Читать книгу When the Bubble Bursts - Hilliard MacBeth - Страница 5

As an advisor to Canadian investors, I meet regularly with individuals and couples to discuss their investments, personal situations, and retirement plans. On most working days in the year there will be one or two or more of these one-hour (sometimes longer) meetings. Often the clients’ questions boil down to two things, especially as the aftershocks from the 2009 market meltdown were still being felt: “Are my investments safe?” and, “Will I have enough money to retire?”

If the stock market has done exceptionally well over a period of years, another question will pop up occasionally during these meetings. It can be expressed in various ways but the underlying premise is this: “How am I doing compared to other investors? Am I falling behind?”

My client base is admittedly a very small sample of Canadians. However, listening to them gives me a valuable window on the thinking of Canadian investors. I get a feel for their concerns and fears as well as their dreams and hopes for the future. Feedback from readers of my first book, Investment Traps and How to Avoid Them, cemented my conviction that Canadians in general had the same experience with investing that I observed with my clients.

Over the years the Canadian public has demonstrated a moderate interest in stock market investing during normal times. Most Canadian investors don’t pay avid attention to the stock market or bond market outside of meetings they have with their advisors or when they review their monthly statements and at RRSP (Registered Retirement Savings Plan) contribution time. In other words, they devote only a small part of their time to thinking about investments unless, of course, we are in the middle of a financial crisis like 2009, or a boom like 2000. And that’s perhaps exactly the way it should be.

I’ve had a gradual awakening in understanding this over the decades as investing in stocks and trying to understand the economy and writing about it has been a lifelong passion for me. But I’ve learned that most people prefer to focus on other aspects of life.

So when there’s a change or a new trend in my clients’ attitude toward a particular investment or if a new concern appears during the discussions I sit up and take notice. If I get twenty or thirty people over a short period of time mentioning similar concerns or displaying the same attitude, it gets my attention. In a long-standing practice that reinforces my ability to identify something new, at the end of each meeting I transcribe my handwritten notes taken during the meeting and enter them into a computer-based profile.

One of the most extreme examples of this sudden change was in the late 1990s when clients started to ask about technology stocks and the Internet. For example, Nortel Networks (originally known as Northern Telecom) became a hot stock and a favourite vehicle for speculation and conversation topic. In the early 1980s it was the oil and gas stocks, especially Dome Petroleum. In the mid-1990s it was a gold mining stock called BRE-X that mesmerized investors. When the public gets consumed with interest in the stock market during a boom like they did during the dot-com bubble, it’s a clear warning sign. These are classic examples of buy-high traps, as discussed in my earlier book. My clients and I were lucky to avoid getting caught in the dot-com bubble trap, partly because I heeded the clear warning signs that came with that hot sector and partly because it was clear that the valuations accorded to those stocks were stretched beyond anything ever seen before.

After the dot-com bubble burst I became more sensitized to signs of the formation of new bubbles. During the stock market decline (bear market) that followed the bursting of the dot-com bubble, investors’ attitude toward stocks changed. Something was different in how they talked about the stock market, retirement, and investing in general. But it was a gradual adjustment so it took a while to notice what was happening.

I can’t remember the exact moment when I first noticed the change but I can narrow it down to a time near the end of 2002 during the last days of the downward spiral of the stock market. After 2000 most clients were still talking about the dot-com bubble and their attitude had changed from “Why don’t we own any technology stocks?” to a feeling of overwhelming relief and gratitude that we had escaped the devastation that many investors suffered. After that bear market, there were many discussions about stocks and the issue of safety and risk in the stock market. Since most of my clients experienced investment returns that were very positive relative to the market index (because we didn’t own any technology stocks) our conversations about risk and the stock market were usually calm and thoughtful.

The boring, basic industry stocks that we’d owned throughout the late stages of the bubble (1999 and 2000) in the mining, industrial, transportation, and energy sectors finally started to outperform and patience was rewarded with substantial gains. However, it became clear that clients couldn’t watch the stock market collapse as it did without being affected. I was very happy to have positive performance numbers and especially thrilled to have avoided the meltdown in technology stocks. But despite this, clients were quietly thinking about another form of investment that only gradually was articulated.

Clients started to talk to me about real estate. For example, it would have been in the early 2000s when, for the first time but not the last, one client informed me that he’d bought a condo in Montreal so that his daughter could attend McGill. That was a surprise to me, as I would never have considered that as an investment.

So I decided to examine the merits of owning a residence for a university student. Many questions came to mind. How long does it take to complete a degree program? What if the student drops out? How does the student keep up the maintenance of a house such as shovelling snow in the winter and cutting the lawn in the summer while attending university? What happens when the toilet stops working? Don’t students just need a room to sleep because they spend almost all their hours at class or studying or partying? Aren’t students supposed to be focusing on their studies, having fun, and meeting new and interesting people? Perhaps they might want to change their study program that would require a change in universities?

I could think of many potential problems that would argue against the idea of buying real estate for such a short period of time in a city away from the home base. How much does it cost, for instance, to buy and sell a condo or a home? In a short period of four years the cost of real estate commissions and legal fees and repairs that always seem to be required would negate any potential gain, I thought. Isn’t real estate close to a major university expensive?

Of course, I am biased. I am in the business of managing portfolio investments in the publicly traded bond and stock markets. I would have been thinking that the money invested in the house would be better invested with us in our portfolio management service. So I gently challenged those people on their investment choices in buying additional housing to rent to students. I was wondering (usually only to myself ) why they would opt for such a bad investment choice as real estate and forego the chance to add to their investment portfolio with my team. Business considerations aside, though, I was genuinely puzzled by this new trend. So I asked them, “Why?”

The answer came back in several different forms but the simplest version was this: “Real estate is a good safe investment and it always goes up in value.”

When I threw out the idea that renting a condo or a house for the student would make more sense because of the short period of use in a typical university experience, the answer came back without any hesitation: “Why pay rent when I (or my child) could be building equity in a home? Why pay the landlord’s mortgage for him?” In addition, some of them would add that they wanted their child at university to experience homeownership and to get into the housing market “as soon as possible.”

I was surprised by this change. My experience had made me much less likely to believe in real estate as an investment. Just a few years earlier (1995), home values in Edmonton and Calgary and elsewhere in Canada were at rock bottom. Prices had declined or had, at best, no growth for the previous fifteen years going back to the 1980 peak. People had been waiting more than ten years just to break even on their homes.

Our family home purchased in 1990 for $300,000 was sold ten years later after a full year on the market, at the same price. Offers to purchase for any houses in that elevated price bracket (at the time) were scarce. Finally, when we’d almost given up hope of selling, we received an offer for the 1990 price before paying real estate commissions. We accepted the offer quickly, although it wasn’t a happy time.

We were selling for no gain after ten years but the financial impact was much worse. We had done several renovations and upgrades at a total cost of about $50,000. To adjust for inflation one should add about 2 percent per year to the purchase price; about $60,000. So that makes about $110,000 lost on a $300,000 investment in ten years. So to break even before the interest cost of the mortgage (at 13 percent) we would have to sell for more than $410,000.

After that experience, I was convinced that housing was a bad investment. I knew that we could have put that money into government bonds or the stock market instead. The interest rate on risk-free Government of Canada bonds when we bought the house was about 9 percent. So annual income would have been about $27,000, for a total of $270,000 over ten years: a loss of $110,000, or income of $270,000?

So I couldn’t understand how this new positive attitude toward real estate investing had developed so quickly. Had somebody put something in the water supply that made people high on real estate?

About the same time, I had another client decide to cash in his RRSP to use as a down payment to buy rental properties as an investment program. He was a realtor, so I could understand that he would be interested in that, but to cash in an RRSP? That meant paying full income tax on the proceeds on the withdrawals. Nobody ever does that. That’s sacrilege for a Canadian. I failed to dissuade him and he’s done very well as he was buying up properties when a basic house could still be found for less than $150,000. Now he owns about fifteen houses and they are all “cash-flow positive,” as the saying goes. Of course, he has a lot of debt attached to those properties too.

In a conversation that happened shortly after the housing crash in the United States, a client in his seventies, whose wife had passed away, was trying to decide what to do about the family cottage, which he believed was very valuable. He wanted to transfer the cottage to one of his children. He hired an appraiser and found that the price had dropped substantially from the peak value reached a decade earlier. He was clinging to the idea that this property would be a legacy for his children. I asked him why he felt it was better to transfer it than just sell it on the market, and he said: “Real estate always goes up in value.” He had just finished telling me about the appraisal five minutes earlier. I challenged him by pointing out that the appraisal showed a substantial drop in value. “Oh that,” he said. “That’s just temporary. In the long run real estate always go up.”

More signs of a substantial change in thinking kept coming. More than one client decided to move to the West Coast, a common decision for Edmontonians as the seven months of winter start to weigh on older bodies. For those who wish to stay in Canada, a popular destination has been the Gulf Islands in British Columbia, especially Salt Spring Island, as a retirement lifestyle choice. When one client announced a move there and the associated withdrawal of funds to pay for the purchase of a house, I suggested that renting for a year would be a good idea in order to see how she would like the climate. She would have none of it. “If I don’t buy now I’ll never be able to afford to buy a place there.”

Clients would take money out of their investment accounts for real estate purchases, especially U.S. snowbirds. More than once I met with a couple, at their request, to discuss the pros and cons of buying a retirement home in Arizona, California, or Florida. At the end of the meeting I thought that I had succeeded in convincing them that renting, initially at least, made much more sense than buying. The next morning, however, I would see a withdrawal request from that same client for the amount of their U.S. property purchase. My arguments were too weak in the face of an unquenchable thirst to buy more and more real estate.

Sometimes real estate-related decisions resulted in unintended consequences. One of my clients, a widow, decided she couldn’t live in the big, rambling house that she and her recently deceased husband had enjoyed for many years. The maintenance work required was beyond her and the secluded location of the house on a large plot of land made her nervous about security. She knew that because of the size of the property it would take a long time to sell so she decided to buy a condo in the centre of the city. When she applied for a mortgage to buy the condo she was turned down. It turned out she had co-signed a loan for one of her children to buy a home one year earlier. The bank wasn’t prepared to lend her any more money as she was retired and a widow. When she told me the story, after the fact, I realized that real estate exposure might extend beyond the properties that I knew about. I had no idea she had co-signed on a mortgage for one of her children.

I began asking my clients about how much help they’d given children and grandchildren to buy into the housing market. To my surprise, parental help was more widespread than I would have guessed. Sometimes it was a gift of cash for a down payment (preferable), or a loan (not bad); it could be co-signing a loan at a bank (horrible idea). Of course the banks love to get a second signature as a personal guarantee from a wealthy parent or grandparent and it seems like a small thing that a parent could do in order to get a discount on the interest rate. This phenomenon of providing financial help to offspring to get them into the real estate market as soon as possible is so widespread that a name has been coined: the Bank of Mom and Dad.

I really started to worry as I learned more about the large amounts of money involved. The alarm bells were ringing loudly, at least for me, even before we witnessed the crash in the U.S. What if the real estate market crashed? If my clients kept buying more real estate instead of investing in a balanced portfolio of stocks and bonds diversified over different sectors and different countries, their ability to fund their retirements would be limited or, in an extreme scenario, their retirement could be ruined. All of the good work done over many decades through careful savings and investing could be overwhelmed by a series of bad decisions in the real estate market – a market that is very illiquid by nature. Mistakes can be difficult or impossible to unwind. I noticed, too, that my powers of persuasion failed completely when it came to my clients’ new love affair with real estate.

Apparently what had happened, which is clear in hindsight, is that people had become frightened by the demonstrated volatility of the stock market and a perception of elevated risk, and became more comfortable with the “stability” of the real estate market. A steady growth rate of a few percent per year attracted them when compared to the 50 percent or greater drop in the stock market. After all, if a stock like Nortel can collapse, the stock market must be a very risky place. So people opted for the tangible investment, the house and the condo and the rental property. Even though my clients hadn’t experienced anything like a 50 percent drop in market values in their personal portfolios, the news media reported the stock market disasters and the general feeling of unease had seeped into their consciousness at a deep level and made a lasting impact.

I had, with skill and some luck, managed to steer my clients through the dot-com bubble in stocks. Retirement plans were intact and investment values had grown. But what if all that work were reversed in a real estate crash? I worried about what would happen to my clients in the event that real estate prices stopped going up or started to slide. The benefits of having a balanced portfolio of investments providing the ultimate in safety and return was in jeopardy because of a gross misallocation of savings into one asset class: real estate.

And then the even bigger shock occurred. The United States real estate market crashed and the world went through a financial crisis like nothing that had happened in my career. Again my clients survived the stock market crash with relatively little losses. The Canadian economy suffered a mild recession and real estate values dropped a bit, but nothing like the 40 percent declines in the U.S.

To my complete surprise Canadians continued in their love affair with real estate, even after witnessing the value destruction and devastating losses that hit so many in the U.S. housing market. I couldn’t imagine that the global financial crisis, referring to the 2008–09 period and known as the GFC, wouldn’t have a profound effect on Canadian investors and their attitude toward risk. But I was wrong.

The Buy-High Trap of This Decade: Canadian Real Estate

While this was happening with the real estate market and the associated financial crisis I had been playing with a book idea to inform Canadians of the buying opportunities in the stock market that would come after the period of deleveraging (paying down debt) ends. I believed that the deleveraging cycle that had started in the United States after the 2008–09 financial crisis must run its course before one can confidently say that there is a new bull market for stocks. That deleveraging cycle has yet to start in Canada.

The book that I started to write was based on my observation that some investors tend to get caught in a buy high, sell low trap that means they will buy at high points like the dot-com bubble in 1999 and sell out of their investment at low points such as the one in 2009 or the one that I believe is coming in the middle of this decade.

Ideally investors should try to take advantage of the bottoming of the cycle when the public is selling stocks at extremely low prices. Investors who are prepared could scoop up the bargains that always appear in the down part of the cycle, near the bottom. But they might be held back by fear, as many were in March 2009. Or they could be unable to take advantage of the buying opportunity because they don’t have any liquidity or money that is not tied up in other investments.

It would be a very unfortunate experience if one had overcome one’s fear and was ready to buy at the right point in the cycle only to be thwarted by a lack of liquid financial resources. Or worse, what if investors needed cash to shore up their illiquid real estate holdings and used the easy liquidity provided by their diversified portfolio of investments to meet their debt obligations? This happens in every market cycle when the best investments sell, because there is a willing buyer, but the worst cannot be disposed of because there is no buyer and no liquidity. That’s when the penny dropped for me. What if this buying opportunity arrives soon, in the next year or so, but my clients have so much money in illiquid real estate that they are unable to take advantage of the opportunity? Or worse, they sell their good investments held with me to prop up their bad investments elsewhere? Nightmare!

I realized that before I get ready to talk to people about the buy-low opportunity in the stock market that will arrive eventually in Canada, there had to be a discussion about the housing bubble and what that means for the many owners and investors who are exposed to excessive debt levels backed by overvalued real estate with little idea of the risk involved.

The possibility that my clients would miss out on a significant stock market buying opportunity caused me some sleepless nights. The idea for this book came out of that imperative: to reach enough people before they were caught in the wrong asset class — real estate — and unable to sell, just at precisely the time when an amazing array of financially sound investments would become available.

A bull market in the stock market represents the chance to make gains that are many multiples of the original investment. For example, the bull market that began in the United States in 1982 ended in 2000 when the index had risen fifteen fold. Not 15 percent, but fifteen times the original investment! So an average amount of money used to buy a modest house or condo in Toronto or Calgary, say $500,000, would grow to be worth about $7.5 million. And that’s just the average return for the stock market during that bull market — there would be some that did substantially better. Can you imagine a six-hundred-square-foot condo in a Toronto high-rise being worth $7.5 million in eighteen years? I agree, it’s not going to happen.

My goal with this book is to alert as many people as possible to the fact that Canada is in a housing bubble and it’s a buy-high trap similar to the dot-com bubble of 1999. If investors want to be successful in the next bull market cycle, it’s essential that they make some adjustments now so that they can protect their retirement assets and prepare their personal finances to insulate themselves against the inevitable deflation of housing values. Canadians must take steps to protect their investments now in order to prepare for the opportunities that are just over the horizon.