Real Estate - Investment

Diversity from Stocks & Bonds

This second of three blogs on real estate will focus on using real estate as a means of diversifying beyond stocks and bonds into real assets.

This blog’s group of readers includes several people who already are diversified into real estate beyond their own home.  These people have 1, 2, 4, 10, even 20 properties that they own directly as a main business, a side business, or a small-scale investment.  All of them are good.  My compliments to you.

Here’s some food for thought on different ways you can make a real estate investment.

Direct ownership:

Direct is the best type of real estate investment because you directly control decision-making, and I believe this is also one of the few relatively safe places to leverage debt to create net worth over time.  You can either operate the property yourself or choose to pay a manager for the property’s operation needs.  Both are good options, whatever suits your interests and life circumstances.

Trusts outside the market:

Real Estate Investment Trusts (REITs) have become a popular means of gaining real asset diversity for your investment strategy.  Accessing these privately, outside the stock market is available to Accredited Investors in Canada.  You are one of many owners who have pooled their funds in a trust.  The pooled funds increase the investment options to include larger apartment buildings, condo buildings, commercial buildings, industrial buildings, storage facilities, etc.  You have relatively little say in decision-making, no say in operation, but relatively more liquidity than direct ownership and without the volatility of the stock market.

Trusts in the market:

Many REITs can be found on the Canadian stock market.  Like the private trusts, your funds are pooled and give nearly unlimited options, little say in decision-making, no say in operation, but with very high liquidity and higher volatility.

Good and Bad Markets:

With Canada experiencing a serious housing shortage, existing homes, apartments, and condos all offer safety for your invested capital.  The new development of residences is relatively less safe as the risk of prices dropping over the duration of the development could place your capital at higher risk of loss.  And I believe any fund which is active in commercial offices is a risk as society continues to figure out the post-covid work from home phenomenon.

Summary:

If you don’t have any real estate diversity, I recommend you research how to get some.  I’d be happy to help.

Real Estate - Home

Where We Live

Previous blogs identified real assets as a primary means of diversifying beyond stock and bond markets, providing more security as history rhymes over the next decade.

In my view, real estate is a key real asset and can be divided into three subgroups:

·         Where we live

·         Investments

·         Farmland

The plan is to provide a blog on each of the subgroups, intending to generate food for thought as you and your families make financial decisions in the coming months and years.  This blog will focus on where we live.  Our own home.

Purchasing a home to live in has been a Canadian norm for two thirds of our population for generations.  In most cases, our parents, ourselves and our children are/will be homeowners.

By circumstances of economic cycles and decades of government influence, our home has become more than just the place we live.  They have become wealth creators for their owners and inequality creators for non-owners.

Food for thought:

1.      ‘Excess’ home equity is that portion of total home equity which will be available for spending and investment after you downsize.  The remaining portion is consumed by acquiring the smaller home or the rent plus fees if that is your downsize plan.  It is wrong to consider your entire home price as available for future non-shelter living expenses.

2.      Accessing excess home equity for non-shelter living expenses while continuing to live in your home is an option to avoid downsizing.  However, it can be a relatively expensive option due to the fees and higher interest rates for lines of credit or a reverse mortgage.  Buyer beware.

3.      History tells us that that inequality will regress back to its norm – one where the younger generation can afford to buy a home with a decent income.  If you accept this history and further consider the regression will probably occur in the next decade, then consider if you think home prices will flatline or drop until regression is achieved.

4.      Cottages, cabins, second homes in Arizona and elsewhere - these belong somewhere between the categories ‘where we live’ and ‘investment’.  They are an extension of where we live, likely chosen for lifestyle ahead of investment.  But they are reasonably considered a capital gains type investment in the Canadian tax system.  Have a tax plan for this.

Your financial plan, whether do it yourself or with your financial planner, needs to include all these factors.  Otherwise, your plan is missing key facts.  Check your plan and Be Prepared.

Baseline

Putting Our Money Where My Mouth Is

If you are to take my concerns about rhyming history seriously, then I should have our money where my mouth is.  In other words, practice what I preach.

Our current portfolio has been put in place over the past four years.  It is a result of considerable research into where we are in the social, financial, debt, and currency cycles.  These positions have all been developed with a five-to-ten-year time horizon:

Stocks:

·         General Stock Market    0%

·         Commodity Producers 20%

Fixed Assets:

·         Bond Market                 0%

·         Direct-Own GICs          20%

Real Estate:

·         Excess Home Equity     15%

·         Apartment REITs            5%

·         Direct-Own Farmland  20%

Commodities:

·         Gold and Silver            10%

Private Business:

·         Debt and Equity             4%

Crypto:

·         General Crypto             0%

·         Bitcoin                          3%

Cash:

·         Savings Account             3%

The portfolio’s risk-reward breakdown over the next 10 years:

·         Low          33%       GICs, Gold & Silver, Savings

·         Medium    44%       Real Estate, Private Business

·         High         23%       Commodity Producers, Bitcoin

77% of the portfolio is in a diverse selection of real assets, with only the GIC’s and Savings as exceptions.

Regarding Debt:

·         We have intentionally prioritized and eliminated debt from our finances and do not use it to make or leverage investment

·         That said, good debt – to own a home, a vehicle, finance a productive private business – for a need, not a want remains a good financial decision in my view

Now you know where we stand.  And what we’ve done in relation to what history has presented us.  Between continuing to address the evolving Big Picture, I intend to comment over time on the individual components of our investments and periodically update this baseline for you.

Diversity

What is a Balanced Portfolio?

For those still in the mindset of what worked from the 80’s to 2020, a balanced portfolio generally means your non-pension investments are in stocks and bonds.  Given the big cycle financial crisis we are in the early stages of and considering the probability higher for longer inflation through this crisis, stocks and bonds alone don’t provide the diversity needed to come through the crisis in good form.

Many thought leaders in the smart money world have a much different view of balance in their portfolio.  Their views all tend to include a significant holding of real assets (gold, real estate, commodities, etc.) to diversify their portfolio for higher inflation.  You can also find some of these thought leaders holding some cash, diversifying their portfolio for deflation.  I’ve seldom, if ever, seen a financial thought leader invest exclusively in stocks and bonds these last few years.  Here are two examples to increase diversification within the stock market.

Lyn Alden shares her Multi-Asset Portfolio each month in her newsletter.  Her April 2024 newsletter (1) delves into why she is concerned about a portfolio with only stocks and bonds – basically because higher inflation is probable for this decade - then moves on to look at alternate portfolios with some real diversification.

She reviews the Harry Browne Permanent Portfolio and Meb Faber & Eric Richardson Ivy Portfolio as two examples:

·Permanent  25% stocks / 25% bonds / 25% gold / 0% real estate / 25% cash

·Ivy     40% stocks / 20% bonds / 20% gold / 20% real estate / 0% cash

She then explains her cornerstone concept of a three-pillar portfolio including specific profitable stocks, commodities and their producers, and cash-equivalents.  She does this for a living and thus invests the time to research and select specific stocks and commodity producer stocks.  Nonetheless, it provides a diversification example even for those of us that don’t do this full time:

· Alden 61% stocks / 0% bonds / 23% commodities / 0% re /11% cash/5% BTC

I agree with Alden that commodity producer stocks, chosen correctly, do provide the benefits of holding commodities more so than the risks of holding generic stocks.  I also think her position in Bitcoin (BTC) reflects a forward-looking speculation on monetary change.

Jared Dillian developed and back tested his Awesome Portfolio (2) to measure returns relative to risk over a period of 50 years, beginning in 1972.  Periods of high inflation in the 70’s and 2020’s thus are considered as part of his data set.  His portfolio tends in a similar direction to Permanent and Ivy in that he diversifies into 5 equal segments:

·Awesome 20% stocks / 20% bonds / 20% gold / 20% real estate / 20% cash

He goes on to explain how this portfolio can be quite hands-off in its creation and maintenance.  Its creation can be achieved with four ETFs accessible in the stock market and a cash savings account.  Thereafter, it should be reviewed and rebalanced once per year.

If you need any further reinforcement about diversification beyond stocks and bonds, you should note the Canada Pension Plan (3) holds 26% real assets, including real estate, infrastructure, and energy.  And the Saskatchewan Teachers Retirement Plan (4) holds 23.8% real assets including real estate and infrastructure.

If you have any interest in having a more diverse portfolio, it may be worthwhile for you to receive Alden’s free monthly newsletter with portfolio and/or download Dillian’s Awesome Portfolio.

Smart money thought leaders and large pension plans are diversified.  Are you?

(1)    lynalden.com/April-2024-newsletter

(2)    jareddillianmoney.com/awesome-portfolio-details

(3)    cppinvestments.com/the-fund/f2024-annual-report

(4)    stf.sk.ca/pension-benefits/investments/portfolio/diversification

Real Assets

The Basics of Real Assets

Why Use Them

The recent Inflation blog identified real assets as an investment strategy for a time of higher inflation.  If the probability of a financial winter proves out over the next 5-10 years, then our investments should be in assets that a) are relatively inflation-protected and b) are real, tangible things whose value may still drop, but less than the stock market.

What They Are & Aren’t

Real or hard assets are physical assets that have intrinsic value due to their substance and properties. (1)  Real assets include precious metals, commodities, real estate, land, and natural resources.  By extension, businesses that produce or support the production of real assets have many of the same benefits as do the real assets themselves.  Think of mining companies, investment trusts for real estate, etc.  For the typical investor, your home is the main real asset you have.

What aren’t real assets?  Banks and all financial institutions, cash, savings accounts, bonds, GICs, technology stocks, consumer discretionary stocks, services stocks, etc.

Other than your house, do you have Real Assets in your portfolio?  The easiest way to find out is to ask your financial advisor.  Or, take a little time and review your stock/fund/etf holdings yourself to see if you can find some.  The same research can be done for your pension fund.

Pros & Cons

There are no bad times to own real assets.  Why do most people tend to have little or no exposure to them?  Because in good times their value provides positive returns, just less returns than higher profile ‘growth’ stocks like tech, and consumer goods.  Real assets also tend to be best suited to longer term ‘value’ investments held for 5, 10 or even 20 years, whereas growth stocks are better suited to active trading.  In other words, growth holdings tend to be ‘get rich quick’ oriented whereas real asset ‘value’ holdings tend to be suited to ‘slow and steady wins the race’.

And remember, like any other investment, there are good and bad real assets.

Where to Access Them

There are a few different ways to hold real assets:

·         Directly purchase a rental property, some farmland, some gold or silver coins or bullion

·         Start or buy into a real asset-based business

·         Dig into Alternative Investments to purchase some Real Estate Investment Trusts (REITs), farmland trusts, real asset-based business trusts

·         Shift your stock market holdings into REITs, bullion trusts, commodities, commodity producers, utilities, or real asset-based funds & etfs

If Alternative Investments is a new thought for you, what they do is provide a means for investors to own a range of assets outside the stock market.  This makes them less volatile and less liquid than the stock market while being relatively more liquid than direct-owned assets.  If Alternative Investments interest you, you will have to first determine if you might be considered an Accredited Investor in Canada (2).  Then, identify an Exempt Market Dealer who can confirm your accreditation and provide access to alternative investments.  Note the Canadian banks do not offer this service.

How Much

Now we know why we want real assets, what they are, and where to access them, the next question becomes how much of my investment portfolio should be real assets?

There is a unique answer to this for each person.  It really depends on your situation.  What I can say is a typical mainstreamish portfolio – modified from the basic 60/40 – will often include 5% to 25% real assets, typically real estate and gold (3).  At the other end of the spectrum, you will find business-minded people and/or those with the slow and steady approach holding 75% or more in real assets.

If you would like more assistance understanding real assets or investigating alternative investments, let me know.

1.      Investopedia.com/terms/r/realasset

2.      Amurcapital.ca/blog/accredited-investor-canada

3.      Portfoliocharts.com/portfolios

Debt

Understand It, Talk About It

Personal:

Personal debt (or credit) is something virtually all of us live with for most of our adult lives.  In fact, it would be very difficult to go through adulthood without multiple personal debts.  Mortgages, auto loans, non-current credit cards, student loans, buy now pay later, business loans, leveraged investments, and more.

At the same time, we mostly treat debt like sex and politics.  We don’t talk about it and as a result risk not properly understanding it.  So, let’s take a run at understanding it a bit better.

Canadians have lived with debt as long as there has been a Canada, and before.  The Debtasized 1 documentary by Doug Hoyes travels from colonial times through to the present.

·         1850’s industrialization brought installment plans for mass produced goods

·         1920’s auto manufacturers started to offer credit with interest charged

·         1940’s and 50’s saw mainstream banks offer mortgages and the founding of CMHC

·         1960’s and 70’s brought government backed student loans

·         1950’s through 2020’s has seen house sizes grow dramatically, larger mortgages to match

·         2020’s car loans are now 7+ year durations, when they were once 3 years

Add to all that credit cards arrived in Canada in the late 1960’s and became mainstream in the 70’s and 80’s.  We are long past the times when mainstream society could get though life on cash and no credit.  Our current mainstream lives on credit to the point that we could not very well live without it.  Our personal buying decisions are too often driven by the size of the monthly payment, not the price of the item purchased.

Government:

Let’s look at the other debt impacting our personal finances – government.  Every tax dollar we pay to the federal, provincial, and municipal governments is being used to pay for A) the services and infrastructure they provide, and B) the principal and interest on debts they carry due to running annual deficits instead of balancing their budgets.  In the plainest language, if governments could balance their budgets, they would not have debt and we would pay less personal tax.

Government deficits and debts have been increasing for decades.  Its 30 years since Canadian governments tackled deficit spending with some austerity to at least reduce their debt payments coming from our taxes.  The ongoing deficits across all government levels are leading to larger portions of our personal taxes going to pay interest instead of health, education, roads, etc.

In summary:

Debt impacts on our personal finances in three big ways:

1.      Personal debt commits our future selves to financial burdens we may not be able to repay

2.      Government debt personally costs us more taxes and/or less services

3.      Personal and government debt cause price inflation1 , causing higher daily living expenses

Those negative impacts need to be weighed against the positive short-term impacts gained from buying what we want now.  It’s really all about needs and wants.

That’s where discussion about personal debt should always begin – is it a need or a want?  Since it’s unreasonable to avoid debt altogether, we should all work towards having debt only for what we need rather than what we want.  When voting and communicating with government, always consider their approach to deficit and debt.

I challenge you to discuss debts with you and yours.  It helps us all Be Prepared.  I’ll discuss it with you too if you’d like.  More discussion is better.

1.       Debtasized – How our Reliance on Credit Leads To Price Inflation, by Debt Free in 30

Where to Start

Create your own Financial Strategy

For starters, all the research tells me this is not the end of the world or even some change into a constant decline.  The great fact about cycles is that they pass through lows on their way to the next highs.  We can all look forward to the next highs after the storm passes.

That we are also able to put some broad timeline on the low period (another 5-10 years) enables each of us to put that in the context of our stage in life and that of our families and friends.  Child, adult, parent, grandparent.  What finances in this period look like for us (late 50’s parents) is very different relative to our (late 20’s) children.

We have recently retired and are in a comfortable financial position.  In 10 years, we’ll be well into consuming our retirement finances.  Whereas our boys are in their early years of income earnings.  In 10 years, they will be in their prime earning years with plenty of time ahead of their retirement needs.  Two very different scenarios.  Each of us must Be Prepared for our own scenario.

Invest in yourself:  Spend a few moments to think about what stage of life you and yours will be at in 5-10 years.

What is the probable forecast for this financial storm?  It is likely to be the largest financial upheaval in four generations, likely delivering a large correction in individual access to debt and its cost.  Growing government spending on debt service will change policies (it already is in Canada) affecting taxation, bond values and possibly even the future ability of public pension plans to meet their commitments to us.

Along with the debt correction likely will come increased stock market volatility and increased probability of major downside corrections which could last many years.  The stock market will probably see several years where value stocks generally provide greater safety and return relative to growth-oriented stocks.  Opportunities beyond the stock market may see increased interest from investors who don’t want to live the daily and monthly volatility of the stock market.

Invest in yourself:  Spend a few moments to think about where you stand with debt, taxes, pensions, and investments.

Financial inequality is likely to reverse direction.  In Canada, with net worths being so heavily tied to home equity, this means that somehow, some way outside forces will transfer wealth from those of us that have significant home equity (us) to those that don’t (our children).  Do house prices have to drop 50% or more to deliver housing affordability for all? 1 Some people are choosing to do so voluntarily (through cash gifts or cosigning mortgages) but the outside forces will still have their way – via government taxation or market forces.

Invest in yourself:  Which side of this inequality discussion are you on?   How are you and yours affected by a major housing price correction?

Some very sobering thoughts can come out of this thesis-making process.  Still, wouldn’t you rather know than be blindsided one day when least expecting it?

Remember too, this will last a finite amount of time before the cycle passes back to better financial times.  And, for the engaged investor, the bottom of the cycle will present a once in a lifetime opportunity.

Be Prepared blogs will work their way through the strategy we have implemented, what we are and are not doing, and what input we will give our children, should they ask.  While each of our personal finance journeys is different, hopefully the blog will encourage ongoing investment in our financial futures.

Footnote:

1.      The Loonie Hour podcast Episode 135 with guest Grant Williams