Go the first post in the 5 ways to make money with investment properties series.
Inflation
In most investments inflation causes you problems. With real estate investing its your friend in a major way.
Inflation is measured by taking an imaginary basket of goods, and figuring out what they’d cost at different points in time. If the purchases would cost more then they would have in the past, the difference is the inflation rate (if it costs less, the difference would be the deflation rate). How much inflation affects you depends on what you typically buy and in what amount. If you don’t drive, clearly the gasoline component of the “basket” wouldn’t affect you as much as it would affect drivers (it will still affect you as increased gasoline costs will get passed along to consumers in the price of any items that requires gasoline for production or distribution – e.g. anything you buy that’s made in China or if you buy a bus tickets to go to Calgary).
House prices (or at least housing costs generally) make up a large part of the inflation measurement. Therefore, house prices and inflation are strongly correlated (some could argue that increasing property values is one of the driving forces of inflation and that house appreciation and inflation are basically the same thing).
Say we buy a house for $100K, get an interest-only mortgage and inflation is 3% over the next year. How much do we expect our house to be worth? In “real” terms (inflation adjusted) we’d expect it to still be worth $100K in todays dollars. In terms of future dollars though, it will actually be worth $103K.
So we now see that without doing any work, our real return on the property purchase is roughly the inflation rate (3%, or a real return of 0%). Since GICs give a real return of 1%, this isn’t too shabby!
It gets better though.
Since we have an interest-only mortgage and have been paying the interest (part of our cost of living, for simplicity’s sake lets say the interest, utilities, maintenance and taxes are equivalent to what we’d pay for rent and ignore them). After a year the mortgage is still $100K (since we’re paying interest only), however, after that’s adjusted for inflation, the $100K mortgage is only actually worth $97K to the bank (money in the future is worth less then money today).
Once we remove the speculation element from real estate pricing, we can clearly see that part of our return from the property is:
Or, in the case of a 100% interest-only mortgage, double the inflation rate times the property value.
Not too shabby at all!
Most of our methods to make money with real estate can backfire and cost you money. Clearly the speculative element of price appreciation is totally beyond your control (or ability to predict), however this is one of the nicest returns, because as long as we have inflation (I don’t think its going anywhere soon), you can pretty well count on this portion of your return Extended deflation would be the negative risk of this portion of the returns – however, again, I can’t imagine a situation where that would happen here in Canada. If it did we’d have worse problems then poor real estate investment returns.
See the next post Taxation.
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Great posts!
Unfortunately, there are places in Canada where home values have not increased. We’d be lucky to get what we paid for for our rental property 4 years ago. Our realtor has informed us that our primary residence would likely sell for less than what we paid 3 years ago (after putting in a new furnace / AC). It wasn’t that long ago that people here were shocked at what their house was worth (in a good way), kind of like I keep hearing from friends in other cities (i.e. Toronto & suburbs).
I just think it’s a scary time to put too much emphasis on appreciation. For a rental property, I would be most concerned about cash flow and value. Appreciation would be icing.
Telly: Unforutnately that’s the jitter of speculation. When people were shocked at what your house was worth (in a good way), you’d had a good run of speculative gains, in the last 3 years fundamentals have been kicking in and the price has stayed flat (or gone down a little bit). Look at the difference between what the house cost when it was first constructed, and what you figure its worth now, and I imagine it’ll be somewhat close to inflation.
One thing I didn’t talk about in this post (and maybe should have) is that local economics can play a role. Housing prices in NY, London or San Francisco keep going up-up-up, well above the inflation rate for extended periods. Also, there are houses in Northern Ontario commnities that are basically worthless because there are no jobs in the town, everyone who wants to live there has a house and no one is buying.
If money is pouring into an area (or out of an area), obviously this is going to affect housing prices (beyond inflation and speculation). Perhaps that’s what’s happening with your house (although it sounds like its just a speculative pull-back to me, the same thing as a stock market correction, except – as with all things in real estate compared to stocks – much slower)
I live in Windsor, so job losses (as you mentioned) have been a big factor here.
I actually don’t worry too much about the price of our principal residence. I’m certain that we made a good decision to buy a small house in an ok neighbourhood that was more than affordable for us. The longer we can stick it out the better (though my husband wants a garage and I want a pool – neither of which could fit on our property). Believe it or not, we do catch some flack for living in a ’starter home in the hood’ but I rather like our $100k mortgage and the house has a lot of character. We have another advantage in that our “Jones’s” aren’t hard to keep up with.
Your point about what the cost to build was compared to current price is an interesting thought. I’m not sure on how to find that info though as the house was built in the 20’s.
telly: What about finding the “oldest” price you can on your house and compare that to the current price and figure out the annual appreciation?
I went looking for either the long-term property appreciation statistics for Canada as a whole, or for specific municipalities (such as Toronto or Windsor) and couldn’t find it. Anyone know where such info might be located (something like “average housing appreciation over the last 40 years”). I looked on Statistics Canada, and if its there I couldn’t find it…
http://www40.statcan.ca/l01/cst01/econ157a.htm seems to show an average aprpeciation of 2.94% over the last 5 years…