A real life Japan real estate investment.

Today I will start describing one real estate operation I did 6 months ago, to give an example of what can be done, by a foreigner, in Japan. Please note that I can speak decent Japanese and somewhat read it as well. Not enough to understand the in and out of a real estate contract, but enough to get the gist of it and definitely enough to surf the web for properties. It was not the first property I bought, which helped, but it was the first property I bought for investment in Japan. My English speaking Japanese wife helped a lot as well.

1- Japan real estate as an asset class properties.

Before starting, I redirect you to the good of bad points of real estate, thanks to an article I wrote a while back which is perfectly relevant today and will most likely remain relevant for a loooong time. Please read it to familiarize yourself a bit with this kind of asset.

Please note that Japan real estate is quite different from the rest of the world as in Japan: property do not get old in Japan. They are usually destroyed to be rebuild on a 40 to 70 years cycle basis. This is mostly due to the earthquakes in the country, weakening or damaging properties, to the earthquake regulations evolution, which are the most stringent in the world and evolve with the technology available and also due to the fact Japanese people do not like 2nd hand things anyway (a bit more on that here).

The main impact is that, contrary to most countries, the building value of a property decreases with time (not really the case in other countries where, if well maintained, a property keep its value or even increases after a long time).

I am not talking here about inflation, or a change in market demand for a specific location. Just plain building depreciation, as a building, in Japan, is a value losing asset (like a car).

It has 2 main impacts:

  • First, it means rental returns are higher than elsewhere, to account for this building depreciation.
  • It also means there may be some sweet spots in a property life where the price of the property is lower (due to its depreciation), compared to its cash flow generation potential.

I will deal with the tax impacts in another post.

2- Looking for a property.

I use mainly two websites for my investment property research.

  • The first one, to identify the good investment properties is the following.

This website is relatively complete and provides important information like the building to land ratio and the max habitable surface to land ratio. It also usually indicates whether the property can be rebuilt or not (this as a significant impact on price). It is mostly used for investment properties and as such mentions an indicate return on investment ratio, usually computed from the actual tenants living in the property, this is a huge feature that cannot be found in other websites. The possibility to filter on things like leasehold/freehold or to search directly from the map are also quite useful and not always available on other websites.

With this awesome website, you can visit the area you are planning to purchase into. You can check if the park around are nice or what colour the sand of the beach close by is and so forth. Thanks to this site, at least in well covered area, it is possible to really do a lot of ground work and information gathering without even moving from your chair.

3- shortlisting some properties.

Of course, everybody is different and as a result, a particular property would not have the same value to two different persons. This is where the skill in identifying undervalued properties come from. That being said, they are some important and recognised criteria that really impact the value of a property for most people. See if in your particular condition and for your particular target audience, some of those criteria can be ignored or at least be less of a focus as it will allow to lower the price you pay.

  • Age of the property: as mentioned above, price goes from full value for a new property to land value only (the building value being totally depreciated). Depending on the material used for the construction this decrease takes longer (more on that here).
  • Floor of the apartment if it is an apartment (the higher the more expensive).
  • Distance to a station: price start decreasing relatively importantly further than 15min walking distance from a station.
  • The kind of station close by: higher property value if there are several stations/lines within walking distance. Bonus as well if express or super-express trains stop at the close by station.
  • Material used for the construction (some more information on why here).
  • various building to land ratio.
  • If the building can be rebuilt.
  • Return when rented: older properties have higher return but will be usable for less time before rebuilding and may be harder to rent for really old property, unless some comprehensive renovations are done.

4- Contacting the real estate agent:

Make a list of the interesting properties, class them, and then contact the agent for the one you are interested in. If the agent looks good, is quick to answer questions, belong to a big company etc. do not hesitate to mention the other properties you are interested in, as even those where his company is not mentioned as the contact may still be in his portfolio. It is much easier to discuss and plan visits with only 1-2 real estate agents for 10 properties than with 10 agents… Also, in doing so, you gain some goodwill with this particular agent (indeed, if you end up buying a property that was mentioned under another company responsibility, your agent will earn the processing fee, not the competition). This may come in handy when you try to negotiate the Real Estate agent fee (there is a bit of negotiating room here, more on that in another post).

In general, try to use a recognised company Real Estate agent (I hate saying that, as I am sure it is possible to make better deals with less recognized companies), as the agent is really important. Indeed he has a duty to inform you about any specific point where the property may have an issue, and can be made liable in the future if he has withheld some information. It is much easier to do so when a big company’s reputation is at risk, especially in Japan, and therefore all the agent from big company I have met so far were all really forthcoming in mentioning all the property issues, so that you can make a well informed decision. It is all the more important if you are a foreigner buying in Japan, as some points may not be clear to you due to local specificities. things such are the present of asbestos or sign of wood ants are for example things that the real estate agent must tell you.

5- Plan visits and do them:

Visits is obviously a key part of the process. There are so many point of attention that could be listed that it is actually difficult to do so… still a few important points:

Check the overall property soundness. The foundations etc. It is not necessarily easy for a beginner, but still try to see what you can and ask questions. Regulation on foundations are evolving and for an older property, when it will be time to rebuild, you may or may not be able to do so without redoing the foundations to a more recent standard.

Check the neighbourhood, do not hesitate to walk to the station to see what kind of area is around, what kind of shops are their etc.

If it is currently rented, you will not be able to check inside the apartments. at the same time, it is a good sign, as it means it is in rentable condition.

I may make a more dedicated post on that aspect another time.

6- Make an offer:

If you have found something you like, you can make an offer. Offers are not “legally” binding until the deposit is paid and the deposit paper signed. That being said, if you make an offer, it is widely expected that should it be accepted, you will have to follow through. Because of that, it is usually difficult to make offers on different properties at the same time (unless you want to buy several at the same time of course), as the real estate agent will usually refuse, since if both sellers accept, he knows you will decline one and he will have to explain that to the seller. On the other hand, should you make an offer and it be accepted, the seller may also change his mind before the deposit payment etc. but again, it is usually a bad move if you want to keep good relationship with your real estate broker.

Having good relationship with him/her is something you should thrive for, as it may mean lower commission, easier access to properties newly put on the market, great service etc. It is all the more important if you want to buy several properties over time or if you are a foreigner, or looking for something a bit special, as your agent will know your specificities and may help fulfil them more easily. Having good relationship may also allow you to make concomitant offers on several properties, where the Real Estate agent knows he may have issues with his boss should several seller accept, as he knows you bring more business than the risk he is taking. I am not being paid by any Real Estate company to say so, it is just valuable advice just by itself.

The offer needs several information:

  • What price you wish to buy the property for.
  • What deposit you intend to pay (between 5-10% is normal, I have paid as low as 3% once)
  • When do you wish to buy (it may have an impact is the seller is still living in the property or on the contrary if you plan to buy only in 6 months).

In general, it is possible to bargain a bit on the price. Japan so far has not been like other crazy countries like US or Europe where there are bidding wars on properties. It is usually possible to get a property for a bit less than the price tag. for Example, if a property is listed 33.8millions, an offer at 33millions is extremely likely to be accepted. It is possible to ask for bigger discounts but then the chance of getting them can be low. Still I strongly recommend bargaining a bit.

7- Deposit time:

Once both parties have agreed, the Agent will setup a meeting for both buyer and seller to meet to sign a commitment to buy/sell and pay the deposit. Such meeting takes between 1 and 1h30.

Deposits are usually paid in cash, it means going to the bank beforehand hand having anything between 1million and 10millions in cash on yourself. If you need more than 2millions, the ATM may not be able to provide the amount (or tour card limit may be hit) so it is better to go to the bank counter. Japan being a really safe country, having that kind of money on yourself is not as big a risk as in other places. Still be careful.

Once the commitment is signed, it is binding. It means should the buyer change his mind, the deposit will remain with the seller. On the contrary, if the seller change his mind, he will have to pay back the deposit, and top it off with the same amount of money from his own pocket.

It is possible to put some particular clauses in a deposit commitment. such clauses, if not met, can result in the transaction not being made at no penalty for both buyer and seller. The most common one is, on the buyer side, to ask for a clause making this purchase commitment dependant on a bank accepting to lend the missing money. should the bank refuses, the buyer cannot purchase, but do not lose his deposit.

8- Bank visit:

It is strongly recommended, when starting to look for a property, if a loan be necessary, to go to the bank early in the search. The idea being that you present to the bank a property you may not want to buy, but in the price range/age/area of what you are looking for and ask for an agreement for a loan. The bank will prepare your file, ask the necessary information on income etc. and should it accept, it would speed up the process for the real purchase, once the ideal property is identified.

Please note that as a foreigner, it is extremely difficult to get a loan to buy a main residence. You would need to have a permanent resident visa (10years in Japan and some paperwork), a Japanese guarantor (can be your wife/husband if you are married to a Japanese person).

Getting a loan to invest, while more expensive interest-wise, is easier as well. Not all banks do those loans to foreigner, but the ones which do are mostly looking at your capacity to pay back, and the amount of deposit you propose.

9- Buying cash:

Buying cash is much easier and does not have any special restriction. Your bargaining power is also a bit higher (since the seller will be sure you can buy, not being dependent on a bank to do so). For foreigners it is clearly the easiest option and can even be done when you are not living in Japan. You would have to provide a certificate of residence from the country you are living in along with a certified translation into Japanese. You also need a certificate of signature, as, not being registered in Japan, you cannot use anko (seal).

For the property I bought 6 month ago. I went to the French consulate (I am French) in Mumbai (I am living there), got such certificates, then brought them to the French consulate in Tokyo (at the time of my visits) to get them officially translated. It does not cost much to do. I actually did the paperwork 1 year early (I was planning to buy in 2015, but ended up, after 3 weeks of visits, with nothing to buy). Since I had by then good relationship with the real estate agent, he agreed to use my 1 year old paperwork to proceed the transaction. I also made the necessary paperwork to enable my father in law to sign the contract as I was back to India by then (the real estate company managed that, at no cost to me).

10- the purchase day:

On the agreed day, both parties will meet, along with the Real Estate agent and the lawyer in charge of recording the sale. Such lawyer can also be provided by the Real Estate company. The whole contract will be read, aloud, to both parties. It takes hours and cannot be avoided, it is part of the Japanese regulation. For a foreigner, it is a bit tough but well.

Once those maybe 3hours are done and the paper signed, the next step is, if a loan was involved, to go to the bank for the bank person to issue to loan to the buyer account, then the buyer to make bank transfers to the seller, the lawyer and the real estate company for the appropriate amounts.

11- Finding a management company

After that, you may also need to find a management company if you cannot or do not what to manage the property yourself. See pros and cons of that in this article. In my case, not being in Japan, I did not really have a choice. The real estate agent company had a subsidiary doing that business so he introduced me. I am not sure it is the most efficient way to find an agent but I had little choice. Keep in mind that it is possible to both negotiate the kind of options such management contract contains (less option means cheaper) and the price itself as well.

When the contract expires in 2 years, if I am back to Japan at that time, I may try the DYI method. I have made limited research on that so far but this website is about finding appartment or tenant without agent, which is the hardest part of managing a property by oneself. The rest can be organized separatly. I will certainly make an dedicated article on that at some point, and also try that hopefully soon.

I will give some details on the property I bought in a later post.

do not hesitate to leave comment or ask questions.

 

 

 

 

 

 

 

 

The best way to make money…

Today I will change a bit from my usual topics on macro economics or trading and instead delve on a seldom discussed topic in Finance, even though it is so central to your capacity to actually build up your wealth.

The best way to make money (check that other post to refresh your understanding on what money is, here I am talking about real money, or Money as Capital, as I call it) is actually not to spend it. I know it is a big secret I am letting out here but as it happens, it is also quite effective.

I stumbled on that blog a few days ago and I strongly recommend it. The blog actually inspired this post and my renewed motivation to post here (even with absolutely no readership so far ^^).

I do not share the author’s view on everything, especially on his reliance on stock market returns to generate a part of the income he considers, at least not on his returns expectations, but most of his advises are really sound and he makes some great point. He is also fun to read and managed to make me chuckle aloud a few times, no easy feat for the internet blasé person I am. That being said, I strongly disagree with his opinion on moustaches, but I would love to share that face to face with him over a few beers.

My opinion on stocks is anyway of little value as being a non-French tax payer, I cannot open a share account in France. Being non-Japanese, it is also difficult to open the same in Japan and in any case due to my current work, it would be a real hassle to make the declarations I would need to make to the Compliance department every time I would be even remotely considering doing anything…

To add a tiny stone to his great work, I will then make a specific topic on the “saving money” aspect where I know the situation well: Japan.

Japan happens to be, in my opinion, the Paradise for money saving:

  • Salaries are quite high, compared to the rest of the world, that leaves a lot of opportunity for saving. Cost of living is high too, but there are a lot of workaround to that. More opportunities to save when you start with a lot than when you start with little!
  • The country is in constant deflation, due to a strongly diminishing population. The central bank and politicians are fighting that, a huge mistake and a huge present to indebted entities in Japan, namely the Banks and the Government, while being a huge disservice to the general population they are supposed to serve. Nothing new here, it is the same almost everywhere. The time of reckoning for those scums will come someday I suppose, but it is not the purpose of the post. The fact is, there will be deflation, at least compared to some other intrinsically valuable constants (oil price, gold price, good companies share) in some aspects, the main one being real estate and land price (at least our of the centre of Tokyo), which can be huge part of saving money.
  • Japanese people simply “hates” second-hand things. On top of that, they also are really conscientious and take great care of their possessions. Finally, they tend to live in small apartments, meaning they have little room to store things and function on a “buy-new-sell-shortly-after-in-excellent-condition” mode, and that for really cheap since other Japanese do not want to buy second hand to start with.
    • Case in point, video games, bought and resold in mind conditions a few days after release, for a 10%-20% discount.
    • Manga and books in general, sold 20 volumes for 500-1000 yen (4-8 USD).
    • Baby equipment: bought a stroller, a car seat, an elevated chair and some baby cloths for less than 5000 yen (40 USD). New, that would have cost well north of 100 000 yen (800 USD+).
    • Sport gear and so forth.
  • Japan has the best public transportation in the world, and unless you have 2 or 3 kids and live country side, you can really live without a car. I have 2 kids now (2nd one born 1 month ago ♥) and, as I may be heading back to Japan soon, I will definitly give the “live with 2 kids and no car” a try.

All of that combined together make for a really high potential saving rate. Which can then be build upon.

I will not mention more that that today, living some for the following posts I consider making on that aspect.

Musing on Brexit vote – what next?

 

My main take on Brexit was that it would be, as usual, a narrow win for stay, with a bit of fraud (pardon me, irregularities), like we have seen in all the recent elections everywhere in the OECD…

I was quite surprised about the result, but honestly, I do not think anything “serious” will happen following this vote, and all the news coming since the vote are making me feel I am right:

First, Europe elite has a loooong history of not following the popular vote:

Some examples:

June 2, 1992: Danes Reject Maastricht Treaty

June 8, 2001: Irish Oppose E.U. Expansion

May 29, 2005: France Vetoes European Constitution

June 1, 2005: Dutch Voters Also Reject the Constitution

June 12, 2008: Another Irish No Vote

April 6, 2016: Dutch Rebuff Accord With Ukraine

I found a great article listing many more items like that on the web last week, but I cannot remember where and cannot find in when looking for it, so I used this article from the NYT as reference.

The bias on this NYT article is quite clear: European integration is good and the unwashed masses, when being asked their opinions, better voter correctly, or there will be a re-vote until they get it right, or even more scandalous, the country parliament will not follow the popular vote and still validate what has been just rejected after cosmetic changes.

One glaring missing example from the NYT article is the Greek vote on more bailout 5 July 2015, to which 61% voted against and after which… more bailout where provided, enslaving the population even more. Maybe this one is missing as it is quite obvious now that the situation in Greece is not better at all, that the population is even poorer now and that in any case, Greece will still default again at some point.

Anyway, back to the main topic:

The impact of the Brexit vote in the coming years, in a political vacuum:

My core opinion is that nothing fundamental will change. First the political class will drag their feet and stall as much as possible, until either an event “save” them from this “ridiculous” popular decision like let’s say a huge crash in Europe (Italy bank or Deutsch bank anyone), forcing the Central Banks to have a coordinated answer and bringing back UK into the fold.

If nothing happens (really unlikely in my view), then the parliament, which still needs to vote on activating article 50 or not, will ask for studies, commissions etc. in order to take an “informed” decision, delaying even more. All the while, the political class can say they are negotiating on better tems with Europe and at the end of the day, may choose, without asking the people, that the cosmetic concessions they are getting are a great victory and that they can remain after all.

Even in case they activate article 50, there is a span of up to 2 years before its activation, leaving plenty of time for events to “force” them to come back to Europe…

 

That is what I am quite certain would happen, in a vacuum. Now UK is definitely not in a vacuum in Europe.

I have always been saying (but not writing, sorry), that the main risk of the Brexit vote (be it a narrow win as I was expecting or an actual lose) is not the changes for UK (with all the banks there lobbying for a stay, and the referendum being non-binding, the chance for an actual, real exit was/is close to none in current environment), but the impact such a vote would have on all the independence parties in Europe (I do not want to write far-right, as wanting to have sovereignty for your own country and not follow the diktats of Europe does not make you far-right in my book) is quite real.

This is not limited to all the anti-European parties in every countries, but also the regional parties within each countries (Catalonia in Spain for example). This is where the risk really is. From the start the UK vote was a non-starter for sure, since the political class was not interested in that, the rich/lobbyist do not want that as well and so forth (see the reaction of the political class winners…). With no popular leader to follow through on Brexit, the situation will remain indecisive until an event brings back UK into the fold.

On the contrary, should a popular leader somewhere else in Europe wins a major election on that “leave Europe” platform, they may really well actually follow through on it. Imagine Italy’s Five Star’s Grillo wining the national elections on a “leave Europe” platform (which means leave the Euro in the case, something far more serious). It would be likely to happen.

Indeed, as a comparison, Greek leaders were elected on a stay in the Euro but no more austerity platform, a contradiction mathematically (meaning it could no happen without a political union and the agreement from the North to bankroll the South, something we are really far from) hence one of the side had to give,. “No more austerity” became… more austerity for longer.

That would be different in Italy I suppose, if they are elected on the “leave the Euro” platform. It could actually be compatible with a “no more austerity” platform (and a huge devaluation of the Lira, something all countries want to get without advertising it). If this happens, say goodbye to Target2, Deutsch Bank and a score of other things…).

Where does that leave us economically:

I see the GBP going down more on a short term basis. Indeed, until it is clear the Brexit vote is not followed by the political class (something that may take 1-2 years easily), Brexit is on, and it means Bank issues in UK, issues on UK sovereign debt, Scotland or Wales possible referendums to leave UK etc. In my opinion none of this will end up happening (or at least not due to the Brexit vote), but until it is clear to everybody, it is negative news upon negative news for the GBP.

I am looking to buy GBP on a 10-20% additional drop from here (Cable at 1.30 roughly today). Would most likely buy it shorting the JPY if the risk-off trade carries on during that period, as GPB/JPY could have dropped even more (beware of BOJ interventions though…). I am not advising to short from here, I am looking to go long later.

I see Banking stocks taking more of a beating short term, and honestly, I could imagine a Bear Stearns/Lehman moment somewhat soon, where a big actor default (Deutsch Bank is a good candidate, Monte Dei Paschi too, one defaulting could actually bring the other down, and a score of others after that).

This would create turmoil, and after that it becomes hard to evaluate what would happen. Brexit may end up happening, not because of the vote, instead that would be because of this chaos and the rest of Europe exploding, which is why my above prognostic was mentioned “in a vacuum”.

That does not change the above trade though, as I see a real Brexit, once consumed, as a plus for UK long term (and the JPY is doomed anyway), assuming the rest of Europe also disintegrate, which is the case “not in a vacuum”. Such a mayhem would mean an even better entry point for a GBP/JPY long. Given the risk to overshoot on the downside first, with the above Armageddon scenario, it will not be possible to use a lot of leverage though (and hopefully your broker will not die in the process…).

China devaluation on deck

Market call for 2016:

I am usually not a fan of making market calls; I prefer “doing” to “talking”. Usually people making calls have something to sell, which is not really my case currently.

Now, 2016 is shaping like an extremely “interesting” year – interesting like the Chinese curse “may you live in interesting times” – and some of the trades I see for this year, I cannot actually make (unless somebody explains me how…), so I record them here.

The first one is that I see China devaluating the CNY (here I am mixing the onshore and offshore yuan/renminbi, both would fall by relatively the same amount) strongly this year (20-30-40%?). They are under strong market pressure to do so, have been leaking FX reserves at a faster and faster path and in general are doing a poor job of containing the problem.

They should, when they devaluated in August 2015, have done the full needed devaluation: USD gained between 20 and 50% depending on the considered currency, which has mechanically also increased the CNY value by the same amount against the rest of the world, killing the Chinese export machine. They should have bitten the bullet and devaluated 30-40% in 1 go at the time. By doing a little bit only, saying it was a one off event, and then doing it again a few days later, they scared a lot of CNY holding Chinese, really exacerbating the capital flight that has been ongoing for years now. With a one-off event, taking everybody off-guard, they could have regained their competitiveness while potentially attracting capital after the surprise receded. Doing it in small installment exacerbated the capital flight, forcing their hand on the devaluation. They will have to devaluate vs the dollar, unless the dollar itself crashes by 30-40% against the rest of the world currencies really soon (it will happen in time, but not fast enough for the Chinese).

My main issue here is that I do not know, as a retail investor, how to play that. No broker I know of offers the CNY as a trading currency (it is non-floating for a reason…). Also, China (Hong Kong to be exact) has recently raised the cost of short position carry to a really high value for a couple of days, to scare people who would consider shorting the currency, this is indeed scary, so the best way to play this would be through put options (1 or 2 years put I guess), but again, not accessible to retail investors and I have no clue about the cost of such puts. Another way would be through CDS on China, but not opened for retail, and in any case should we get a real event, I am quite certain excuses would be found in order not to honor the CDS (Greek “voluntary” restructuring to avoid “credit event” anyone?), so puts would be the best (assuming again that the counterpart from which you are buying the put would pay up… hard to be sure). One could consider shorting the Chinese market from abroad (keeping the CNY short exposure that way), but again not even sure it is allowed, and if it is, it will be forbidden the second your position starts making money…

In short, a really clear trade, but no good way to implement it…

Proxy trades for such devaluation are hard to find. I suspect other emerging market would follow suit and devaluate again (currency war), so shorting EM vs USD could be a trade, but it is quite pricy already, since the reason CNY must devaluate is that they are late to the devaluation party to start with.

I expect a lot of mayhem if it comes to pass, but mayhem we may have this year, with or without Chinese devaluation, so taking a position on that front now, could see much volatility even before the event, so I am not convinced.

In short, I will sit this one out unless somebody has a really good idea, I just want to record the call here, to be able to say “I told you so” later :D.

Cheers.

P.S.: the idea does not come from me only, I formed the idea reading various sources on the internet, and incorporating that with my macro-view and my bullshit-o-meter. The following article from TheAutomaticEarth, taken again by ZeroHedge, exactly on the topic, is in my opinion pretty much spot on and makes me feel things are close to a boil currently.

P.P.S.: read the disclaimer again.

To buy or not to buy a house, all the aspects to be considered

In current environment, there are some really good reasons to buy a house but also really good ones not to. I will first give a macro-economic panorama of the situation, and the impact on real estate.

Please note that my knowledge of real estate market is mostly limited to Japan and France, where I have in the past bought/sold properties and still hold some. This is nevertheless sufficient to give some important insight at the macro-economic level.

The macro view of the real estate market:

  • Rate are super low today, this is a fact. It may still last a bit, but there will definitely be a limit to that. What most realtors never tell you though is that low rate means high purchase price, meaning it is not a good time to buy when rates are low:

Indeed the Real Estate market, like other market, is driven mostly by supply and demand. Demand is related to the demographics in a given area, although demographics can evolve, such evolution is usually really slow, baring mass immigration. As a result, we can assume the need for shelter is constant on not too long periods of time. If demand is constant, then the buyers pool is. Higher rate or lower rate has no big impact on the portion or earning someone can pay for shelter (should not be more than 30% of net income for most middle class family).

If interest rates decrease, for a given property at a given price, the installment value per month would decrease, that would result in more people being able to afford the said property (people with insufficient income to buy the property if the rates had remained the same would become able to do so), increasing demand and mechanically the price. Alternatively, should the rates be super low like today and start increasing, should the property price remain as high as now, the pool of families being able to afford the monthly installment on a given property would decrease, resulting in slower sells at first and depressing prices at some point.

The conclusion is that rates being low by historical standard is definitely not a good reason to buy; it just means the price of the property being bought is higher than historical standard, so that the installments remain roughly the same. Should you buy without loan and just savings, it is actually a really bad idea to buy a property in low rates environment, as you do not benefit from locking in those low rates with a loan but would be penalized by the decrease of property price should rates rise after purchase.

On the contrary, buying when rates are really high mean the property being bought is cheap. It is an excellent time to purchase in cash. It is still a good deal when buying with a loan, as even if rates decrease in the future, it is possible to refinance (borrow again at lower rates to pay back the initial loan with the higher rates early), while benefiting from the property price appreciation.

Conclusion: in today’s environment, if considering buying, somebody should definitely consider using a loan, and this loan should absolutely be with fixed rate. Buying with floating rates means that, should rates rise, not only the installments would increase, but also that the property price would decrease, resulting in the worst outcome possible.

The only case where one should consider buying with floating rates instead of fixed rates in current environment is if one can pay back the loan quickly (meaning that the person already has the cash, but choose to invest this separatly cash and buy with a loan instead). Should the rates remains the same, the person get the benefit of lower rates (floating rates are lower than fixed rates for a given period), while still earning some income from the investment. Should rates rise, the person has the option to pay back the loan early. It is nevertheless important to consider in what kind of investment the savings are kept. It should be something relatively liquid (that can be sold easily), and something uncorrelated to the rates movement (if rate increase results in loss on the investment side, it means that the person may end up not being able to buy the property with cash due to the loss) or even better, positively correlated to the rates movement (where rates increase would result in investment gain, an kind of investment really hard to find today for an individual).

  • In some markets, the property prices is extremely high (on top of the rate effect described above), due to other reasons:

In France for example, recent laws (rent control…) and stricter and stricter regulations on the builder side result in a dearth of property being built and therefore a shortage of property. This combined with increasing populations in the cities (both from rural exodus and immigration) result in really high prices.

In major world cities (NY, Paris, London, Toronto, Sydney etc.), there is also an important demand from foreign investors. Such foreign investors increase the overall demand and the property prices in such cities.

In Japan, aside from Tokyo (where there are some foreign investments and rural exodus increasing demand), population is decreasing, and has been decreasing for a while. This results in Japan being one of the cheapest developed market to invest in compared to the median income of the population, if out of Tokyo. Special care needs to be taken though, as, with declining demands; some property may end up really hard to sell/rent in the future. This is expected to continue, as I do not foresee massive immigration to compensate this population decline, and I do not foresee Japanese people having more children in the near future (in any case, it would take 20-30years for those children to become buyers and drive the demand higher).

As can be seen, from a macro standpoint, prices are really high today. Can they go higher? Certainly, if the rate policies and the immigration policies etc. carry on, for example Central Bank implementing Negative Interest Rate Policy (NIRP), but I am not convinced on a 20-30years horizon, which is usually the horizon to purchase a home.

The thing to consider when buying a house:

There are a multitude of aspects to consider before buying a house in current environment, given the really high price-tag today.

  • Real estate is an asset that is extremely non-liquid (cannot be bought or sold easily and cheaply):

Selling a property takes months, especially if the seller wants to get a good price. Transactions also come with hefty costs (real estate agents, legal cost, loan processing fees, etc.), usually around 10% of the property value at purchase time, and another 3% at selling time.

It means, when buying, you need to be quite certain you will keep the property for several years. If, for your career, you expect to have to keep mobile, it may not be a good idea to buy a property, unless:

  • You intend to come back in such property in the future (retirement for example).
  • The property can be rented relatively easily.

As a rule of thumb, you need to stay at the minimum 3 years in a purchased property to breakeven, meaning the savings you would have made on the rent, minus all the costs of owning such property offset the purchase and selling price. In some market with more expensive transaction costs or extremely high prices today, it can be even more than that (something like 5-7 years for Paris for example).

If you need to remain mobile and cannot find a property meeting the above 2 criteria, do not buy to live. Consider buying to rent in an area where you consider retiring and use the income to rent where you need to live. It is not the most efficient, due to tax, management fees etc. but it definitely beats buying and having to sell too early. You do not need to buy a house in which you plan to live in the future, some small investment units could be better. The idea is that once you come back in the area, you can manage those properties by yourself instead of relying on an agent.

  • Real estate is a quite low-return investment:

Real estate is not high return investment (it has nevertheless a big list of other benefits that I will talk about later).

The past 20+ years are absolutely not a good example of real estate’s return. During those 20+ years, interest rate have been decreasing steadily, resulting in important prices increase on the period. This is more an anomaly than the norm. Given the fact it will be difficult for rates to go much lower (crossing fingers here, central bankers are actually considering NIRP, which would increase prices even further), capital gain possibilities are limited at that point.

Real estate costs quite a bit to maintain:

Between the income tax, property tax, building maintenance, coop costs for condos, potential damages by tenants, risk of non-paying tenants, time where the apartment is unoccupied, managements fees etc. the rents earned disappear really fast.

Real estate income is limited:

On average, a property price, if well maintained, track inflation in area with limited population growth. Real estate is not well suited for capital gain historically (the last 20years are an anomaly, the longest decreasing rates period in history). Of course, in a particular area, at a particular time, good capital gain can be made, but it requires deep knowledge of that market, usually the shouldering of extra risk (extra cost to renovate for example, or a bet that a train line will be created in the area in the near future etc.). Such gain expectations should be considered as risky as stock market gain appreciation, combined with a cost of transaction far greater than stock and really poor liquidity. In short do not buy a property for capital gain unless you know what you are doing.

The only potential gain from real estate is therefore on the rental income, either earned if rented to a tenant, or saved, if lived in.

Rental incomes are not high, if properly accounted for:

Let’s assume a 100 000 property, with a gross income of 5% (better than what can be obtained in most major cities when decently located already).

You have to account or provision for a lot of hidden costs:

  • Management company to rent the property, usually 1 month rent to find a tenant and 1 month rent per year (so 1/12th of your income is going to the managing company every year, and if your tenant leaves, you have to pay extra)
  • Assume your tenant changes on average every 2 years, and the management company find a new tenant in 1 month (not optimal, but not bad either).

Over 2 years (24 months of potential rent) you would end up with:

-1 for having the building unoccupied 1 month

-2 for 2 years of management company fees

-1 for the management company to find a new tenant

So 20 months of earned rent over 2 years, 10 months per year instead of 12. Your 5% income is already looking like a 4.16% income.

  • Coop costs for condominium: usually 1.5 months rent per year. For a standalone house, coop costs do not exist, but maintenance costs are a lot higher, so let’s assume it is the same 1.5 of extra maintenance for a single house.
  • Maintenance costs: conservatively, for a condo, ½ month rent per year.

So an extra 2 months of rent gone, before any bad things happen: only earning 3.75% now, before tax.

Then there is the property tax (varies too much from one location/country to another, can be anything between less than 1months rent to 2-3 months rent), let’s be generous and say it is only one month rent. Before income tax, you are already only earning 7 months rent out of 12.

And after that let’s assume a 25% marginal tax rate: 2.2% of net return, before the real risks of real estate investment: bad payers, tenants who damage the property, and regulation forbidding to out a non-paying tenant, along with lawyer costs to recover what is due (a crap-shot depending on the tenant). 2.2% net return with that kind of risk is not particularly appealing, but when thinking about the alternatives (close to 0% bonds rate, extremely expensive stock market today etc.), that may still retain some allure.

A good way to increase the income is to do away with the management company altogether.

It allows for:

  • 3 months of fee saved over 2 years, as described above (2 months of fee + 1 month to find a new tenant).
  • Better control on tenant (you can choose them), potentially avoiding some of the above issues.
  • Potentially less delay between tenants, due to the high motivation for the owner (yourself!) to find a new tenant (a motivation that the real estate company may not share to the same extends). In any case, with the 3 months of fee saved already, even if you find a tenant in 2 months instead of 1, you are still ahead.

Now, doing so is extra work (quite a bit actually), requires that you live close to the property (meaning you are back in the situation where you are less mobile somehow), and other risks (can you find a tenant by yourself? You need to redact a proper rental contract etc.).

In some countries, this direct owner to tenant market is quite developed, so it may not be too hard to pull off (like in France for example), in other markets, on the contrary, most transactions still occur through real estate brokers so it may be harder (Japan is the latter case).

Another risk not covered above is taxation risk: a sharp increase in property tax can a have significant impact on the overall investment. In some countries like the USA; it is a real risk in most states.

Still, real estate has a lot of hidden advantages:

  • Inflation hedge:

Real estate keeps its value, in light of inflation, over long period of time. It means the 2.2% net return considered above can also be considered net of inflation. Should there be inflation, the property value would increase, and the rent value should also increase, albeit with a delay.

In current environment:

  • Bonds and stock are far too expensive (meaning almost guaranteed losers over a significant period of time, especially after inflation).
  • Cash is a guaranteed loss over time (inflation is quite high those days in most countries, whatever our beloved governments say, while rates on short term deposits are at rock bottom). Also a big pile of cash at the bank has other risk, when you consider what happened in Cyprus or Greece recently: bail-in of depositors, capital control etc.

So faced with certain important losses on bond and stock, small losses on cash and money market items (along with confiscation risks), real estate’s 2.2% net of tax and inflation do not seems so bad after all.

  • Efficiency of buying to live:

Buying to live has a lot of extra advantages. It solves several of the issues mentioned above:

  • potential damages by tenants
  • risk of non-paying tenants
  • managements fees
  • time where the apartment is unoccupied

On top of that, usually, buying a property to live in comes with several tax breaks, depending on jurisdictions, such tax breaks are usually not available for investment properties.

Finally, saving on rent is more efficient than renting. Imagine a person has a 25% income tax and has the choice to either buy a property to live, or buy a property, rent it out and rent another one to live. Assume the rent paid and received are the same.

Assume the same funding is used in both cases, meaning no difference between the two solutions. Assume the same maintenance needs for your own property and for the bought to lend property (so I ignore both aspects for the below calculation)

Case1: the person rents its own dwelling and buys an investment property to rent it.

Extra income gross is 100 minus all the various charges related to using a management company explained above (from 5% we went to 4.16% before tax or 1/6th gone for management), as those charges are usually tax deductible, so 100-100/6 = 83.3

Extra income tax: 83.3*0.25 = -20.82

Extra expense for own rent: -100

Total: 83.3-20.82-100 = -37.5

Case2: the person buys its own dwelling.

No extra income (so no tax) and no extra expense, no management company issue, no period without tenant.

Total: 0

The gain is indeed substantial, and the risk lower (no agency risk with the management company, no period without tenant, no “bad” tenant issue…).

  • intangible benefits:

Being the owner of your dwelling comes with serious advantages that cannot be quantified as well:

  • Feeling of belonging with your family or neighbors, the kid school etc.
  • Possibility to remodel, renovate etc. when and how you want.

For some people, those benefits will be the main drive toward buying a property.

You will find here an Excel sheet that can be used for Real estate simulation. It is a lot more detailled than anything I have found on the internet so far, especially on Real estate or Banks websites. It allows for realistic simulations, where not everything will go well. Fell free to use it. When distributing it to another person though, I request that you redirect this person to this website.

buy-to-rent-buy-to-live-xls

Comments on the post or the worksheet welcomed!