Thursday, October 28, 2010

An ironic and very interesting tidbit from GlobeInvestorGold

Long-term investing is not so long

David Berman

14:38 EST Thursday, Oct 28, 2010

Barry Ritholtz, at The Big Picture, tackled a peculiarly interesting investing statistic that I hadn't actually seen before, and found it to be false. But even as a wrong stat, it is still indicative of a trend: 70 per cent of all trading volume is due to high-frequency trading by computers, and the average holding period is 11 seconds.

Mr. Ritholtz wanted some backup evidence, and found that the 11-second holding period is nothing more than an estimate – or worse, a guess. Still, it does get you wondering...whether the actual number is 24 seconds, or three-and-a-half minutes or four days. The fact of the matter is that holding periods, whether we’re talking about computers, professional money managers or regular Joes and Janes, is steadily falling.

Mr. Ritholtz quotes a recent article by David Hunkar, at, to show what is going on: “Based on the [New York Stock Exchange] index data, the mean duration of holding period by U.S. investors was around seven years in 1940. This stayed the same for the next 35 years. The average holding period had fallen to under two years by the time of the 1987 crash. By the turn of the century it had fallen to below one year. It was around seven months by 2007.”

Those numbers take all investors into account, so presumably the holding periods for high-frequency traders would be considerably shorter than seven months.

If long-term investing is generally a good thing – at least for smaller investors – then this trend is a problem if we measure our commitment to long-term investing by how we stack up against the average. In other words, if your average holding period is above seven months, then congratulations, you are a long-term investor. But by the standards of the 1940s through to the 1970s, most of us would look like high-frequency traders.

This interesting tidbit is from:

Tuesday, October 26, 2010

I tell my own children to use a TFSA (Tax Free Saving Account)

I tell my own children to use a TFSA and once they make enough money (30 - 60K per year) then combine it with a RRSP. Basically, the idea is that when your tax-bracket is high enough, you could contribute say $4000 per year to your RRSP and put the tax refund (say $1000) in your TFSA.

If you do not maket enough money to pay a lot of tax right now, put your money in a TFSA. With a disciplined investment approach and improving salary, over the years the account will build up to a sizeable portfolio (deposit every year the max of $5000 and in 5 years you have $25,000 plus profits).

The disadvantage of both account types (RRSP and TFSA) is that you cannot deduct capital losses from your taxes. So a loss is a loss. A lot of people put only fixed-income investments in them which are less volatile than stocks and you have often to pay the full taxes on them (e.g. GICs or anything that earns interest). I am not entirely in favour of that because over time, inflation will eat into your investments and the overall ROI is not sufficient to accumulate more money. When you withdraw money from an RRSP you have to pay taxes on the withdrawal and the typical end result is that you only take out what you originally put in plus inflation. So RRSPs are more a 'capital preservation' than a wealth building tool in my opinion.

TFSAs are similar but since you put in 'after-tax' money you do not pay taxes when you take money (including profits) out afterwards. But don't use it as a ‘chequeing account’ - taking money in and out during one year because then it becomes taxable - tricky. If you have a long time horizon - i.e. intend to keep investments 5 to 10 years, or better longer then a diversified stock portfolio is good as well. This is because the 'risks' in stocks disappear the longer you hold them. The key is 'diversified' though, since individual companies can, and from time to time do, go bad or broke. Thus, buy a lot of different stocks.

Best in my eyes are ETFs like i-shares that comprise the 60 largest Canadian companies trading on the TSX. The stock symbol for that ETF is ‘XIU’. You put them in your account and reinvest the dividends that are paid every 3 months or so. (B.T.W. use a discount brokerage account - a full service brokerage is too expensive for a small investor).

Holding individual stocks of excellent companies purchased at a good price is not bad. But in a small portfolio the combination of stock volatility, commissions on small transactions and individual company risk makes this approach not ideal. Besides many of such stocks are part of the XIUs anyway.

Another thing a small investor should consider is becoming a member of the Canadian Share Owner Association. They offer education on-line through webinars, have a monthly investment magazine, they have an excellent stock database and they allow you to invest for very low commissions in small investment accounts. My son has an account of $1700 and dividends are automatically re-invested. Since it is a 'practice account' he does own individual stocks.

The Canadian Shareowners Association, kind of like REIN, teaches how to invest in stocks - they use fundamentals like earnings per share, revenue, dividends, profit margins and several other criteria to determine whether a particular stock is a good investment. They are 'value investors' and they are good at it. Their website is a mess and geeky but with some patience you will figure it out. Annual membership fees are $90 (last time I checked).

Of course read as many books as you can about investing - both on real estate and on paper securities. In my opinion it is best to start building your nest egg in stocks and bonds, then when you have a sufficient down payment buy your first residence and pay it off ASAP. If you want landlord experience rent out the basement suite. Once you have the basics under control, you have a solid financial base and a decent down payment (30%) move into real estate investing. But be careful, nothing is as bad as being overleveraged and with vacancies. (I speak from hard experience).

Thursday, October 21, 2010

Call Options

Option trading is considered high risk, but this is far from true. It depends on the way you trade options. Sounds familiar? Real Estate investment ranges from low to high risk depending, for example, on the amount of leverage.

What is an option? An option provides you the right (the choice) to buy a good at a certain price somewhere in the future. On the other side is the option seller or ‘writer’ who sells the right to buy a good at a certain price somewhere in the future. For example, I have the option to buy an average single family house in Calgary for $400,000 (strike price) five years from now.

Such a property you could buy right now for around $350,000. So why would I want to pay $400,000 instead? Well chances are that 5 years from now, this property (based on an average annual appreciation rate of 6%) will be worth $468,377. So now I have the right to buy 5 years from now an average single family house worth $468.377 for $400,000! Oops that is quite profitable; especially if I had to pay very little for this option in the first place. So 5 years from now I pay $400,000 to buy the property and sell it that same day to a buddy of mine for $468,377! During the 5 years I could have invested that $400,000 in a GIC. If I had bought the house for $350,000 outright using a big mortgage I would have to pay interest on the mortgage say 4% annually or some $14,000 per year. Thus, after 5 years I might have paid close to $70,000 in interest. In case you are wondering, Rent-to-Own transactions could be considered an option to buy.

You can do the same with many other investments. Investors trade in options to buy or sell shares at a specific price that expire a certain time from now. Typically traded stock options (not the ones issued by an employer) are valid for a certain time; say a month or, more common, 3 months. Options that expire 12 months or longer after purchase are often referred to as LEAPS (Long Term Equity AnticiPation Security) options.

If you WRITE or SELL the right to buy a share of say the Bank of Montreal 3 months from now for $62.00 (strike price), then the buyer of that option has the choice to buy that share for $62 regardless of what it trades for at that time on the stock market. Say BMO trades three months from now for $50 per share. The option buyer will say “thanks but no thanks, it is cheaper for me to buy BMO right now on the stock market rather than paying you $62.00”. Your option then expires without being exercised
But suppose a share of BMO would be worth $70 three months from now. Then the buyer of your option would love to buy your share for $62 dollars (i.e. exercise his option) and make a quick profit of $ 8 per share. You, the issuer of the option are obliged to sell the share for $62.00. Why would you do such a stupid thing?

Well maybe it was not such a stupid move after all. See, you the seller owned already the BMO share. You bought it a year ago for $50 and right now it is trading at $60.85. You could sell it for a tidy profit and feel that holding on much longer would not add a lot to the profits. But suppose you could sell it for $62 a few months from now? Of course there is a chance that the share price will fall again. Hmmm... if this is a good investment sooner or later BMO will sell for $62 anyway, holding on a bit longer may be worth the extra money earned for writing a ‘call’ option.

Right on! You can write or sell a call option say for $1.00. The buyer of the option would have the right to buy your share for $62.00; a price you are happy to get. You have the chance not to sell for the current $60.85 but for $62 plus another $1 proceeds for selling the option. In the meantime, over the coming 3 months BMO would also pay another 70 cents of dividends, so that would bring the potential proceeds to $64.70 or an extra $2.90 in profits. And... if the share price falls, you have no problem holding on to the BMO share somewhat longer while getting paid an extra dollar on top of the $0.70 dividends. You could even write another call option once the first one was expired earning even more!

Now if the writer of the call option did not own BMO shares and the share price rose to $70.00 he would be forced upon expiry of the option to buy one for $70 in order to sell it for $62 to the option buyer. So for the chance to make a buck betting on BMO trading below $62.00 three months after selling the option, he now has to pay an extra $7 to buy the BMO share. If BMO had risen to $100, the seller of the call option would not be $7 but $29 in the hole.

If the option had expired worthless the seller would have made $1 on a 0 investment, i.e. an infinite return but he ran the risk of losing a lot more. Selling or writing a call option on a share you already own is called ‘selling a covered call’ and it is low risk. Selling a call option without owning the underlying share is called ‘selling a naked call’ – it is high risk and extremely speculative.

Here is a way I like to play with call options. Suppose I consider investing in BMO a good idea. It pays a $2.80 dividend. It earned $4.64 last year (of which $2.80 is paid to the share owner and $1.84 is reinvested in the company to make even more profits). Next year, analysts expect BMO to earn $5.48. So I’ll make 5.48/60.85 = 9% based on earnings. Compare that to 3% on a 10 year Bond of the Government of Canada. Especially, since in terms of cash flow, I will receive $2.80 or 4.6% in tax advantaged dividend. Also, the dividends will likely increase over the years along with earnings while the interest I get on the bond will not!

So I buy a share for $60.85. Pity I couldn’t buy cheaper! But wait a minute, if I write a call option, I can get $1.05 in today’s option market. Basically, I get a buck and five cents off the share’s purchase price. What do I do for that? Well say I write an option for the right to buy my share 3 months from now at a strike price of $62.00. If it gets ‘called’ or exercised I can decide to be happy with the results. After all, I made $1.05 from the option sale, I made another $62-60.85 = $1.15 in capital gains over 3 month and oh... I collected 3 months worth of dividends or 70 cents. Wow, that is 1.05+1.15+0.70=$2.90 profits on $60.85 invested in under three months or 27% on an annual basis.

If the call option is not exercised, I own a good investment on which I can write another option and chances are that I will be able to sell it 6 months from now for $64 rather than $62 dollars plus 2 times the quarterly dividend of 70 cents. That would be a respectable ROI of 21%.

In the table above are the profit calculations for both scenarios. An earlier posting on this blog shows the profits you could make on a typical Canadian Bank as a long term hold. Writing on a regular basis call options would increase your profits even more.

Tuesday, October 19, 2010

I just cannot stop myself

Once in a while, you hear people shout: I like real estate because it is less volatile than the stock market. Besides, I am a long term investor and real estate makes me rich over the long term while I lost lots of money in the stock market.

My response: if you are a long term investor then why do you care about daily volatility?

 If you lost so much in the stock market, I bet that was because you were a short term gambler who bought on tips from your 'buddies' and from the bus driver. I bet you studied the stock market a lot less than you studied the real estate market.

Really every investment has risks and rewards. Just ask Donal Trump or one of the many duped U.S. real estate owners. Investing is about achieving maximum profits for minimum risk. A very simple concept that is so tough to achieve. One way of minimizing risk is diversifying (not diworseifying) your portfolio.

Thursday, October 14, 2010

Update on Natural Gas Prices

New well completion techniques, in particular multistage fracturing, combined with the 2008 recession (plus Stelmach's old new royalty scheme) have created havoc in Alberta's natural gas industry. It also has given us an entirely new outlook on energy supply now that shale gas (and other tight gas reservoirs) have added decades of gas reserves to our dwindling energy supply.

We still don't understand the impact of all these new technlogies and plays.Neither don't we know whether a similar revolution would be in the cards for oil production - less likely. I for one think that T. Boones Pickens is right with the assumption that natural gas is the 'cleanest' source of realistic energy supply for some decades to come. My personal ultimate hope lies in the potential of geothermal energy as I think the capacity for solar and wind energy are not sufficient to make North America fossil fuel independant. And that is a goal at least 50 years away if not further out into the future.

So for now, the natural gas reserves of the world and North America are limitless - at least in the decade or two ahead. On the otherside of the equation we have consumption and one restrained is infrastructure. Electricity generation is still dominated by coal and to switch a significant proportion to natural gas will take many years. The use of natural gas for heating purposes is already extensive; while natural gas as an energy source for transportation requires a lot of work as well (hydrogen car and propane using cars).

We can assume, coming out of the recession, demand for gas will likely increase but at a modest pace only. So really, gas prices are then mostly based on production supply; winter temperatures and summer temperatures. The one easiest to predict is production supply. I took this chart from the The Oil Drum website.

The chart show Daily Marketed Gas Production in the US in BCF/D over time. Also plotted is the number of gas chasing drilling rigs (dashed line) over time. If tomorrow no new wells would be drilled, gas production would drop off from 63Bcf/d to less than 30 Bcf per day within 2 years (Cyan curve). Chesapeak Energy who constructed this graph also calculated how much production would be added for  various rig counts. If 750 rigs were drilling for gas each month then gas production would drop to 52Bcf/d. With 1100 rigs gas production would be stable, while drilling with 1500 rigs (as at the peak in 2008) would result in production increasing to 72Bcf/d.

What would determine how many wells are drilled with how many rigs? Right the gas price; or better the profitability of drilling for gas. That question is dealt with in the next graph, where gas prices and production costs per Mmbtu are plotted over time. When gas prices are higher than production costs then it is profitable for companies to drill. Since gas reserves are 'unlimited' for now, gas price and production costs are strictly a matter of supply and demand. Chesapaeak's calculation and a rig count currently around 760 predicts a production drop to 52Bcf/d and with gas prices far below production costs this may get even worse. Consequently, demand and supply may be in balance within 2 years. Factors that may accelerate this are a cold winter on the east side (highest population centres) of the continent or warm summers in states such as California. Pricing is likely to be somewhat higher than projected production costs, so in the range of $8 to $10 dollars per mcf (1cf = 1027BTU or 1Mcf = 1.027MMBTU=301Kwh). That is nearly double today's prices.

Investors in oil and gas stocks are advised to start buying into companies with a diversified oil and gas  portfolio; while real estate investors may look forward to reinvigorated markets in the prairies of NW Alberta and in NE B.C.

Sunday, October 10, 2010

Cash flow and ROI

When we talk about postive cash flow, it means that your current operating income is sufficient to pay the bills and have a bit of a safety cushion in case income falls or costs increase. It is about investment survival.

But it does not tell you whether you make money or better how fast your net worth goes up. That you measure as a rate - Rate of return on your invested money or ROI. The strange thing is, whether you invest in gold, bonds, the stock market, the ROI always seems to swing back to a current average. Depending on the time and sweat you put in your investment you may get better returns.

The current 'average return on investment' is a the middle ground of a range of ROIs. The ROI on low risk investments like a GIC is little and that of high risk junk bonds is a lot. In other words, high risk often spells high ROIs. Investing in U.S. real estate is high risk and if your investment survives it may give you a very high return or in otherwords, you would make oodles of money. If it does NOT survive you may loose all and in some cases even more.

There is room for high risk investments in every investor's portfolio as long as you have enough to cover the losses of such an investment and to 'to fight another day'.

Young people have many days left 'to fight'; old geezers like myself have less and tend to be more conservative in our overall investment behaviour. I think many investors including Don Campbell have extensively pointed out the risks of investing in U.S. Real Estate right now. The choice and the responsibility for the results are yours.

Should I rent to this nice couple?

They broke up in the past; now they want to live together again. They are both handicapped and they are nice. Should I rent my vacant rental apartment unit to them? This was the paraphased question I read on a real estate forum. I want to share my answer with you:

When I buy shares in a company, there are many reason why I may decide to do so.
  1.  I may buy shares because they have a good track record and have gone up already 40% last year. The statement: 'Past performance is no guarantee of future performance' comes to mind. In fact, when shares have already gone up quite a bit then chances are that the company's merrits have already been included in the price and therefor the risk for under- or non-performance has gone up substantially. I bought such shares and over the long term I made OK money.
  2. I may buy shares because they have fallen dramatically while the only reason for falling appears to be that we're in a bearmarket. There is the risk that I try to 'catch a falling knife'. So maybe I should wait until prices stabilize. On the otherhand overall risk is now a lot lower than before the share price fell. This is the time to buy and you tend to make (often after some stomach sickening moments) excellent money.
  3. I may buy shares because the investment looks somewhat profitable and I like being a progressive and responsible member of society. I usually lose money in such cases. Sorry I don't do story-investments anymore I have learned the hard way.
  4.  I invested in recreational properties and confused my 'Belize' with an investment. I lost my shirt!

 There is investing - being in business and there is being nice for the world around you. I have learned that investment/business in those cases comes first. Once an investment works out I can always give some of the profits back to society. Whether it is a landlord on a small scale, or billionaires like Bill Gates and W. Buffett. It does not matter, you cannot run a charity and a business as one. That does not mean you have to behave inhuman, but neither does it mean that you have to take on more risk than you have to. Greg [this guy gave a lot blunter but correct reply: do not rent] is absolutely right - I wanted to say it more diplomatically because from the way your question was formulated I figured you had already made up your mind trying to be a nice guy.
You don't have to be a nice guy. There are enough vacancies that other landlords may fall for this couple. You have to look out for number one and chances are that this couple will break up again if not soon, then very soon and you walk around without rent-checks.

Friday, October 8, 2010

The TSX has broken out of it's trading range

If you like technical investing, you must have noticed that over the last week or so, the TSX has broken out of its trading range and that the Dow is above 11,000.  Considering the black mood prevailing just a few months ago - a mood that even affected me - this is just a miracle.

This chart copied from the Globe and Mail shows you how dramatic the break-out was. This is likely the signal that a double dip recession scenario is quickly becoming less likely.  September and probably now also October of 2010 are likely to become the best performing months when compared to numerous past years.

Monday, October 4, 2010

The right attitude about commissions

Are full service stock brokers charging too much commission? Are mutual fund managers charging too much management fees? Are real estate commissions too high? Who cares?

As an investor you cannot do everything. One of the first things you learn is that you need to surround yourself with a good team of experts and advisors. It is not only important to have the right leverage for your investment portfolio, it is even more important that your time and efforts are properly leveraged.

As a small investor it is expensive to hire a full time staff of lawyers, stock brokers, portfolio managers, property managers, financial planners, etc. So, you pay them piece meal using commissions! These people make up the staff of your investment company. Whether small or large, your investment company will need staff.

Guess what happens if you do not properly compensate your staff? Staff typically does not only work for money; a lot of satisfaction is found in providing the right service and in adding value to the company. But motivational studies of employees have found that a certain level of compensation is required along with the recognition that staff contributes to the overall company success.

A good team that enthusiastically works for your investment company deserves to be treated with respect, empowerment, recognition of contribution and appropriate compensation (commissions). Of course, the performance of your employees should contribute to your company’s bottom line. In fact, I do not necessarily care how many hours my staff puts in, I only care for how much they add to the bottom-line.

When you invest in Berkshire-Hathaway do you care about how much Warren Buffett makes or do you care more about the returns you receive from investing in that company? If you have a person that markets your services do you care how much that person makes or is it more important that you sell profitable services and make a certain amount of money?

I teach sometimes geology courses using a marketing agency. They always are concerned about me being concerned how much commission they charge. I tell them, I don’t care as long as I get paid at least what I want. The Agency can even set the price of the courses that I teach and often I have no idea how much they charge participants. Why should I? Since my courses are offered via several avenues, agencies that charge too much will not sell and clients will go buy the course using another agency. The same is true for my investment company; I really don’t care how much my staff makes in commissions as long as I get what I want.

Take for example mutual fund investments. In most cases I want at least the same performance as a comparable stock market index (e.g. the TSX). Since most mutual fund managers and their companies cannot achieve that performance I look for an alternative. Solution, Exchange Traded Funds or ETFs! You may also look at Index Funds. Either way, the fees charged by these funds are low enough that I get the desired performance.

If ETFs did not perform, I could always buy the individual stocks that make up the exchange index. This maybe a bit difficult to do for a small investor and for them buying ETFs through a discount broker makes sense. So here we introduced a few important concepts:

1. For small investors to set up a diversified portfolio it is more cost efficient to buy an ETF fund rather than buying stocks piecemeal. Just image buying 1 share of the Royal Bank at $53.00 plus a minimum full brokerage commission of $85. Next you buy 0.94 shares of TD Bank for $63.00 per share or $59.22 plus $80 minimum commission. This would be crazy!

2. Even if you would buy every month $100 of a particular ETF a full service brokerage minimum commission of $80 for each trade would not make sense. Hence the small investor ends up at the discount brokerage. Even if such a small investor would want to retain a full service broker, he/she would have to have a minimum portfolio size before it becomes worthwhile for the full service broker to take you on as a client. So this is clearly a two-way street.

The staff that you hire has to fit-in with your small investment company model. Even for a larger investor, using a full service broker to buy an ETF fund often does not make sense. Such an investor would still use a discount broker for this type of investment. The same is true when trading options, for example covered calls (which we may discuss in future postings). Often the high commissions of a full service brokerage do not make sense and these trades (up to a certain level) can be done more efficiently by the discount broker.

When your investment portfolio is large enough you may want to buy shares in individual companies, then it is time for a full service broker. However before going that route, most people first will buy their starter home. So that is the time to start looking for a Realtor on your team instead. Even though you are investing initially in ETFs, this should not stop you from studying stock market investing or investing in realty. Your investment education should start even before you put your first penny into a discount stock brokerage account and you will continue learning until the end of your life.

After you have read a few books on stock market investing and possibly attended some seminars on real estate investing, you are still a beginner. So, when buying your first house with all the pitfalls of real estate would it not make sense to hire an expert if you could? Of course it does! The Realtor enters the stage. You are lucky, the Realtor does not require a minimum account size and he does not even require you to pay a commission. The seller will take care of the commission. Wow!

As always there are exceptions, but if you stick to an MLS listed property (and there are plenty) the seller pays the commission. Yet Alberta law states that your Realtor has to act in your best interest not that of the seller. The seller is represented by his/her own Realtor as well who has to act in the seller’s best interest. Often the total commissions involved for selling a property in Alberta are 7.5% or $7500 on the first hundred thousand dollars and 3% on the remainder of the purchase price. So on a $250,000 starter home that would be $7,500 plus $4,500 is $12,000 dollars. A lot of money! However, only half ends up with the buyer’s Realtor and the other half with the seller’s Realtor; so $6,000 for each. The Realtor has to pay out of this his/her expenses but really you don’t care about that.

So, this is the time to select your new staff member for your growing investment company, the Realtor. A lot of consideration goes into the selection of your new staff member. Realtors vary in experience level, service level, expertise (residential, commercial, investment properties) etc. So once you have decided what kind of property you need then you can define what type of Realtor you need. I suggest you don’t select a Realtor for just one deal but one with whom you build a relation that could last for many transactions. As long as you pay for the property what you want, you really don’t care what the Realtor gets. And guess what, as long as you get the service and results you desire when you sell a property, you shouldn’t care about what the Realtor gets either.

Use your Realtor to teach you in Real Estate and real estate investing. Even after you bought many houses, you still may find it useful to use a Realtor. Often you have enough experience by that time to do all by yourself. Yet, do you really want to spend a lot of time on finding your next property or on selling it when a Realtor can do it more efficiently and with less trouble? Isn’t your time better spent on more profitable matters – things you are expert in?

Now that you are securely established in your starter home, your investment money has reached the level where you could use the services of a full service broker. Now you may be interested in a more targeted portfolio and you will need some objective advice and ideas. Your investment company’s staff is in expansion mode once again. You don’t pay minimum commissions anymore on your trades and your stockbroker (who has gone through a couple of stock market downturns and spends all day yakking about and dealing with stocks) will be not only buy/sell investments. Your broker will generate investment ideas and act as devil’s advocate for your investment ideas while providing market background information. As long as you get the value and performance you need, you really don’t care how much you pay your staff. Of course, you should compare what other brokers charge. But apart from working at a reasonable level of commission, the performance of your broker and how comfortable you feel working with him or her is more important.

Overtime you will deal with more and more people and your investment company will grow as well as the company’s staff. You are the CEO and Chairman of the Board. You decide the direction of the company and which staff members perform, meeting your company’s needs, and those that you no longer wish to retain. You may also notice that when your company evolves, your staffing needs change as well. So, really, there is no need to worry too much about commissions, you will hire staff when your company grows and when you are ready. The commissions will prove to be justifiable.

Some investors fret forever about commissions and it is no fun for their company’s team members to deal with them. There is something called the ‘pain factor’ and it seems that those people who always complain about commissions also represent the investors with the highest ‘pain factor’. These investors are just not worth dealing with; they’re causing too many problems (pain) and are not worth pursuing. The result is obvious; these investors are not likely to attract the staff their investment company needs.

Are you ready to set up your investment company and hire the staff you need to achieve success?

Sunday, October 3, 2010

I'm interested in reading more discussion on the future direction of Alberta's housing market

 I can see that Vancouver and Toronto may be overvalued in general terms, but Calgary or Edmonton?
Since 2000 property values have increased dramatically even taking into account a 5 to 30% (depending on market segment) drop in value from the peak. As with any boom like the one we experienced in Alberta there was initially a significant catch up component when compared to the other Canadian cities.
There are (just like in other investments) so many ways to value properties and there is always one that points to overvaluation. REIN members look at cap rates and base value on investment income. Others compare values based on the prices of recent sales for comparable properties. Some is done in excruciating detail others are happy with a CMA. Value is in the eye of the beholder and a lot is emotional and also depends on the pocket book of the potential buyers.

I have attached the Calgary Single Family Price chart from 1973 - 2010. You can interpret this charts in 2 ways the glass is half empty (pessimistic view) or the glass is half full (optimistic). In the pessimistic case you can interpret the chart as representing a bubble that hasn't crashed yet. In the 'half full' case, my most likely scenario, we had a value catch up and now we are returning to more sustainable levels of appreciation. I bet you can come up with every scenario in between and some that are a lot more bullish than the 'half full' view.

 So let's start with the bubble scenario or 'half empty' scenario. Many investment bubbles are characterized by a gradual value increase that suddenly steepens with valuations reaching unsustainable levels. Classic examples are the U.S. Real Estate 2000-2007 or the high tech bubble of 2001. After an unpredictable long or short time period, the market crashes. It crashes not back to reality but it overshoots to extreme levels of pessimism and undervaluation. Just like in March 2009, investors will realize that their pessimism is overdone and values will restore back to the original trend (possibly with some volatility). Based on this scenario, Calgary housing prices may collapse and fall back to the $300,000 - $350,000 range and from then on-ward appreciate at its historical rate (prior to the bubble of 7.3%). Right now the rate of appreciation is somewhere around 2-3%.

The scenario favoured by me is shown on the 'steady as she goes' or 'half full' scenario. My scenario is that Calgary's real estate appreciation accelerated because of a fundamental economic change. Namely commodity pricing and heavy oil. After decades of depressed commodity prices, Alberta's resource potential, in particular for heavy oil in Eastern Alberta was recognized; it became technically viable and economic attractive. This was a fundamental game changer and allowed Calgary real estate valuations to catch up with that of other North American cities of similar size. That is why we experienced not a crash as elsewhere in North America because Calgary's fast rate of appreciation was supported by fundamentals. I guess a solid Canadian banking system helped as well.

So now that we have caught up and are getting past the volatility experienced in North America overall, we will likely revert back to a more sustainable and very respectable rate of appreciation reflecting Calgary's vibrancy even during normal economic times. In that regard, 7.3% may be considered very attractive and we would do well et even today's more modest growth rates of around 2-3%.

When looking at Calgary's current income levels, in-migration and potential as an energy power-house, I think we are far removed from bubble conditions. But... as always, the world is unpredictable, just look at what a new technology such as multi-stage frac'ing has meant for the Natural Gas industry or what technological innovation has done to the profit margin of the computer manufacturers.

Even if there is a bubble in Calgary, as long as you bough before 2005 and are in a positive cash flow with a responsible level of leverage, 10 years after the bubble 'burst' you would still be ahead. If the 'Steady-as-she-goes' scenario (Glass is half full) will play out, you're hollering all the way to the bank. And at even better economics, you'll go hysterical for joy.  In my experience, optimistic realism is what makes you rich!

Friday, October 1, 2010

Do Realtors have a monopoly?

This morning, I read the so maniest headline that Canada's housing market, in particular BCs and Alberta's, is overvalued. Whatever! I don't believe so seeing that some segments of the Calgary market have fallen over 30% since the peak (and Edmonton is not much better). BTW how much did property values drop in the US (on average)?

Anyway, I feel bad for those guys (and gals) that bought at the market peak with 20% down. But that is not the topic of this post. The same article states that in 2009 19,139 houses changed hands in Calgary, I hope for the local realtors that this does means resales and does not include new housing sales. The number of realtors in town are just over... 5500. That is only the active realtors, not the thousands who have given up.

So, eh... 19,139 divided by 5500 and an average commission after brokerage fees and royalties and marketing costs of... $3000. So that is an incredible net revenue total of 3 houses at $3000 or $9,000 PER YEAR. Some other statistics showed me that last year there were over 600 Realtors who sold nothing and that 80% of the properties were sold not by 20% but approximately 40% of the realtors. So the top 40% Realtors sold 15,310 properties i.e. 2200 realtors selling 7 houses per year or an annual net income of... $21,000. Oh yeah, isn't it lovely to be a Realtor! BTW I am about to join the top 40% having now been licensed for 8 months. I am so glad I taught a few well paid geology courses this year while living in semi-retirement (soon to change).

OK so the top realtors and their teams (maybe 10% of the pack) are likely to make a lot more - over a 100K I would guess based on the number of leased BMWs. Yet, realtors are a happy, self deluding crowd and only those that have been around for many years without offending too many clients do OK.

So when investors complain a bout the 'MLS monopoly' and those darn Realtors cornering the market that is kind of talking about two entirely different things. The MLS 'monopoly' is like Stats Can having census data collected on Canadians that you can buy. However, MLS is owned by the Canadian Real Estate Association not the government. The MLS is funded by the Realtors for many years and contains only data of sales sold by Realtors via the MLS. A Realtor pays for MLS through monthly fees (I think $50 per month), a Realtor also pays for the Realtor key to get access to properties for showings. MLS is also paid through membership fees with the local Real Estate Board.

The data collected through MLS is of a certain quality because Realtors are trained to obtain/verify data on properties and know what can be said and what cannot be said. The Realtor is insured for errors of omission (mandatory in Alberta) and as such the MLS data is fairly reliable (but not without error so always check yourself). MLS is one of the most effective marketing tools for selling a house, although no-one prevents a seller or buyer to look on other databases such as the classifieds in the news papers or Kijiji on-line. For Sale By Owners (FSBOs) do not have to adhere to the MLS standards and are not trained in the liabilities and requirements of selling a property to a third party. That is why FSBOs listing their properties on MLS may contaminate the reliability of that very extensive and expensive data base.

If I understand it correctly, the recent squabble with the Competition Bureau has resulted in Realtors being able to list your property without being required to provide the full fiduciary duties he or she is required to adhere to by law. So that allows the Realtor to list your property on MLS without any further required involvement. Not sure how that works legally though! Personally, I won't risk working that way.

Some of you would like to browse through the database on your own. You can do that as well for free. There are some restrictions on the data but really it is minor. In some ways I like the public MLS system better, especially the map you can use to zoom into an area to look for listings. The MLX cannot do that, but it can search based on features, like 25 bedrooms, floor area exceeding 721.5 sqr ft, full basement etc. If you want that bit of extra data from the MLX database just ask your Realtor and he will run the program for you and e-mail you the result. Guess what, you don't even have to pay for the database!

So being a Realtor is not a fat-pot. It is extremely competitive and all Realtors use the same MLS database plus personal expertise to help clients to sell or find a property. If you were ever wondering how much money you save in commissions when you get your own license, just do the math and you will find that you may have to buy 5 properties or more per year before that is worth your while!

I thought, now that this issue of the competition bureau has cooled off a bit, this might be an opportune time to present it in a more obvious setting.

BTW, I enjoyed being a Realtor although it is a wait-and-run game. I also was, as a rooky, successful at it. But there are a lot easier ways to make money than being a Realtor and I am seriously contemplating to use the easier route.