Inaccurate Assumptions

A couple posts back an anonymous poster sought to establish my bull pedigree by throwing out the old canard about a rising market translating into more business for me:

“Hmm… a bull in disguise? Well, that’s understandable. For sure in a declining market, Rob isn’t going to starve. But given a choice, a rising market sure brings more business to Rob so why not?”

Its no secret that I’m bullish on real estate long term, especially when acquired in a disciplined manner.  Who in their right mind isn’t (regardless of what investment choices they eventually make)?

The poster’s comment is emblematic of one of the challenges that comes with that blessing we call the internet: once something is said it acquires a veneer of truth, regardless of its real value.

In this case the poster has no insight into how my business works.  He (or she) doesn’t know what increases my volumes, or my margin, or how either effects my bottom line.  He certainly does not understand how my personal business fits into my larger corporate activities. 

Yet he seems quite confident in tagging me as a closet bull based on my statement that, “…real estate, long term, tends to increase in value. It has been proven, time and again, that it is worthwhile to get in more often than it is worthwhile to get out” and the unqualified assumption that the current market translates into more money for me.  

I find it interesting that this kind of inaccurate speculation is so common.  If anyone actually buys into that kind of thinking it is, as Keen writes in his editorial, a case of the blind leading the blind.

I’ll pull back the curtain a little.  I make money from a variety of sources.  Some comes from brokering real estate transactions. That’s where I charge other Realtors a portion of their income in return for letting them use my corporation and licence to do their business.  I also earn money from representing buyers or sellers in transactions.   Nowadays I tend to find myself selling clients’ properties, but not in high volumes (I don;t like to see my clients get rid of good property).  In different markets I buy investment properties for clients, but that’s currently hard to do (a search of the old blog will show that even last year there were some great opportunities; take a look at those old posts and compare the number of possible buys that I pointed out then to what I point out now).  I also manage rental property.  The more properties I manage, the more income I earn, and the income is steady.  And, of course, I invest in, among other things, income producing properties.

This brief description is not intended to impress anyone with my abilities, or to justify my income by pointing out how hard the work is, or how competitive the business is.  I work hard, but I’m very fortunate.  I’ve got my health, a great wife, a great family, I live where and how I want, and I’ve got a few bucks.  It could be a hell of a lot worse, and I’m the first to recognize that.  

It is intended to show that a market like ours doesn’t simply translate into more profit for me.  Not too many years ago I had a peculiar challenge: I couldn’t find properties for clients that would lose money.  They had high tax bills, and wanted two things: stable investments and tax write offs.  Most lenders required 25% down on investment properties.  In Maple Ridge it was common to find properties that were cash flow positive at 25% down.  They were very stable investments, but they had no tax write offs. 

Today I’m in worse shape.  The tax write off is there in spades, but the other numbers don’t make sense.  Does anyone think that portion of my business is up?

Of course, those investment properties roll right into my management company.  If I’m helping a client liquidate their holdings I’m also reducing the size of my management portfolio. And, if I’m not buying properties for my clients, I’m not adding to my portfolio.  Some might speculate that a slower annual rate of appreciation would contribute to a healthier bottom line for someone like me, and they’d be right.

Oh yes, my foreclosure business is way down over the past three years.  It could increase 100% and still be negligible.

On the investment side, I bought my first investment property for $65,000. It was cash flow positive with 25% down.   Before long I bought another for $75,000.  But the third cost me $150,000.  Today its hard to find anything comparable.  Of course, those properties have performed extremely well, and I’m grateful.  I’ve always wanted to fly, so maybe I’ll sell one of them and by a plane.  But I can’t help but think:  If we were in a 5% appreciation per year world, wouldn’t I have more tenants buying me more property sooner?  The answer, of course, is yes.    Open up Excel and do a few spreadsheets.  Start in 2003.  Buy three properties that cash flow at 25% down for for $65,000 each.  Apply the historical returns we’ve had to date, and then pencil in 5% per year (i.e, no correction, period).  Then compare that to buying the same three properties but only getting 5% per year over the past 4 years.  Add a property each year, again, based on cash flowing at 25% down.  Its clear which gives a better retirement.  Yes, adding properties requires the downpayment, but that’s the rub: double digit increases mean you can’t buy a condo that cash flows for $20,000.  5% per year increases means that you can.  And in my scenario you wouldn’t have needed $20,000 for a downpayment until this year, at which time you’d have 7 tenants.  

What’s the point?  I’ve presented both anecdotal and factual evidence that this market is nowhere near as lucrative for Realtors (and for me in particular) as some assume.  Yet the assumption persists.  Its really not a supportable assumption (I know because, like most people, I’m on intimate terms with my income).   How many other unsupportable assumptions do we run across on the ‘net, and how many do we accept as fact?

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25 Comments

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25 responses to “Inaccurate Assumptions

  1. nineofiveland

    Great piece Rob .. have always admired your ability to stay balanced .. at least in print .. maybe you kick your dog after reading some of the inane comments .. great reading from the vantage point of “back east”.

  2. passerby

    “He certainly understand how my personal business fits into my larger corporate activities. ” — I think this sentence misses “does not”.

  3. -A-

    So sad, so very sad.

    You fail to see your moral failure, and the breakdown of your logic.
    But just as bad your post reads as if Aaron wrote it.

    Sorry Rob, but I honestly think you hit a new low.

  4. confident

    Rob, (or anyone else) …can you write off losses in rental properties against capital gains in the stock market? If not, Rob , what are your clients wanting the tax write offs for? thanks

  5. Anonymous

    I’m Excel challenged, so I did the calculation manually. I did it real fast, but here’s what I came up with:

    Scenario 1)

    I assumed (for easy rounded numbers) 20% annual appreciation on the 3 $65,000 properties bought in 2003 with no other purchases to today.

    Today’s asset value of those properties: $404,352. & the mortgage paydown (I assumed 5% interest rate for easy numbers) by tenants equates to liabilities of: $129,231.88.

    Equity of $275,120.12 in Scenario ONE

    Scenario 2)

    5% annual appreciation on the three $65,000 properties bought in 2003 with 1 additional investment property purchased each year to today:

    Today’s asset value of all those properties: $586,915.88. & the mortgage paydown (I again assumed 5% interest rate for easy numbers) by tenants equates to liabilities: $281,271.88.

    Equity of $305,644.00 in the 5% appreciation scenario TWO.

  6. Buck Wild

    Very well-written and patient explanation going from the particular to the universal – you’re a mensch and your post deserves a much wider audience.

    The NP could use you.

  7. robchipman

    Passerby:

    Thanks for catching that. WordPress was giving me all kinds of problems last night, with partial posts and whatnot. Anyway, thanks.

    Confident:

    When my clients want write offs its generally a regular monthly write off (i.e., mortgage interest) against other earned income. I’m not giving accounting advice to any of them, or to you, but the practice seems to be borrow money to make an investment and then write off the interest. You reduce the income tax on your regular earned income. Later, when you stop working, you will pay a capital gain tax on disposition, but its at a lower rate (although probably on more money). Its a tax deferrment plan, really. Its best suited, as far as I can see, for people with high and stable incomes and no other tax write offs.

  8. robchipman

    -A-

    As usual, you’re too cerebral for me. Can you explain it to me like I’m six years old? Where’s the moral breakdown? Where’s the failure in logic? And are you saying that unsubstantiated assumptions are a strength of the internet? (If you are I think I might work with you – after all, we can always use more good fiction, right?)

  9. deb

    Thanks Rob
    It is interesting to see where you make your money. You must be busy, but I’ll bet you basically like this work.
    As always, my thanks for your patience with all of us and for the ongoing numbers.
    My day would not be the same without Rob Chipman.

  10. confident

    thanks for the info , Rob

  11. Crabman

    Today I’m in worse shape. The tax write off is there in spades, but the other numbers don’t make sense.

    “numbers don’t make sense” = “RE is overpriced”

    There it is…. proof that Rob is currently bearish on real estate!

  12. robchipman

    Crabman – you need to change your name to Newsflash! 🙂

    Truth be told, to be bearish I’d have to think prices are coming down. All I’m saying is that I can’t make a great case for buying most properties right now. That’s not enough to make prices drop. Its enough to make me not buy everything in sight.

    That said, if a property turns up with good numbers for a particular person, it stands on its own merits as a buy, right?

  13. annon

    Based on previous posts I have read, I must agree with A.

    Rob seems to have a “blind spot”.

    Rob, you could benefit greatly from a course in Ethics, and Logic. But, if that is too time consuming, perhaps even a conversation with any person of faith would help.

  14. robchipman

    Annon:

    Anything concrete that you can point to? I’m always trying to become a better person, and any help you can offer would be appreciated. Is there any chance you can point out where I’m being unethical or illogical?

  15. The Original Joshua

    Rob:

    Great post, and very insightful.

    I think, however, that you have demonstrated another challenge that comes with the internet – no matter what you say, there is always someone there to anonymously crap on your head. 🙂

  16. robchipman

    Crabman:

    In most cases it would have to be a unicorn, but not all. You’ve still got portfolio improvement (sell a dog, get a gem). Also, there can be situations where people simply have to/want to get out of renting for one reason or another (just got evicted for reons for the third time, just got evicted due to a sale, need a place to house the stray dog they adopted, etc.) Other trade examples are among the “must sells” and “must buys” ; get divorced or have anotehr child, and if you already own you might just be changing the equity, therefore the numbers can work for you (i.e, I bought my house for $25,000; I can sell it today for $1 million, but the super nice townhouse I’m retiring to so that I don’t have anymore landscaping costs $1 million. What do I really care about values if I’ve got my other needs covered? I’m just trading one house for a different type of house. The numbers are just numbers).

  17. robchipman

    Gotta love wordpress! Crabman posts, I respond, and I turn up ahead of him. Go figure!

  18. robchipman

    Looks like he’s posting from the future.

  19. Annon

    Just to clarify, the “annon” above is not me. And I don’t know if it is just coincidence that we just happen to have the same name/alias/handle. I will accept if what Rob presents is true to his situation but I know at least one RE agent that is doing very well the last 2~3 years… bigger and multiple houses, and a fancier car he now owns. The thing is, in a rising market, RE agent with years of experience should get more business because of reputation (words of mouth?) and that simply should help business more. No? Sure, there may be competition from new RE agents but I am sure it’s probably harder for them than for you to get more business as they likely do not the kind of establishment and/or resources you already have. Unless my logics here don’t make sense?

    And Rob, if you feel offended, I apologize as it was not intended that way. If my words were a little too strong, perhaps I just wanted to put more emphasis countering the bulls and it was not personal.

  20. Annon

    And by the way, Rob, you once said you would respond to this question but I never saw it. “What would you say to those that take your words and buy houses and prices fall below their purchase price despite the initial increase in the first couple of years?” They may be happy thinking they make such a great choice taking your advise initially…. But move forward even more, if the price should fall…. Of course, this is just one of those “if” questions and it serves to answer my curiosity only. Thanks in advance for your response.

  21. robchipman

    Annon:

    No hard feelings. I had hoped to make that clear in the post. My point is that you made some unsubstantiated assumptions about me (not your Realtor friend), and treated them like facts. That happens too much on the net. (BTW, it could be that your friend is hitting the sweet spot in his career at the same time the market is going up; his present success could be the result of other things as well). Bottom line, no offense taken, and none intended back your way.

    You’re right; I did fail to answer your question, so I’ll do so now. When I talk with people about buying real estate, we look at the whole picture. That includes the downsides. You may have noticed that I’ve said on more than one occassion that with investment property you need to take care of the downsides and let the upsides take care of themselves.

    Additionally, I tell people to buy and hold long term. The clear implication, and one which we explore, is that between the present and the long term there may well be some rough patches.

    I also make it clear that all of my projections are made on the basis of an assumption. The assumption is that real estate in the Lower Mainland will continue to increase in value, and will do so, long term, at 5% per year. The facts indicate that we’ve done better than that, but I’d rather under-promise, so I pick a low number, and I make it clear that its an assumption, not a guarantee.

    In other words, I make it clear that I can’t predict the future any better than the client, and what’s more, I don’t try to. I share my belief that real estate will go up in value, long term, and I share the effects of the numbers (and that’s just math). I offer some competitive services for people who share my assumptions.

    If someone follows my advice and actually loses money they tend to share blame with me. It hasn’t happened often over 20 years, because we try really hard to avoid it, and because if we make a boo boo we try to mitigate the losses. I can count on one hand the bad deals that we made (if you define bad deal as an actual loss of cash).

    Think your scenario through, btw. I advise someone to buy something they can hold long term that meets specific criteria. They put 25% down and do so. After 20 years it hasn’t gone up in value at all, but the mortgage is paid off, they’ve enjoyed certain tax advantages and they have free cash flow. The extent of your complaint is that they could have used the 25% down differently and gotten a better return if they’d invested somewhere else, but that’s predicated on real estate not rising in value at all over 20 years. Its unlikely that that would happen, and if it did its likely that the proeprty could have been bought for much less than 25% down.

  22. Crabman

    That said, if a property turns up with good numbers for a particular person, it stands on its own merits as a buy, right?

    If such a unicorn exists in Vancouver right now, I suppose it would be ok to buy. ;^)

  23. The unthinkable "Renter"

    Rob said, “All I’m saying is that I can’t make a great case for buying most properties right now.”

    Rob, I love you, your beginning to say it like it is.:P

  24. tqn

    “Rob, you could benefit greatly from a course in Ethics, and Logic. But, if that is too time consuming, perhaps even a conversation with any person of faith would help”

    what is wrong with investing in RE buy low sell high? what does it have anything to do with ethics? by your description, Rob should buy RE low and provide rent free to the needy? I suppose that you donate all your income to the charity then!

  25. robchipman

    UTR:
    You’re late to the party. Last year I was pointing out properties that could be bought to turn a profit. This year I think I’ve pointed out one. The ones I pointed to last year have been profitable, btw. In other words, its been quite a while that I’ve been saying the numbers are tough.

    However, this is the internet. Mention that you spoke to an American who wasn’t worried about real estate meltdowns and you’ll be accused of recommending that people buy real estate (which is pretty much where my bull credentials come from).

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