the night, all of whom had to stop and say their individual congratulations and goodbyes to the happy couple. This resulted in them spending almost the entire night saying goodbye, rather than partying hard at their own fete and then getting kicked out as the lights came up and saying a big goodbye as they got into the limo. Instead of a big crowd sending them off and cheering after the car, they were virtually the last ones to leave.

I’m an understanding guy. I understand that you have external demands on your time. I understand that it can be difficult to arrange a day off when you only have a year’s notice, or that you don’t want to eat into your limited vacation time for a wedding. I understand that you need your beauty sleep to function properly the next day. But understand this: the bride spent the last year of her life (in Teresa’s case, the last two years) planning the perfect party to celebrate her once-in-a-lifetime event. When you leave early, it says either that she didn’t do a good job in the planning, and you’re just not having a good time; or that you have better places to be, that there’s something more important out there than her special day.

Just fair warning: this will not happen at Wayfare’s wedding. Yes, it’s selfish of us, but you’ve been warned. Play it safe: tell the sitter you won’t be back until 3, or pump some breast milk and tell granny you won’t be back at all. Book the next day off work if you are stuck working on Sunday, or learn to cope with 5 hours of sleep for one day. Decide not to cut back on caffeine that day. I don’t care if I have to break the fire code and bar the doors, but no one under the age of 60 will be leaving before we do. At the end of the night, we will rush out to the car, and you will follow and cheer and wish us well, and you will smile. The only acceptable alternative is a weepy farewell, and then only for Ryan and the aunts. Now, Wayfare has a hell of a time staying up until 1 am, so we understand some of the difficulties involved, and we’re going to try to work with you as much as possible. But remember: if she can do it, you can do it. We’ve scheduled the whole thing so that the ceremony starts late in the day and goes straight into the reception, without you having to figure out what to do with yourself while we’re off getting photos taken. It won’t take up the whole day on you, and you won’t have to wake up early. You’ll have lots of time to relax and nap through the day, or even get a full day of work in if you skip the ceremony and jump straight to the reception. The reception is centrally located in North York, close to the 404 so the Torontonians and Markhamites can get home quickly without having to factor in much in the way of travel time; we’ll try to arrange decent rates at a nearby hotel for those from out of town. We’ll work with you to make sure that you can make it through that grueling marathon of merriment, good food, and dancing. Let us know why you had to leave so early the night before last. Was it a car issue? We can arrange cabs for everyone. Was it too hard to go up to the open bar? We can send out more waitresses with more free booze. Too much hootch, and you were ready to pass out by 10? We can hold the alcohol until after dinner, or indefinitely. We can get rid of the dessert table if that temptation was overcoming your willpower and you just had to leave to avoid scarfing down a whole cake. I know a lot of doctors, if you need a note to take a sick day at work. If the narcolepsy’s got you down, I’ll see if my dad can bring the camper van so you can catch a few zzz’s in the parking lot and still pop back in for the last dance.

I’m not big in the way of arbitrary traditions for “showing respect”. I don’t care if you wear a suit, or bring a gift, or bow to the altar, or wear uncomfortable shoes, or can’t wait your turn and just start incoherently yelling out a speech you’ve prepared in the middle of the ceremony. Show up in shorts and a T-shirt with some flip-flops. Don’t even take your hat off in church, it’s a nice look on you. If you don’t like the food, go ahead and order in a pizza, I’ll even chip in for a slice of plain cheese. I don’t care if you throw a tissy fit like my dad did about the guest list or the seating arrangements. I don’t care if you follow the seating arrangements. They’re a suggestion, sit where you want, just sort it out with the person whose seat you’re taking. I want you to be comfortable, have a good time, and moreover I want you to be there to share our big day with us. But if you can’t block out 8 hours of your time a year in advance for Wayfare, then that will be disrespecting my wife.