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Real estate in 2009 - Crisis or Opportunity?

DrewBetts

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Hey folks,
Below is an article I just wrote for our Investor Community newsletter. Thought you might be interested. Cheers!

Real Estate in 2009 – Crisis or Opportunity?


The question I’ve been asked most in the last month has been, “What impact do you think the financial crisis will have on real estate in Western Canada?” We have certainly seen a barrage of unprecedented events and turmoil in the market over the last year. What does this mean for us?


Financing Has Become More Expensive

One result of the financial crisis we are feeling North of the border is the increase in borrowing costs. Banks do not have the same access to capital they once did, and the cost of their capital and lending risk has gone up. Lending has not come to a grinding halt, as the media would have us believe, although it has become more challenging.

This October banks stopped offering 40 year amortized and 100% loan-to-value mortgages. We have also seen a significant increase in lending rates. To give you a concrete example of this, 6 months ago I refinanced a property and secured a prime minus 0.6% interest rate. If I applied for the same mortgage today, I would receive a prime plus 1% mortgage. However, prime has recently been reduced from 4.75% to 4%, offsetting this increase in spreads.

Because of this change, purchasers are required to have more income than in the past.
To illustrate, I’ll use an example of a $500,000 property. In the past I could have used an 80% mortgage, amortized over 40 years, at 3.4% interest (prime minus 0.6%). This results in a payment of $1,520.00, requiring income of $56,999 annually (banks typically only use 32% of your income to qualify you for a mortgage payment).

Take this same property and get a mortgage today, and I’d be getting an 80% mortgage, amortized over 35 years, at 5% (prime plus 1%). This results in a payment of $2,005.68, requiring income of $75,213 annually. That’s a 32% increase in the amount of income you need to qualify for a mortgage!

Does this mean we should run for the hills and stop buying real estate? No! In fact, in times like these it’s beneficial to be a landlord. Fewer people can afford to buy homes, which means there will be more renters and higher demand for rental housing. I don’t know about you, but I want to be the guy to supply it to them!

Cash-Flow Properties Are Essential


Because of the increase in borrowing costs, cash-flowing properties are essential now more than ever. Market appreciation is one of the main benefits of owning real estate over the long term, however, money now is much more important than money 5 years from now. Investors who are purchasing properties without cash-flow are hurting themselves in 2 ways: 1) They are speculating that the market is going to increase enough to provide the return they desire, 2) Negative cash-flow leeches away your monthly income and reduces your ability to borrow more money from the bank. Banks like to see cash-flow properties that cover their own debts plus a safety buffer of additional income. Their required safety buffer (read as cash-flow) has just increased substantially, making cash-flow more important than ever.

Research & Expertise Have Never Been More Important


Over the past 5 years, while the real estate market was superheated and booming, virtually anyone who owned real estate looked like a genius. Every second person on the street was a real estate expert. Well, a rising tide floats all boats and when the tide comes out you can see who’s been swimming naked. That’s one of my favourite sayings, and what I mean is that when there are bumps in the road it takes more than rolling the dice to make a successful investment.

Your secret weapon in times of market uncertainty is research. Investing based on the numbers and economic fundamentals and working with experienced professionals. Doing your “homework” so to speak. In the last 5 years, the market has covered up the mistakes of hundreds of would-be “expert” real estate investors that will lose their shirts if they continue to do the same things. Investing in real estate in today’s market conditions can still be extremely profitable, but you have to make sure you’re following a proven system, thoroughly researching your markets, and not being overzealous.

For more information on our comprehensive system of researching markets, download our recent Grande Prairie Opportunity Report from our website. It walks you through everything we look at before investing in a market.

Don’t Let Fear Lead to Inaction

In studies of past economic crises, history has always shown that fearful investors always let fear keep them out of the market for too long. People miss countless buying opportunities when the market is down or rebounding. Canadians right now are hoarding their money and putting it into precious metals, GICs, and cash or cash equivalents. Because of all the money being pumped into the market right now, combined with higher commodity prices, inflation is higher than it has been in the past. Inflation erodes the value of cash!

Good news for you, is that real estate is inflation proof. Land has always appreciated FASTER than inflation. Therefore, owning real estate in a high inflation environment is an excellent place to store your wealth. Real estate is also a much safer investment because it is tangible and able to generate cash-flow for you today. There are many excellent buying opportunities waiting for you right now, so don’t miss the boat!
 

UTCVenturesLtd

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Very good post!
I picked up a property in the Crowsnest Pass last June and with some exterior renovations, it looks like the property has almost doubling potential in approx 4 months of ownership!!! Prices had dipped back then and the one that i bought was reduced around $45k for a quick sale. I took a look at prices and was surprised to see the lower prices are nonexistant. My contractor and his helper both were talking to the locals of a ski resort expansion that is proposed for Blairmore and recommended that i do not flip it. Looks like it will be a furnished short term rental within a few weeks now.
Aside from real estate, the stock market has opened up the doors to some buy low deals. I do a number of penny stocks and have seen many lately for very cheap. Some are starting to wake up now which there may be a stock market rally coming soon as things settle. I think some savvy investors could easily create a downpayment for more real estate purchases by going the short term route in the market and that being for up to 6 months.
 

terri

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QUOTE Because of this change, purchasers are required to have more income than in the past.
To illustrate, I`ll use an example of a $500,000 property. In the past I could have used an 80% mortgage, amortized over 40 years, at 3.4% interest (prime minus 0.6%).
This results in a payment of $1,520.00, requiring income of $56,999 annually (banks typically only use 32% of your income to qualify you for a mortgage payment).

Brett,

I`m not sure I agree with how you are calculating your figures here, you are using a discount of prime minus .6% with the current prime rates of 4%, but you need to match the discount off prime with the prime rate at the time it was offered.

You could get a discount of prime minus .6% when the prime rate was 4.75%. so using that # of 4.15%, 80% ltv, 40 yr amort, the monthly payments would have been $1709.27. Qualify household income would be about $64, 100, which means you now need 17% more income that you did just a few months ago

BUT.....

One year ago prime was at 6.25, I got a mortgage @ prime minus .7% open. If you used that # of 5.55% with 80% ltv, 40 yr amortization, the monthly payment is actually $2076.71 which means that one would need a household income of almost $77,890 to qualify for that same mortgage one year ago. That`s more than what you need to make today.

Just a thought,

T.
 

wealthyboomer

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QUOTE (DrewBetts @ Oct 31 2008, 08:07 PM) Good news for you, is that real estate is inflation proof. Land has always appreciated FASTER than inflation.
What`s your source for that?

Robert Shiller, a Yale economist, tracked U.S. real estate markets between1890 and 2005 and found that home prices edged up a mere 0.4% a year in real terms over more than a century. Another study, by Dutch economist Piet Eicholtz, traced prices in a neighborhood of Amsterdam over 345 years and found they went up and down a lot, but over the long haul averaged a miserly gain of only 0.2% a year after inflation. The conclusion: real estate seems to keep pace with inflation over the long term, but that`s about it.
 

JohnS

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QUOTE (wealthyboomer @ Nov 1 2008, 04:19 AM) What`s your source for that?

Robert Shiller, a Yale economist, tracked U.S. real estate markets between1890 and 2005 and found that home prices edged up a mere 0.4% a year in real terms over more than a century. Another study, by Dutch economist Piet Eicholtz, traced prices in a neighborhood of Amsterdam over 345 years and found they went up and down a lot, but over the long haul averaged a miserly gain of only 0.2% a year after inflation. The conclusion: real estate seems to keep pace with inflation over the long term, but that`s about it.

Okaaaaay, I might be reading this wrong, but aren`t both of your sources just proving his case? I mean, both of your sources say that historically (over 100 years, and over 300 years) real estate increased more than inflation. Granted, not 20 times inflation, but they were both still more than inflation, which is all that he said in the first place.

Please, tell me if I`m wrong, but so far, I`ve seen more negative posts from you than positive ones, which makes me wonder about your world view.

Have a good day, all!

JohnS
 

Thomas Beyer

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QUOTE (wealthyboomer @ Nov 1 2008, 02:19 AM) The conclusion: real estate seems to keep pace with inflation over the long term, but that`s about it.

Right ! Hence: buy @ 20% down, with little or no cash-flow (but enough to break even and hold for a while), and make 4% annually, on 20% down .. or 20% cash-on-cash ROI !!! PLUS: pay your mortgage down to 0 in 25 or 30 years (ie.. quintuple your money, say in 30 years ) !

So even in an average average market over the long term you make 25% + ROI on your cash invested ! This is a proven path to wealth !!

And if you`re a smart REIN member, buy slightly below market from a motivated seller, with slightly more than 0 cash-flow and in markets that grow faster due to in-migration or the economy .. you do even better !!
 

PeterKinchMortgageTeam

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40 year amoritizations are actually still available conventionally - from a couple of lenders without increased rates or fees. It is only on high ratio mortgages that they are no longer available, per the insurers guidelines.

You are absolutly correct, the variable rate mortgage at prime + 1% is not nearly as attractive as it used to be, but there are alternatives. One popular option is to look at the short term fixed rates -several of the lenders are offering really great rates on the year fixed rates (some at low at 4.35%). As you pointed out, lenders have not stopped lending nor have most even changed thier guidelines - what they are doing is tightening up on conditions to ensure that they have documentation supporting that borrowers meet thier guidelines.
 

PeterKinchMortgageTeam

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The 40 year amoritization is still available conventionally from a couple of lenders - it is only for insured mortgages that it is no longer an option.

You are correct in that the prime + 1% VRM is not nearly as attractive as it used to be, but there are alternatives that allow you to keep your borrowing costs lower. One very popular option is to look at the short term fixed rates - a couple of lenders are offering rate sales on this and are as low at 4.35%

Food for thought.......
 

wealthyboomer

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QUOTE (JohnS @ Nov 1 2008, 03:10 AM) Please, tell me if I`m wrong, but so far, I`ve seen more negative posts from you than positive ones, which makes me wonder about your world view.

Have a good day, all!

JohnS
Whether it`s a negative post is up to each person to decide, but I`ve done my best here to offer some facts.

Journalism is (or used to be) the profession of gathering and presenting a broad panorama of news about the events of our times and presenting it to readers for their own consideration. I believe in the intelligence, judgment and wisdom of our readers to discern for themselves among the data which appears on this site that which is valid and worthy...or otherwise.

All readers have a right to dispute the articles by using logic and evidence, as well as forwarding their responses to the original authors of those articles.

Sobering Economic News Wins You No Friends in a Delusional Nation.
TRUTH NEEDS NO DEFENDING!
 

Nir

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Great post Drew!



Hello John, I agree in this case perhaps it was not accurate to question Drew's statement "Good news for you, is that real estate is inflation proof. Land has always appreciated FASTER than inflation".



However, I am sure the 20-80% rule works in the case of REIN's forum too, meaning 20% of the forum members contribute around 80% of the postings. Wealthyboomer is definitely among the top 20% participants and I'm sure sharing his knowledge and his feedback on different topics, as long as it is done with tact, is highly appreciated by other investors.



Just a few examples of Wealthyboomer's contribution by sharing knowledge and promoting successful investments:



- http://myreinspace.com/public_forums/Real_Estate_Discussion/62-7885-Have_a_buyer_who_hasnt_a_downpayment.html



- http://myreinspace.com/public_forums/Real_Estate_Discussion/62-7266-My_house_has_been_used_for_an_ad_scam.html



I'm sure everyone can appreciate the experience, skills, knowledge and also different styles of different investors participating in this GREAT REIN forum!



Regards,

Neil
 

DrewBetts

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QUOTE (wealthyboomer @ Nov 1 2008, 12:19 AM) What`s your source for that?Robert Shiller, a Yale economist, tracked U.S. real estate markets between1890 and 2005 and found that home prices edged up a mere 0.4% a year in real terms over more than a century. Another study, by Dutch economist Piet Eicholtz, traced prices in a neighborhood of Amsterdam over 345 years and found they went up and down a lot, but over the long haul averaged a miserly gain of only 0.2% a year after inflation. The conclusion: real estate seems to keep pace with inflation over the long term, but that`s about it.

Thanks for the reply. That`s good info. To be more specific, land appreciates faster than inflation. Land is only a component of what we refer to as real estate, which is land and a building, the latter of which depreciates over time. The 50 year average of appreciation of Canadian residential real estate (from CREA) is 6.5%. If the building is depreciating over time, then the land must be appreciating at a higher rate. Inflation over time has been much less than this. Therefore, land appreciates much faster than inflation. Thomas, who`s company owns $85M worth of real estate corroborated this if you want a second opinion.

Also, in your post you mention gains in "real" terms. In economics, real means a gain net of inflation. Both of your examples seem to prove my point no?

For reference, the definition of real from Wikipedia is: In economics, nominal value
refers to any price or value expressed in money of the day, as opposed to real value
, which adjusts for the effect of inflation.
 
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