Tuesday, July 20, 2010

The Zen of Real Estate

Some of the most hard working and well-paid realtors in Canada sincerely believe that real estate prices can only go up over the years. It’s the safest investment in Canada. Until only a few years ago, American realtors felt the same. They talk about bricks and mortar and say it’s “real.” They’ll say things like: “Land – they’re not making any more of it!” The inference is that land, bricks, and mortar are somehow “real” and stock market investments are not.

In the 1970s I was a real estate appraiser. Since I became a stock broker, I have met many real estate agents who smugly compared real estate investing to stock market investing. They always conclude that real estate is safer and more profitable. The vagaries of market psychology and economic turmoil can move stock prices up and down wildly. Canada’s biggest bluest chip company, The Royal Bank, for example, went from $60 a share in 2007 to $26 in 2009 and back over $62 in 2010. They claim that real estate is much more stable: you can bank on your real estate investment being there when you retire – whereas you don’t know what to expect from your stock market investments. And that’s because real estate is real and the stock market is not so real.

Half of that statement is true: “the stock market is not so real.” The only part of the stock market that’s real is your month-end statement of your portfolio’s value; that’s what you could have sold your portfolio for on that date. And if they printed another statement the next day, the value would be different. That’s the real part. All that opinion about what the market will do in the future, all that analysis, all that economic information – that’s just bull. That’s the part that’s not so real.

In my book, Beyond the Bull, I explain how investors should behave in the “not so real” world of the stock market. We can succeed in stock market investing because we understand it’s not real. We know it changes every day. We know about unforeseen events and we understand risk. That’s what stock market investing is all about. And that’s the Canadian realtors’ blind spot.

Japanese realtors can see what North American realtors cannot. In Japan they understand the concepts of Ken and Zen. In Japanese culture, Ken is the concrete world of atoms and molecules, logic, science, cause and effect. In real estate, the world of Ken refers to the bricks and mortar, lot size, location, the physical attributes of a property. Then there’s the world of Zen, the mysteries of your mind. The Zen of Real Estate refers to the trendy-ness of a neighbourhood; the kind of people who are moving in; the best way to generate a bidding war; the credit-worthiness of the buyers; the willingness of banks to mortgage a property; all those mysterious human forces that blend together to create the value of a home. In Canada, we understand The Ken of Real Estate; but we are babes in the woods in the world of Zen. The only Real Estate Zen Canadians ever think of is how much money we’re going to make and how high mortgage rates could go.

Our American cousins are much more sophisticated about the nebulous nature of Zen Real Estate. Their home prices have fallen in a steaming heap of sub prime mortgages and unconscious credit underwriting. They’ve seen home-owners dropping off the keys to their houses at the mortgage company and driving off. They’ve seen the dark side of Real Estate Zen.

The interesting part of the Zen-Ken Japanese approach to real estate is how they turn Zen into Ken.

Imagine that you bought a house for $250,000 in the year 2000. You put $100,000 down and took a mortgage of $150,000. And now someone tells you your house worth $350,000. The Ken of Real Estate is the actual house and land you bought. In addition, it’s the new roof you installed, the shrubs you planted and the new sink in the bathroom. It’s the real part of real estate. The Zen of your Real Estate is the $350,000 someone told you your house was worth. It’s the floating rate mortgage you put on it when you bought it and the secured line of credit you picked up 5 years ago. It’s the re-zoning application for those vacant lots on the next block. Our question is: “How can we turn mysterious imaginary Real Estate Zen into concrete Real Estate Ken?” Here’s one way: sell your house for $350,000 and redeploy your equity by buying two “fixer-upper” houses for $300,000 each, with $100,000 down and a $200,000 mortgage on each. Now you have two houses, one for your family and one for rent: Ken Real Estate. The real part of real estate.

But the part that most Canadian real estate fans do not really understand is: when you change the Ken of Real Estate, you change the Zen too. The Zen of Real Estate is inseparable from the Ken.

Imagine that you were able to do it again: you sold your two houses and reinvested and re-mortgaged again. Now you would have four properties in the concrete world of Ken Real Estate. And, of course, you have the accompanying Zen Real Estate risks – more mortgage debt and more rental vacancy risk. Let’s let our imaginations continue until your inevitable death. Now your heirs own those properties. You have physically left the Ken part of your world. You are 100% Zen now. But your Ken Real Estate still exists. AND the Zen of those houses still exists too: the mortgage risk, the trendy-ness of the neighbourhood, the willingness or ability of the banks to mortgage it. The Ken and the Zen of those houses still exits, even though you have personally moved into the world of Zen. (That’s the estate part of real estate.)

Because of Zen, real estate has more in common with the stock market than Canadian realtors would like to admit. Because of Zen, house prices don’t always go up. Because of Zen, real estate investors have to manage risk too.

To order your copy of Beyond the Bull and the Five Levels of Investor Consciousness CD, or to sign up for Ken’s free monthly webinar, visit www.gobeyondthebull.com (Bullmanship Code = SS32).

Contact Ken directly at ken@castlemoore.com.

1 comment:

DGMunro said...

I expect this insightful comment will lead to a new pen name: Zen Norquay.
The last 17 years in Asia have slightly eroded my memory of the 1992/93 Toronto real estate market, but I recall one neighbour in Lawrence Park who had a large mortgage and soon learned the Zen of bankruptcy as prices fell anywhere from 30 to 60%. House prices, like any market price, are a function of supply and demand.
The old argument that "they don't make anymore land" was always an easy pro-housing debate tactic, but now we have to contend with the fact that they don't make any more baby boomers.
At 50 years of age, with kids in University or working, many empty-nest parents opt for smaller homes. Japan's baby boom peak in 1948 led to a housing collapse in the 1990's. The US & Canadian baby boom peak of 1958 led to a housing collapse in 2008 in the US, but not in Canada. I don't believe Canadians have permanently avoided lower housing prices. The inevitable (baring demographic sleight-of-hand or hyper-immigration) has just been delayed.
Thanks for a thought-provoking blog Zen.