experts: real estate column Wednesday, March 19, 2003

Real estate versus stocks

Of course I'm biased, but the right real estate purchase is really no different from other ways of investing your money.

By Ozzie Jurock

This article appeared in The Vancouver Sun on March 15, 2003

The two hottest questions today:

1. Should I lock in my mortgage?
2. Is real estate or are stocks better in the long run?

1. Should I lock in my mortgage?

This first one is easy. It depends. (You knew it!). If you are a homeowner diligently watching the rates every day ... go short, but be ready to lock into a predetermined rate, when (when) rates go against you. If you are an investor wanting to create a stream of unearned income over time paid for by tenants - match your term to the length of time you intend to keep the property. Today’s best rates (ten year rate -6%) are fantastic fix your cost, while your income will rise ... best of all worlds.

But do, do you due diligence ... The variety of mortgage products is simply overwhelming. The mortgage that is best for you is best created with a mortgage professional. Today there are mortgages granted (there is a cost) at 100% of value, mortgages for the self-employed based on ‘stated (not proven) income’ and this week we even have a 5.1% - 5-year term available, that with some innovative maneuvering can result also in a 1% cash back to you.

2. Is real estate or stocks better in the long run?

Stocks in the dumps and real estate booming? No wonder this is the question that keeps battalions of investors gnashing their teeth at night. Where, oh where am I to park my cash.

The answer? Also easy. It depends. Yes, real estate can pay off big time - as can stocks. But both can reverse also. And while real estate provides steady rental income, it's a not liquid like stocks. (Mind you, you couldn’t get out of many stocks either now - at least at a price you paid for them).

But, I am shown statistics by this or that company that ‘over the long run’ stocks were always better? Well, statistics can be made to show anything. Throughout 2001 and early 2002 many a stock market advisor preached that “small investor should stay in there for the long run.’ Perhaps they will be proven right eventually, let's face it all investments are cyclical...but in the long run we are all dead.

The real question is: What are YOU going to be more comfortable owning? What has your experience been over the last 30 years in your circle of friends, colleagues? What return are you expecting and with what certainty and safety? What is your motivation? A quick profit or income for the long haul? Because in the long run ... real estate has some sweet features.

I am showing my biases of course, but for myself, I would rather own a piece of real estate, one that I have some sweat equity in - as in researched and evaluated personally. Your decision to invest in a particular property should be based on the economic, sociological and demographic considerations that apply at the time. Don't just buy something because you'll make X amount of dollars on it ... or because the stock market is down right now. It has to fit within the framework of your personal investment objectives. The risk factors have to be in balanced with what you can tolerate.

Let’s look at an example. Say an esteemed relative gave you $15,000. Or, an even more esteemed one gave you more ... . What are you going to do with it?

Well, let’s say you plunk your windfall down as a down payment on a property. You have three ways to make money here ... potentially. Rental income, mortgage reduction and appreciation on the full price if you sell the place at a profit.

If you stay conservative and match rental income to debt ... you would buy an older 1 bedroom suite in - say New Westminster, Surrey, Langley, Abbotsford at a price of $65,000. Your $15,000 down payment leaves you a mortgage of $50,000.

After one year (assuming a small 7% increase in value -actually used condos all over the Lower Mainland rose by 11% in 2002 on average) your unit now clocks in at $69,550. Nice return 7%, right? Well, yes ... but it is actually much better - you forgot leverage. Your $15,000 made you that $4,550 you are up 30%. Hello! Good stuff ... well, wait, it does not end there. You took out that mortgage we talked about earlier of $50,000 at say 6%. Your payment is $320, your strata fees are - say $60 as are your taxes. Total monthly costs $440. Your rental income is say $550. Cash flow monthly is $110. After one year you have a cash return of $1,320 ... add that to your capital appreciation and you get to 39%. Not bad, you say ... well that’s not all either ... there is also a mortgage reduction of about $800, bringing the total to a 44% return.

However let’s say you plunk it into a Mutual Fund that returns a conservative (although I do not know of any of late that have) 6 percent. That's a $900 gain this year.

You choose.

“Foul,” cry all the financial community. And they would be right. Ok, ok, clearly, it works here ... because you bought a property with maximum rental value to price ratio and we are making some favourable assumptions. But real estate works because house prices rise on the total value of the property, your cash return is on your down payment - giving you great leverage. Of course these gains exclude Realtor fees and other costs you'll incur when it's sold. The profits on investment real estate are subject to capital gains tax and you may have headaches with tenants.

And, says the financial community: “There are investors in real estate that don’t like owing these low end properties. Some want to own the big property of $300,000 that rents for only $1,200 ... throwing out all calculations on return on investment out of the window.” Not all calculations, just not as sweet. But, yes, some investors will. “There is also work involved here. You are assuming that finding a property where you'll get enough rental income to pay mortgage, taxes and expenses.” Yes I am. And some work and learning is involved. “You are assuming everyone can be the type of person who can manage it a rental property. “Yes. I am. It can be learned. “You are assuming that markets won't drop in the next 10 years.” Yes, I am. Particularly in The Lower Mainland area. But even if they do not - a cash flow of $1,320 plus an (ever increasing) mortgage reduction of $800 represents a 14% return ... even if values never were to go higher.

We did the calculations on a 25% down payment ... take a pen and work out the numbers - if you learn to tie up that property with $10,000 or $5,000? How sweet it is ...

Finding the right real estate investment is really no different then any other investment. We all understand everything ... doesn’t mean we are going to do anything about it. After a war, stocks could soar. But which ones? Today, March 10, 2003 is the anniversary of the all time high (3 years ago) of the NASDAQ - when it was over 5,000. Today it broke through 1,300. It probably is a good time ... but it isn’t a sure thing. But then again ... what is ... ? Real estate on the other hand ... Is at least still there, you can touch it, drive by it, walk in it ... in the long run.

(There is a section ‘Q & A section’ on my website where 16 experts answer hundreds of questions take a look, perhaps yours is answered there as well.)

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