Sunday, April 22, 2012

I lost so much money! Really?

 I have been promoted, or better suckered, into becoming president… of the board of directors of a small condominium corporation. Somehow, I always fall for those jobs. Maybe because I am a control freak who cannot keep his mouth shut and who cannot say ‘yes and amen’ to everything the condo manager tells us. Yes, it is a weakness but alas… we all suffer our curses.

One of my co-owners is quite a likable fellow, but like all investors he grumbles (complains). We’re nearly like farmers – only worse. “Oh this real estate is so terrible! I barely made any money over the last couple of years’.  That is probably true, but he forgot to mention that in the tree years prior to those lousy years his property value doubled and that he got a monthly distribution of $400 or more each month until things went south for a while. Right now, we once again have no vacancies, the rents are slightly on the increase and we’re standing at the start of an upward pricing trend. In fact, it is pretty tough to buy a good rental property in Edmonton right now because they have ‘all been sold’. Yeah, that is if you only want to pay last year’s prices and assume last year’s rents and high vacancy rates. But as usually, I digress…
So here is a simplified internal rate of return calculation (akin to return on investment - ROI) based on the cash flow stream over the last 7 years when the unit was bought. The initial purchase price was $60,000 and even after a significant value drop from the peak in year 4 followed by a minor recovery, today’s value is around $110,000. There was also a $7000 renovation involved (the unit was trashed by a tenant) and the condo corporation did a special assessment of $2300 in year 6. Also there were a lot of vacancies during the ‘bad years’.
The annual rate of return (IRR) was a devastating… 12% compared to Warren Buffett’s 5.2% over the same period! Oooohh… that hurts! J

Worse, my co-owner probably had a mortgage. Assuming he had the standard 20% down payment, 35 year amortization and an interest rate of 3.25% his cash flow would have been:

Ohh my G! Sorry, OMG, OMG! That looks awful. The rate of return (IRR) on this disastrous, calamitous case was… 32% per year! Poor, poor little investor, I feel for you! (I can't keep my face straight.)
When you look back at an investment from what it was at the top of the market, especially when you just went through a down turn, things look often much worse than they really are. It may tempt you to do rash things. So always look over the life of an investment before jumping to emotional conclusions. To be honest, I tend to fall for this myself. It is an easy mistake to make and it may have you throw away a terrific investment because of your emotions.

No comments:

Post a Comment