With all of the fiscal uncertainty throughout the world, it seems that there are many people pitching investment opportunities.
I have been asked how my investment strategies are safer than others. Here are the answers.
Firstly, real estate is a hard asset.
Your money is secured by the physical structure you can go look at and touch. It is simple, in that people need to live somewhere, and almost everyone has experience in renting. From a Hotel room, to a one year lease, Real Estate renting is a concept countless people have experienced since the beginning of time.
Step 1: you invest in a building. Step 2: people rent from you. Step 3: you get a return on your investment
But, when comparing real estate investment opportunities, things get more complicated when variables are introduced: ie. Rent increases or decreases, Mortgage rates, tenant pool, vacancy rate, and Appreciation.
Secondly, I am a proponent of conservative projections.
Many Real Estate projections can be deceiving due to the countless combinations of ways that salesmen can manipulate a prospectus.
A higher looking projected return is desirable for salesmen who want your investment money. One of the most misunderstood pieces around Real Estate projections is Appreciation.
Rents for an area can easily be verified, interest rates are common knowledge, but the Appreciation variable is largely a mystery. Appreciation can also make a dismal investment a home run, as a loss in value can turn an otherwise great investment sour.
My investment methods support my S.A.F.E. business model, and I prefer conservative estimates, especially with Appreciation.
I find when doing real estate projections, some investors use high Appreciation numbers, perhaps because of their belief in the strength of their local economy.
Perhaps they do it for less honest reasons like the the salesmen I mentioned before, who are prone to be overly optimistic just to make a sale.
While the most conservative projections would not include Appreciation at all, it is not simple enough to disregard Appreciation when looking at real estate projections.
Appreciation must be accounted for in a long term hold, such as a holding period of 5 years or more. In some years real estate prices may go up, and some years down. Indeed, throughout even in a single year prices and sale volume are generally lower in winter than in the spring.
The long term trend for Real Estate is to increase in value. There is lots of evidence to back this up.
Ask anyone who owned a property in the last 30 years what happened to their value long term! The fact is, comparing buy-and-hold real estate to another investment simply would not be accurate without accounting for appreciation.
What is a fair target for appreciation?
Because I like to do my numbers in a conservative manner, I peg appreciation in my projections to the Bank of Canada’s target for inflation.
Here is why I calculate Appreciation as a function of inflation. Inflation is fact of life in a capitalist, democratic society, and governments do their best to control inflation to make sure the economy grows in a healthy way.
In making the rate of inflation my target for appreciation, my projections conservatively account for appreciation of real estate, without being overly optimistic.
Since Real Estate is a hard asset, all things being equal it will increase in value at at the same rate money decreases in value.
This reasoning does not take into account the laws of supply and demand, however when buying in town such as Kamloops with strong economic fundamentals, and using this method to predict appreciation is the most conservative way possible without discounting appreciation altogether.
The above graph shows inflation rates for the major economies of the world since 2000. As you can see, the Bank of Canada’s current target rate of 2% is below what appears to be the average inflation rate throughout the world.
Of interest to my readers who watch China closely, you can also see how China’s inflation rate is all over the map, and to me this indicates that China is artificially influencing its currency, inflation rate and other factors of its economy. Notice how the Democratic Economies have a much more stable inflation curve :).
Where do you think Canadian inflation is headed?
If you are an investor who is searching for cash partners, how do you calculate Appreciation for your local market?
I would love to hear from you.
Until next time,