Congrats to Veselin who won a free copy of the QuickTax tax preparation software.

As many Canadian taxpayers know, the Home Renovation Tax Credit (HRTC) was a one year tax credit for eligible home renovation expenses incurred between January 27, 2009 to February 1, 2010. The 15% credit applies for eligible expenses between $1,000 to $10,000 (here is a full summary of the HRTC).

If you own a condo, the HRTC works on two levels: within the unit itself and on eligible expenses spent by the condo corporation. Since the condo corporation spent eligible expenses on behalf of the unit-holders/owners, the HRTC is passed down to each owner/taxpayer on a proportionate basis.

It is important to note that only owners are eligible and occupation of the condo is not necessary to be eligible for the HRTC.  The key is that the condo corporation spent money which, if it was within the condo unit itself, would be classified as an eligible expense.

The amount of the HRTC is determined by the share of your contribution to the total contribution of maintenance fee by all unit-holders/owners. For example, if a condo unit contributed to 1% of the total maintenance fees of the condo corporation, the taxpayers HRTC will be 1% of the eligible expenses.

It is possible to add up eligible expenses both within the unit and by the condo corporation to bump a taxpayer over the $1,000 threshold to claim the HRTC. For example, a taxpayer may have spent $900 on bathroom renovations inside the condo unit; given this is below the $1,000 minimum, this expense cannot be claimed under the HRTC. However, if the proportionate eligible expense incurred by the condo corporation and passed down to the unit-holder/owner is greater than $100, the taxpayer now qualifies for the HRTC.

To claim the HRTC, the condo corporation issues documentation which the taxpayer in the prescribed form. In other words, there is no need for the contractor to invoice each condo and ultimate responsibility for preparation of the HRTC receipt is the condo corporation.

Thus, it is important to ask your condo corporation when the documentation is available and to pick it up. Given the sheer amount of notices that go up in most condos, this may get lost in the shuffle so please do be aware of that condo owners are eligible for the HRTC on the condo corporation level as well. As always, please consult your accountant for specific accounting advice and questions.

For anyone who is interested in investing in real estate, one undoubtedly runs across individuals or groups who speak or write about cash flow positive joint ventures or some other variation of this phrase linking real estate, passive income and investment returns.

The pitches tend to have a familiar refrain: there a generalized notion of positive cash flow related to real estate. However, there are very rarely little specifics mentioned. Read positively, it follows standard sales and marketing tactics: sell benefits and not details. Read negatively, the generality of the pitch seems evasive and troublesome.

Several years ago, I briefly investigated the possibility of investing in real estate. For a wide variety of reasons, I took a pass. Nevertheless, it was interesting to discover just what some of these vehicles were.

The following is by no means an exhaustive over-view of the topic; some of these may not be favor anymore or tweaked to reflect the market. I readily admit this may not be current information and I am more than happy to be corrected for the education of all concerned. But, to dis-spell the mystery of cash flow positive vehicles,  here are some nuts and bolts of some private real estate investment vehicles being offered. I have avoided real estate related securities (other than the one exception below). I have added some quick and dirty pros and cons.

1. Investing in 2^nd (or 3^rd mortgages): Million Dollar Journey had a thorough post on investing in 2^nd mortgages. These types of deals are typically found through mortgage brokers or real estate lawyers. Pros: mortgage grants you security to your investment. Returns can be higher than stock returns (8%-12% for 2^nd mortgages 12% + for 3^rd mortgages). Steady cash flow. Can be invested through RRSP and income received on a tax deferred basis. Cons. 2nd mortgage is, practically speaking, not fully recoverable if the appraised value of the home drops or the borrower is not significantly paying down principal on mortgages (in other words, beware the interest only mortgages in an uncertain real estate market). RRSP administrators are known to be difficult.  High returns = higher risks. Some key factors to consider: Borrower’s financial standing and understanding of historical appreciation rates of real estate in that localized area.
2. Co-ownership with a “finder.” In a nutshell, finder has found an income producing property and has secured financing but requires some more money to meet the lenders financing conditions. Investor contributes the remaining down payment in return for a proportionate interest of title and cash flow after finder takes a property management fee.  Pros: Participate in both monthly cash flow and appreciation of real estate. If finder performs property management functions, income is as passive as one can get. Cons. As partial owner, if the roof needs replacing, you may need to make a capital contribution to the property. Cash flow return may be quite modest after expenses and property management fees are paid (mid to low single digits). There are a certain politics involved in determining the finder’s value. Some key factors to consider: Do you trust the finder to be reliable? Understanding the rental market in that localized area. What’s the exit strategy (needs to be formalized in a joint venture agreement).
3. Special purpose loan to a finder. This has multiple variations.  One variation is finder requires a loan for special purpose typically extra capital to acquire a property to flip or capital used to improve a home already acquired to rent out. Investor loans money which can be secured or unsecured depending on negotiations with a quick exit event (sale of home, refinancing once home is improved and can be reappraised etc). Sometimes there is a bonus payment to the investor on exit. Pros: Rate of return can be high given short use of funds. Cons: Is the actual exit event realistic or pie in the sky? Some key factors to consider. Due diligence on possibility of exit is key. For example, can the property actually be flipped for the appreciation claims? Can the units be rented out for what the finder says it can be?
4. Limited partnership units. A quasi real estate and securities investment. A general partner (GP) has identified a property which it will acquire and manage. Limited partners (LP) contribute money to make the down payment. In income producing properties, LP’s receive distributions proportionate to their interests. The GP assumes the liability of the project. The LP’s loss is limited to its investment. Pros. Ability to invest in more sophisticated projects. Losses are capped at money invested. Limited partner offerings can fall under securities law legislation meaning a relatively high level of financial disclosure. Projects tend to be larger scale (apartments, entire condos, commercial premises). If structured properly, can be quite tax efficient. Cons. Depending on jurisdiction, it is only offered to accredited investors (hence it is more popular in Western Canada where the threshold of an accredited investor is lower). Much larger cash contribution required. Cash calls can occur and, given the larger scale of the project, they can be quite substantial per unit. Less control given larger pool of LP holders and GP controls the entire project. Some key factors to consider. GP has the experience and knowledge to manage the project properly. Investor understands the financial statements provided in more sophisticated projects.

Four Pillars has a tangentially related post on purchasing foreclosed properties.

The level of due diligence has to work on at least two levels- on the individual the investor is partnering with (or the potential borrower) and with the property itself. One could argue that it is better invest in real estate with a Grade A partner and a Grade B property than the other way around.

At the end of the day, real estate investing is much like stock investing. One has to conduct its own due diligence thoroughly. Just because the investor can touch and see the investment does not mean there is less opportunity for abuse by the intermediary or it is a good investment. Good luck.

Multiple listing service (MLS) is short-hand for a system that co-ordinates the orderly buying and selling of real estate. One of the key components of the MLS system is a centralized database of listed homes for sale. Owned by real estate associations like The Canadian Real Estate Association (CREA), it can effectively shut out competition by setting their own rules on membership and deny the flow of information to non-members.

Battered by the internet’s race towards to the bottom and a DIY niche, MLS fought back and their tactics struck were seen by some as uncompetitive. As with all things having to do with consumer protection, Canada, better late than never, acted on the allegations of MLS’ uncompetitive conduct, with the Competition Bureau announcing it was challenging how MLS does business.

What exactly is the problem?

MLS is, in practice, a totality of real estate services. For the real estate agents, it is a way for listing agents to publish its compensation along with the property description. For the public, in order to list real estate on MLS, one typically has to buy the bundle of services which includes hiring a real estate agent, using the standardized agreement of purchase and sale forms, negotiating the deal, registering the sale etc.

There are two primary ways around this traditional model. Flat-fee MLS describes a real estate agent posting a property for sale on MLS for a customer with no other services provided; The compensation is paid immediately. Think of the investment advisor paid to render an opinion on your portfolio rather than to sell you the full gauntlet of products.

Others attempted to set up internet-based businesses outside of the MLS system. Typically, these allowed customers to search a separate database downloaded from MLS themselves rather than having a broker do it. For the time saved, brokers could, and often did, charge less commission. These types of sites are sometimes known as virtual office websites (VOW) because they operate without traditional bricks and mortar operations.

Various MLS’ prohibited flat fee MLS to prohibit real estate agents competing on price (according to the Canada Competition Bureau, CREA engages in this practice). In other cases, real estate brokers simply did not deal with brokers who set up VOWs or information from MLS was not provided in a timely manner to VOWs.

What has been the solution?

In 2008, the U.S. Department of Justice settled with the National Association of Realtors (the equivalent of CREA) after an investigation of its practices in connection with VOWs (here is the press release). As part of the settlement, VOWs will be treated no differently than the traditional broker. A real estate broker operating a VOWs must be accepted as a member of MLS regardless if she is operating a non-traditional business model. The VOWs shall be provided with timely information and MLS members who do not operate VOWs must treat VOW brokers the same as a non-VOW broker.

Two things strike out at me reading the settlement:

• First and foremost, the settlement really speaks to real estate association conduct against its broker members. In many respects, the Department of Justice is settling a civil war between agents who uphold the status quo vs. agents who want to provide different service offerings.
• The settlement protects the proprietary intellectual property of MLS. VOW must take precautions against any customer misappropriating MLS information. The settlement is not about smashing MLS; it is about defusing the information in a responsible way which acknowledges the capital costs of building and maintaining the MLS.

In many respects, the settlement acknowledges that real estate agents can chose to race to the bottom on fee or provide traditional services with traditional compensation. The question comes down to what the customer perceives as value.

What does this all mean to me?

MLS’ get big for a reason; they are smart and ruthless. What did some MLS’ do in the wake of the Department of Justice settlement? They set up their own VOW to compete with the existing VOWs. More service offerings to the consumer is not such a bad thing. After all, a MLS owned VOW can always up sell a customer to full brokerage services.

In Canada, the Canada Competition Bureau has most likely dissected the Department of Justice settlement in a thousand different manners. I would not be surprised if it took a similar approach and, in addition, force CREA to allow flat fee MLS. In many respects, the solution has already been presented to the bureau and, absent a made in Canada spin, it is hard to imagine the bureau taking a substantially different approach. Of course, this is speculation on my part.

The ultimate effect may be a choice between a quantity based model (low margins, high volume) of a VOW and flat-fee MLS and a quality based model (high margins, lower volume). This is not altogether bad for the consumer.

Canadian Capitalist has a post on the MLS’ alleged uncompetitive practices. I found some of the comments have a sky is flying tone to them and others believe this will alter the real estate industry for good. The result will be somewhere in the middle.

Real estate associations and MLS are analogous to the legal profession: an insular, self-governed body which guards its intellectual property like a jealous lover. In the 1980’s, Jane Harvey opened a pure retail law firm to the horror of the profession. All her offices were in malls and she advertised her prices; advertised was prohibited by the Rules of Professional Conduct. In 1987, the Law Society of Upper Canada allowed advertising due in part to Jane being a ground breaker.

Jane Harvey & Associates caused waves in the profession. But, contrary to many people’s beliefs, she did not destroy the legal profession. She merely recognized that there was a niche for cost-effective legal services for the retail market and filled it.  Jane also did nothing to stop fee creep in many lawyers. In other words, the sky has not fallen and Jane may have merely filtered out the weaker market players who could not provide value to their clients.

In some cases, vendors and purchasers will require a full set of real estate brokerage services just like some smaller clients may need a larger law firm to represent them (if your civil liberties are at stake, you really don’t want to hire the lawyer on a fixed price schedule). In other cases, a flat-fee MLS may do them just fine.

However, at the end of the day, you get what you pay for in life and, if given a range of choice, one picks a choice which costs them money because it is unsuitable for their individual context, they live with the consequences of that decision. You cannot deny the option of that person to make that choice  and that mistake and policy-making should not be around this concept.

It will be interesting to see when and how the Competition Bureau rules.

If you are a condo owner or a condo real estate investor investor, or are contemplating investing in a condo, there are a few key factors to consider in 2010.

Maintenance fee escalation on new units: In the last 5-7 years, there have been a staggering number of new condos built in many major urban areas. As recently as 2008, 100,000 condo units were being registered a year in Toronto. In the first few years, maintenance fees can be kept low but in year 2-4, they tend to escalate as reserve funds and repairs begin to occur; condos are like new cars. They run fine for the first few years then you have to start putting money into them.

How great is the maintenance fee increase? I pulled this historical data from my own condo (which is now more than 10 years old). Here are the year to year increases in condo maintenance fees for the first 5 years: 0%, 2%, 15%, 7%, 0%. The spike in year 2-4 (I did not live here then) is probably due to reserve fund contributions given there is no pool, golf simulator or other perks to maintain.

Maintenance fees are typically included as part of rent in our local condo rental market. Thus, in newer condo units, owners may find their cash flow decreasing as maintenance fees go up. It is difficult to make up these increases since: (i) it is a renters’ market in most places and tenants can vote with their feet; and (ii) in rent control jurisdictions, an owner’s ability to increase rent is limited (for example, rent caps in 2010 are 2.1% in Ontario and 3.2% in British Columbia).

HST: Related to the first issue, HST will affect both condo owners and condo investors. The Globe and Mail summarized the issue with HST and condos very well. If you have bought a new condo which has not been occupied (i.e. you bought on plans), it may be worthwhile to consult your lawyer about the “material adverse change” or “material change” clause referenced in the Globe article.

Vacancy rates. In the U.S., rental vacancy rates rose to 8% nationally in Q4 2009- the highest in 8 years.  In markets where the vacancy rate fell (New York City), the average rents also fell. In Canada, the national apartment (includes condo) rental vacancy rate according to CMHC was 2.8% in October 2009 but, in terms of local effects, there were large increases in Alberta (3% increase) and B.C. (1% increase).

In other words, it is a renters’ market on the whole but all real estate is local in nature so please do investigate  the local vacancy rates and average rent in your market (preferably without a real estate agent who has a bias in the outcome; CMHC stats is a good start).

The above does not mean that one should not become a condo investor. Instead, it should frame an expectation of return for 2010. The one issue which is constant in condo investing is that cost control is not completely your own. The condo board sets the annual maintenance fee.

Thus, as a few practical steps, one should consider the cost side of the condo investing equation carefully by: (i) being active on the condo board; (ii) looking at the cost of financing carefully (there may be a stronger argument for condo investors to lock in mortgage rates  to give certainty of expenses especially in a rent control environment); and (iii) budget maintenance fees 5%-10% higher than they are in running your cash flow analysis.

Good luck.

To paraphrase the words of the SteadyHand blog, is this a financial crisis well wasted? Last week, ING in Canada and the UK warned of the possibility of a real estate bubble in the residential and commercial real estate market spurred by the low interest rate environment. Beside the obvious bubble and double recession concern (a theory I subscribe to), the issue with rising real estate values is that it tends to act as a negative influence on a household’s ability to save more money.

The reasons are both obvious and not so obvious.  Household savings rates were quite robust (9.6% in the 1970’s) until our paper net worth began to multiple manifold in the 1990’s with the real estate and stock market boom. From the 1990’s onward, we ceased really to save and more often than not consumed instead.

However, studies show a negative correlation between the increase in our net worth and our savings rates. This effect is most pronounced for real estate than the stock market. A 2004 study found that for each $1 increase in real estate worth, we saved 8 cents less.  While for each $1 increase in our stock portfolio, we saved 2 cents less (the link to the paper is quite buggy so I did not link it but google “Real Estate Versus Financial Wealth in Consumption” by Benjamin, Chinloy and Jud to read at your own risk).

Some of the reasoning is obvious. Purchasing a home costs a lot of money and we tend to save less money since we have to make a down payment, pay for movers and new stuff for the house. The more subtle reason is that, for most middle class households, we are restricted in tapping our stock portfolio since the majority of assets are locked into non-accessible vehicles like pensions, RSP’s, 401(k). Finally, on a more marco level, it is easier to save more money when interest rates are higher (like the 1970’s) since there can be a healthy return investing in high interest savings accounts; conversely, low interest rate environments encourage leveraging and its associated effects of increased costs of borrowing on a household budget.

From a practical perspective, one tip to save more money would be to simply to turn a blind eye to the value of your home or, more accurately, remember its only paper wealth and not cash in the bank. If you live in a region with depressed real estate valuations, do not bother looking at the price of your home. Instead, enjoy it.

For those trying to be better savers and living in healthy real estate markets, ask yourself if you really need to buy a larger home rather than wanting a larger home. A lot of people I know are rushing to buy real estate because of favorable interest rates, an external stimulus justifying a want, not because they need a larger home, an internal condition necessitating the fulfilment of a need.

From a larger contextual perspective, if the stimulus has worked too well, and a spike in house hold savings rate is only temporary because the government says its time to consume again, then we truly have short memories and we have no one but ourselves to blame if we suffer another financial stress we cannot recover from. Money in the bank smoothes over a lot of personal finance mistakes.

Today is a continuation of yesterday’s post on what to do if you buy a home with a problem; a dialogue between myself and my regular columnist, Mom2KG. Today we talk about how real estate lawyers help (or don’t) and how to approach the vendor in solving problems in the house they are selling you.

My comments are in italics and Mom2KG in bold. Enjoy.

TMW: Yesterday we left off at how the real estate agent was helpful because she knew time was of the essence and got on top of the problem quickly. How about the lawyers?

Mom2KG: The lawyers, on the other hand, were a mixed bag at best. We ended up having four different lawyers, plus ourselves. The lawyer we retained to close the purchase does a very narrow type of work. He closes sales all day, and never deals with problem properties. This was way beyond his retainer. As lawyers, we understood his position.

TMW: Moral of the story is the business model of real estate lawyers is quantity, quantity, quantity with prices to match. Most retail real estate lawyers are ill equipped to deal with problem closings or closings which are out of the norm (shared drive-ways, properties with water frontage, very old homes etc). In this case, you need to pay a few extra dollars for a specialized real estate lawyer or you need to get a second opinion. So what did you do?

Mom2KG: We decided we had to retain a lawyer specializing in environmental law. The first guy we found was very good, again holding our hands and giving us options. He had to educate the vendor’s lawyer on their obligations (with us footing the bill on that call) and again made our position clear.

Unfortunately, he had to pass us off to someone else at his firm, and that lawyer was a complete train wreck. He was incapable of assessing risk, and refused to provide any advice on the real estate side of things. For example, he would not discuss anticipatory breach, claiming that was a real estate issue, and he did not do real estate. So, we had to retain a real estate specialist to help us assess the legalities of backing out or staying in the deal. It was really, really trying.

TMW: That sounds horrible. How could that lawyer have handled things differently? Why do you think the lawyers were less helpful than the agent?

Mom2KG: That second environmental lawyer provided almost no value. No context, no “real world” examples of what our real risk was. We got tons of education on the requirements of the environmental legislation, right down to the maximum parts per million of petroleum allowed in soil and water samples. Who cares? I wanted to know what the risks were in buying a property that was probably clean (after the sellers removed the tank and got in an expert to test the soil). But he simply would not help us with that.

That lawyer was clearly concerned with the extent of his own liability. He kept saying “I’m an environmental lawyer. I don’t do real estate.” Or, “I can’t tell you what to do. I can only tell you the law.” To some extent, that’s true, but lawyers are also supposed to be trusted advisors who can help with decision-making. Our agent, on the other hand, was more interested in helping us than in potentially getting sued. She actually endeared herself to us by freely admitting she had “missed” the oil tank when we first looked at the house. The lawyer, on the other hand, was primarily concerned with his own responsibility in the matter and was unwilling to take any risk himself.

TMW: With your lawyer’s hat on, what role did tackling the problem early help in dealing the vendor?

Mom2KG: We knew there was no time to lose when we first found the problem. We know getting environmental reports can take weeks, and we didn’t have that time. We had to give the sellers time to remedy the problem and satisfy us. You can’t wait to present a huge problem until the day of closing. We were also able to educate ourselves on our possibilities and choices. Finally, it meant we were able to send a consistent message for the weeks this took: we wanted the house, but without the tank or environmental damage.

TMW: What steps did you finally take to provide some satisfactory conclusion that you would be buying the house of your dreams?

Mom2KG: We advised the sellers, through their lawyers and agent, what we needed: the tank removed, and proof we could rely on that it was a clean property, free from oil contamination. We managed to get the purchase and sale agreement amended to say the sellers would do that, so we had some contractual strength. Then, we kept a close eye on what was happening. At every step, we consulted with our lawyers to assess how things seemed to be going. We used our second visit to the house to bring in our own environmental consultant to determine the progress. We continued to advise the sellers of what we needed and expected. We also ensured that the report provided by the seller’s consultant was addressed to us, so we could rely on it if ever there was another problem.

TMW:  What would you have done differently?

Mom2KG: I would have asked for an all-party meeting or mediation early on. It was very frustrating communicating through agents and lawyers. We all should have sat down together so we could present the facts, issues and needs with a more human face. We kept wondering if in fact the vendors were getting all the info we were lobbing over, and I don’t think they did. I think an early meeting would have helped thing along immensely. I would have kept it very low-key and agreed to have it as “no prejudice” – not admissible as evidence in court.

TMW: Let’s recall lessons learned then if you run into an issue purchasing or selling a home.

1. Know what you want
2. Time is of an essence
3. Be specific as to remedy
4. Don’t assume the other side will do your work for you. Be proactive in the solution.
5. Use your professionals but always refer to #1.

Is that about it?

Mom2KG:  Yes, I think that’s it. You also have to have good communications with your partner, and you have to resist the temptation to lay blame. There a solution does not lie.

TMW:  Wow, you dropped some Yoda-sim on us. Thanks for sharing. It is a great home in a beautiful neighborhood. If you ever build a spare room over the garage, I will gladly play the Arthur Fonzarelli role and move in.

Decide to buy a home. Hire a real estate agent. Look for houses. Look again. Make an offer on a home. Make another offer. Enter into an agreement of purchase and sale…. and, now, there is a problem before closing. What do you do? Can your real estate agent help you? Your real estate lawyer? Fight or flight?

Today’s post is a 2 parter between myself and my regular columnist, Mom2KG. We re-live a real life issues arising from  purchasing real estate with some problems and share lessons learned. As always, in these types of situations, it is important to obtain advice. My comments are in italics. Mom2KG’s in bold. Enjoy.

TMW: Mom2KG, I believe it was a Wednesday morning when I got an email from you indicating that there was a problem with buying your home followed by a bunch of four letter words. What exactly was the problem?

Mom2kG: Yup, and now that the problem has been solved, we continue to tell the story using lots of 4-letter words. It was an extremely stressful situation.

We had agreed with the seller that we could visit the home twice before closing. Typically, this is so you can measure for curtains or think about paint colours, or just gaze lovingly at your new ensuite bathroom. On our first visit, my husband realized there was an oil tank buried in the back yard. This was bad – an untold environmental liability. We had purchased the home with no conditions – so no home inspection – so we had no idea if we could get out of this or what our options were.

TMW:  Just so that the readers don’t think you are not a smart consumer, buying a house without conditions occurs in Toronto quite often, in order to head off bidding wars. So what you did was not out of the ordinary course.

By way of background to the readers, in Ontario, under the environmental legislative regime, oil tanks buried in grounds were required to have been removed. In other words, having a buried oil tank is now illegal in Ontario. At this point, you really have two obvious options: buy or don’t buy. What did you end up doing?

Mom2KG: We ended up buying. As readers may know, we’re both lawyers. So we called some contacts, and if things weren’t already off the rails, this compounded matters. Astoundingly, each lawyer gave us a different answer, ranging from “GET OUT NOW” to a more reasoned approach. It was really scary in the first few days. And confusing. Besides the illegality issues, we didn’t know if the tank had leaked and caused contamination under the house or even offsite.

However, there were very good reasons to pursue a remedy instead of running. First, we wanted the house – it was great. Location was great. Nothing else had come on the market in weeks. We had already sold our own home. As well, we knew, as lawyers, we had to give the sellers a chance to step up. You have to give them a chance to be reasonable. Finally, we had a leg to stand on – the oil tank existed illegally and no court (if it got to that) would force us to accept a property  not complying with law. But court was also the last place we wanted to end up.

TMW: What is important to note in your response is that as badly as you may have wanted out, I am assuming here, the lawyer in you probably said “have to play this out and put ourselves in a position where a reasonable person would say you did everything you could” before you backed out. Process is key. In most cases, you can’t pull the plug without going through the process.

Mom2KG: Yes, that was a major driver in the decision. You can’t just back of a contract and not incur some wrath, which can lead to serious fights and even litigation. We mapped out a lot of “what-ifs” and one was that if we ever got to court, we needed to be able to say we acted reasonably, even if it was the sellers who were ultimately in the wrong by not removing the oil tank years ago and then by not informing us of its existence.

TMW:  There’s a couple of educational items for readers to note. As you imply, that you cannot contract for an illegal act and, even if you breached the contract, you breached it for an illegality, which makes your argument substantively stronger.

But most home purchasers do not buy homes with illegalities in them. In most cases, problem closings come down to less dramatic issues like the purchaser bought without conditions or the conditions are waived and the purchaser gets laid off and cannot obtain a mortgage and closing.

In these instances, there is a doctrine known as “anticipatory breach.” In plain English, this means a promising party knows that they can’t fulfill their part of the bargain before the time promised and tells the other side before the closing dead/date the bargain is closed.

It may be strange to a non-lawyer that one would tell the other side you are in breach but the reason why you do this is because the other side has a duty to mitigate damages. In the real estate context, this means the vendor has to resell the house. If the house is resold for more than the purchaser bought it for and their other costs are covered (legal fees), the purchaser is basically off the hook for damages. If the house is sold for less than what the purchaser agreed to, the purchaser’s damages is the sum between (purchasers offering price + costs) – (new purchaser price). What the vendor cannot do is nothing and push the entire burden of damages onto the purchaser.

Mom2KG: These are all good points for your readers to know, and we actually discussed playing the anticipatory breach card as a way out of the deal. But, in our situation, there were other pressure points on how it all played out. We certainly tried to figure out who was in the wrong and why, and that included whether either agent had been negligent. As I’ll discuss in more detail later, though, we never played those cards and got what we wanted mostly through negotiation.

TMW: How helpful was the real estate agent in the beginning of this process?

Mom2KG: Our agent alerted the vendor’s agent to the tank. They realized right away, thankfully, that it was their responsibility. They knew they had to take it out for us, and could not hide it from the next potential purchaser if we backed out. (At that point, it’s what’s called a patent defect – an obvious, known problem with the property. When they sold it to us, however, the vendors, we believe, did not know about it, and that’s called a latent defect.).  Our agent was great – she did online research, talked us off the emotional ledge we were on, and made the hard call to the other agent. She knew it was important to communicate that while we really wanted the property, we weren’t taking it without the tank removed and proof of a clean property. I have to say, she leapt into action on our behalf and tried to find solutions.

TMW:  Timing was very important. Your agent got to their agent very quickly, identified the issue specifically rather than a blanket statement like “my client hates the home” and gave the vendor a reasonable amount of time to fix the issue. In other words, you gave a road map to a solution. Too often, real estate problems are ignored or raised at the last minute which allows the other side to raise the argument you were unreasonable or the issue is raised without a proposed solution being given; this comes off very badly as a negotiation tool. All you are saying is “here, do all my work for me” which provokes a really bad reaction. Be reasonable no matter what since you are framing your problem solving exercise in the context of either litigation or a title insurance claim.

to be continued…

If you are a regular reader of the money gardener, you will notice that his monthly net worth updates include the ratio of house value/total assets. In essence, he is attempting to assess whether he’s overly exposed to real estate. After all, one of the lessons from the credit crisis is that too many people relied upon the paper gains of an appreciating real estate market  and got over-confident. But the question is, if you don’t want to make the same mistake twice, do you own too much house?

First, let’s deal with valuation. I asked money gardener how he valued his home and he indicated he made a “conservative” valuation based on comparative sale prices of his neighbors’ homes. I understand that he lives in a neighborhood that is relatively homogeneous in terms of size of lot, square footage etc. with sales in regular intervals. Thus, he was more or less conducting an apples to apples comparison with current data.

The issue always is what happens if you live in a unique (not in your own mind but to the buyer’s) house/property or the comparable data is quite dated (i.e. more than 12 months ago). At that point, you have a couple of possible options: (i) find the last comparable sale price and add in appreciation based only on the rate of inflation (unless your area got wiped out when the housing bubble burst); or (ii) find a comparable as close as possible and use that valuation. The point is never to “add” anything to what the market shows you and to aim low rather than high if in doubt. For example, in the event you have an upside down mortgage, I would, sadly, use that appraised rather than acquisition price.

Assuming your valuation skills are a little bit better than how rating agencies rated corporate debt circa 2005-2007, what is an ideal ratio of house value/total assets? In the abstract, both money gardener and I agree that anything in the 75%-80% range and above would be over-weight in real estate and is simply too many eggs in one basket.

I would add two wrinkles though. If you are a first time home buyer or have bought your house less than 2-3 years ago, a high house value/total asset ratio is simply a reflection of your reality that you used a lot of your assets to purchase your home. The key in this situation is to make sure the ratio is not extremely high (90% plus), you didn’t buy the best house in the worst neighborhood and, post purchase, to ensure that your house value/total asset ratio continues to decline steadily year over year.

Typically, this would mean adding assets which generally move opposite to housing values. Since housing is considered by some as a consumer discretionary purchase, one would try to balance it out with consumer staples, assets that don’t decline as much in a downturn (gold may be a possibility but its value as an investment is up for debate), plain old cash (since house valuations are paper gains), dividend yield stocks not in real estate (again, dividends are cash in the bank).

The second wrinkle is to add REITs and real estate stocks as part of your house value since, to state the obvious, REITs and real estate stocks tend to mirror the real estate market as a whole (even though the commercial REIT market tends to react about 12-18 months after the residential housing market as seen by rising commercial vacancy rates in North America).

The notable exception to a high house value/total assets ratio is if you hold many real estate investment properties. In this situation, a higher ratio may be warranted (emphasis on “may”) assuming the properties are in the aggregate cash flow positive, the local vacancy rate for the type of investment property is relatively low and there is a sufficient cash reserve built up to weather against vacancies. In this case, one would assume that the real estate investor is quite competent; expertise and positive cash flow management would mitigate against a diversification strategy.

Special thanks to money gardener for contributing to this post.

Our regular columnist is back to complete her series on buying and selling her home.

In my last post, I spoke about tips to sell your home. This follow-up will give you some tips on buying a house.

1. Pick a Neighbourhood and Pick your Neighbours. Take your time and do your research about where you want to go. Do you need schools, transportation, proximity to airports and highways (yes, this is pretty obvious stuff)? Once you’ve narrowed down your search, spend some time actually driving and walking around. Are there lots of kids/too many kids? Is there somewhere within walking distance to grab a coffee? Are the neighbours in bed at 9 p.m. or blaring with a garage band at 11 p.m? Ask yourself if you can really live there happily for at least a few years.
2. Do your financial homework. How much house can you really afford? Interestingly, I got a lot of advice to “stretch myself” and buy a house that seemed slightly out of reach. Go back and forth between lenders, playing their latest offers off each other. Figure out how much renovating you’ll want to do, and whether you should finance that yourself, or ask for home improvement loans. Spend lots of time on this, and make sure you know all the ins and outs of your mortgage. For example, how much can you increase the payments every year, and when?
3. Don’t get into a bidding war. Sometimes this is inevitable, especially in high-stakes areas in Vancouver and Toronto. Be comfortable with the maximum amount you’re willing to spend. If it looks like there’ll be multiple offers, I suggest going in at your best offer right away (but listen to what your real estate agent tells you). If you’re the only one at the table, don’t panic and bid against yourself (i.e. talking yourself up to a higher price to make sure you get the house).
4. Get a home inspection. Just trust me on this. It’s worth the few hundred dollars you’ll spend. Good inspectors have no interest on what you’re paying for the house. They should just want to tell you whether or not the place is sturdy or about to fall down from termite damage on the next windy day. It’s sometimes difficult to get a home inspection clause into an offer, but it’s a cheap insurance policy.
5. See the house at least twice. The open house will fool you into thinking that there’s more interest than there is. All those people checking the place out – they’re nosy neighbours. An open house will invariably show pretty well, with fresh flowers, room spray and recent vacuuming. Try to go another time when no one else will be there and the house is more lived-in. Take your time and really “see” the rooms, warts and all.

Over the last year, many commentators have noted that one may have been better off investing in something other than stock market given the 10 year return of a board based U.S. equities index would have returned you approximately nil. But the question arises, if not the stock market then what do you invest your money in?

For some, the question has been turned into an either or answer. Either you invest in the stock market or you invest into some other investment class altogether, ignoring that a healthy balance would serve one well. For most employed people, this other investment class would be real estate (for the entrepreneur, the answer has been, regardless of circumstance, the business; she of the constant need for cash). The either or analysis shows a certain simple-mindedness in thinking since real estate investing can include both investing physically in a real property or a REIT, which is a security.

But, the larger point remains, would an average investor done better investing in real estate or stock?

As stock market investors, we are a pretty poor lot. Using a 20 year period of study, which removes the selection bias of picking a 10 year window with the end date being market bottom,  DALBAR’s analysis estimates that an average investor earned a paltry 1.87% a per annum. The poor results have been attributed to investors investing emotionally and buyin high and selling low.

As real estate investors, we may not be performing that much better. The U.S. Census Bureau took a comprehensive survey of property owners and managers as part of its Property Owners & Managers Survey (POMS) in 1995. The date itself is pretty important since the survey was taken during “normal” market conditions. The source is also important since the Census Bureau has no particular pro or con bias.

Of those surveyed, and regardless of the type of property unit, only 41.4% of all property owners reported a profit. 16.2% of those surveyed answered that they broke even; 26.7% reported a loss and 15.7% did not know whether they made money, broke even or lost money. In other words, the majority of real estate owners lost money. The only downside of POMS is that it does not break down rate of return on real estate investments (I suspect this would be much too difficult to conduct given types of units, geographic differences etc.)

The statistics get a bit grimmer if we begin to drill down on the data.  More people surveyed reported they lost money investing in single-unit condominium units than made money (196,787 lost vs. 192,976 made): a troubling statistic since many real estate investors in large urban regions can only afford to purchase a condo. Only 45% of those people surveyed who owned or managed over 50 units reported a profit; this is surprising since one assumes that a property owner in this scale could make money by sheer volume alone.

As an investment class, some tend to gravitate towards real estate over stock investing because of the tangibleness of the asset. You can touch it, feel it and taste it (if you have a taste for dirt and brick). One also understands the appreciation factor in real estate in normal times but can the same argument not be made for many stocks (especially dividend paying stocks) and what good is appreciation if you are cash flow negative every month on your real estate investment?

A tentative observation can be drawn that, reading DALBAR and POMS together, stock market investing and real estate investing are neither, in and of themselves, good or bad things. Neither asset class has a meaning. Instead, the moral of the story seems to be its not what you invest in but how you invest in it. Most would find it shocking that nearly 16% of those surveyed did not even know where they stood with their real estate investments.  It appears that, regardless of asset class, the average investor has a lot of work to do to become competent managers of their own money.