“Borrowing money won’t take you where you want to go”
07 Feb, 2021
The title for this weeks blog post comes from The Dave Ramsey Show on 31 Dec 2020. More on that later in the post.
Here goes.
Without a doubt my least favorite thing to talk about is real estate investment because it’s always such a fraught topic and one that is constantly being hyped up alluded to in the media. Rental real estate investment brings out some pretty passionate opinions and although I always enjoy a conversation, I don’t like arguing, therefore I rarely write about property. That and the fact it just does not interest me as a way to grow wealth.
So, if you thought I would write about GameStop, the price of silver and day trading today, you were wrong I’m afraid. I found all of that quite interesting, but it’s really just a distraction and I just continue to invest as normal into two index funds. Boring yet effective!
If you have subscribed to my blog for a while now you will be pretty well aware that Jonny and I do own real estate in the form of our own home. We bought our first house about 19 years ago, paid it off and then after the Christchurch earthquakes we had our land acquired by the government and we were paid out by our insurer for the house. We are now in our second home down in Central Otago and we still don’t have a mortgage. Some say I’m crazy ‘wasting’ all that equity when we could leverage it and buy more property but for Jonny, myself and our daughter (who started at high school for the first time this week by the way!) that’s just not our bag, we are not interested in becoming landlords, not interested in ‘cheap debt’ and owing money and mostly we are not interested in complicating our lives or giving up the financial peace and income we have created for ourselves. All of which gives us a huge amount of freedom.
I feel stressed talking about rental property
So why today, why bring the subject of rental property up when even just writing about it makes me feel stressed as I think about the comments I might receive?!
I regularly speak with such a wide range of people about money and I’m lucky that I get to see the allure or otherwise of property from many different angles and I conclude from talking to a lot of people who are ‘real estate investors’ that most of them appear not to be making any money. They argue otherwise, yet with no factual basis, happy in the fact that the ‘tenants pay the bills’, claiming that the value will always go up so all the myriad of costs they incur while they do are ‘meh’; irrelevant. Which I find surprising given that you often hear the phrase “don’t put in money that you are not prepared to lose” in relation to share investment when I think it’s actually more appropriate to many in the rental property market. I just can’t understand why, with high debt levels these days, people keep tending to the bank's assets when it costs them so much money to do so? Clearly, they are quite happy to invest money (both theirs and the tenants) that they are prepared to lose.
How on earth is rental property a great investment?
I come away from a conversation with someone who has recently bought one or two additional properties wondering how on earth they are a great investment when:
House prices are sky high
They put their own home up as collateral thereby adding an element of risk to their family
They buy a property with a minimum deposit using all of their savings and equity, leaving no backup cash in case of emergency. The only option here is to borrow more money
They borrow the majority of the sale price off the bank and sometimes even off family to get the deposit together
They may even gamble on an interest-only mortgage and then set to praying that house prices continue upwards
They have ongoing repairs and maintenance costs from the day they take ownership
When the tenants pay rent they send the biggest portion onto the bank
With the remaining portion, they pay rates, insurance, upkeep, property manager, accountant and more
They may even have to top up the mortgage payment from their own income meaning they might have to work even harder at their own day job
If they are lucky they might get a 2-3% return after expenses
And then eventually, 20 - 30 years later they might finally own it and finally, FINALLY get to keep the rent (after all of the expenses have been deducted)...
Or they sell it, take the capital gain and then try to work out where to put that money which is hard as they have never invested outside of property.
After 20-30 years, the property has indeed gone up in value but is that capital gain all profit, given the costs that it has hemorrhaged over the previous 30 years? Not to mention that now the house is old and probably in need of even more repair. Not to mention that sooner rather than later a government will devise a capital gains tax on the profit.
And the bit I really don’t get is that in today's market even if you have an asset worth hundreds of thousands of dollars, and more often than not for you Aucklanders, over a million dollars it’s returning you somewhere between $400 - $900 a week. How is that good math, such a huge amount of money with such a low return - out of which you still have all of those expenses to pay?
Why is property still so popular?
I think there is a massive amount of FOMO going on in the property market with investors absolutely convinced that values will increase over time, just like they have been, and that is why you own an investment property. The point that it does not cash flow for year after year seems lost on many. And when I speak with people who own rental property, the tenant rarely gets a mention, if ever. I also hear from a lot of people who have a rental property but really don’t enjoy it, but what else are they supposed to do they ask? A huge lack of financial education about other ways to grow wealth, yeah you know I’m going to say it…by using index funds for example… is apparent. So there are a lot of landlords out there who actually hate what they do but stick with it because what else can they do with their money. That is crazy.
Conversely, I know of many people who have chosen to invest in property and have gone into it with a sound and robust strategy where just like when you operate a business, every action has a reaction and they are actively forecasting ahead for both seen and unforeseen circumstances. They have created both a wonderful home for someone and income for themselves. But sadly I know more who don’t, they ‘get into’ property because everyone else is, they barely own the front room of their investment property, yet they think they are winning. I think if these people did some math they would realise that they are actually not.
Who makes money out of rental properties?
The only people I know who make money out of rental property actually own it outright or are on a firm path to doing so. They get to keep the rent (after tax, accountant fees, maintenance, insurance, property management fees, rates etc). Yet, the people I know who have really gained wealth from property are actually the ones who have then sold all of their paid for properties which they have studiously paid off, maybe retaining just one fully paid for property for diversification and enjoyment, and invested that money in the share market instead using a diversified portfolio, because it actually returns them a decent annual income, with low costs and zero hassle. Those that appear to be really financially secure have created a level of diversification that spreads their wealth around, creating multiple and stable income streams. The important part is that they now live a balanced life and that to me is the sign of a wealthy person, they have work/life balance and financial diversification. And no debt.
This should make you think...
Crikey I take a while to wind up to what I actually wanted to share with you today!
All that to say, today I wanted to show an excerpt from The Dave Ramsey Show podcast where he so succinctly summed up for this caller why his rental property is more of a liability than an asset and I thought it might strike a chord with those Kiwis reading this who are about to buy a rental or have been owning what might just be a poorly performing investment property. Dave uses less words than me and gets his point across far better. This excerpt should make you think.
Excerpt from The Dave Ramsey Show podcast: Borrowing money won't take you where you want to go - 31 Dec 2020
Hosts: Dave Ramsey and Ken Coleman
Caller: Adrian
Minute: 30.34 - 34.40
Adrian - Three years ago I decided to buy a townhouse as an investment strategy and you know, now after listening to you, I just dont think it was a very wise decision. So, right now I am $400,000 in debt and so I’m renting out this property but after paying the mortgage, the home owners association and taxes I end up paying $350 a month out of my pocket. Something that is coming up is that I’m getting engaged soon and I would like to buy a home with my future wife and that is something that we talk about. So my question is, how should I handle this? Should I just go very intense in paying the mortgage or should I just save for the home on the side?
Dave - How about selling it?
Adrian - Well I don’t kinda want to sell it. I just kinda want to keep it.
Dave - You should!
Adrian - I should sell it or keep it?
Dave - You should sell it. It loses money.
Adrian - It loses money. OK.
Dave - You are writing a cheque to own it. Most investments that I have pay ME. That is what they are supposed to do!
Adrian - Yes
Dave - Will it sell for enough to pay off the mortgage and put some money in your pocket to help you start your life with this new lady?
Adrian - It should.
Dave - Good. This is baggage you don’t need. I don’t think you are going to do it. You are a new listener, I appreciate it, it might take you a little time to think about it. But, I love real estate. I can’t stand real estate that doesn’t cash flow.
Ken - What’s the psychology going on here, because he is not the only person in a situation like this. He is a new listener, but when you said ‘sell it’ you could hear it, it was just like, ‘huh’? He didn’t know that was coming at him, I knew you were going to say it, but what is the human condition there where they go “woah, selling it Dave, why in the world would I sell it”? Why is it such an unnatural conclusion for him and others like him?
Dave - Well, because he is deeply invested in the idea. Emotionally invested in the idea of owning this rental property.
Ken - And that eventually it is going to be a great investment?
Dave - Right. Some day he is going to look back because “all real estate turns out”. Well all real estate doesn’t turn out. Real estate that doesn’t cash flow doesn’t turn out. What it does is puts a pinch on you rather than be a blessing to you. So, when you got no equity, and he has virtually no equity in this property, he’s got a little bit so he will get out of it whole but you know he doesn’t have a 50% equity position, so it’s not going to cash flow. So it doesn't make sense. But what he was taught and what a whole bunch of people believe (the same crap I was taught in the real estate business) is that if you buy this, the renters are going to pay it off over 30 years. Well the renters are not paying it off. You're paying it. You are paying $350. And if they don’t pay it, you're paying a bunch more. If something breaks, you are paying a bunch more. This thing is a drain on you for 30 YEARS before it becomes a blessing. This is not a good investment. It's not a quality investment. It's a liability more than it is an asset and so that's what we get into when we buy rental properties with almost nothing down because they always pinch you but people have this mindset of... it's all going to work out... it's all going to work out… it’s all going to work out. And I’m just saying, dude, if you were marrying my daughter I would say sell it. If you were my son getting ready to get married I would say sell it. And I own a whole bunch of real estate and I want you to own a whole bunch of real estate someday, but this real estate owns YOU.
The caller, Adrian, was considering doing what most Kiwi’s are already doing. He had debt on one property, but his life had changed and he was about to get married, so he was about to buy a second property, also with debt. The title of the podcast was “borrowing money won’t take you where you want to go” and where he was trying to go was to start out a new life with his partner. Therefore, piling himself/themselves up with debt sounds like a terrible way to start a life together.
So many Kiwis do it...
Yet, that’s what so many of us do here in New Zealand. With a small deposit we buy our first property (either when single or when in a relationship), which is generally our home. That’s great in my view. After a couple of years of paying the mortgage, having spent a small fortune on DIY, we have built up some equity (whilst paying no heed to what we actually spent on all that DIY) so the bank willingly lends us more money. We then move onto our second property but keep the first. Why? Because our living needs have changed (kids come along perhaps), making the first “a rental” by default. Two mortgages now and neither of these ‘investments’ puts any money into our back pockets. Instead, it’s off to work for you and your spouse to earn an income to pay the mortgage on the home you are in and more often than not in this current market, top up the mortgage of the rental property. Then, life happens! Kids arrive, one of you wants to stay at home with them but you can’t afford to so they reluctantly go to work and the kids go into care. Houses need repairs, cars need replaced, holidays need to be taken, your partner wants a divorce, a global pandemic shows up, there is a job loss. You get the picture. Your resilience to cope with all of these things is severely compromised because of your investment properties often being more of a liability than an asset.
Think deeply about your ‘why’ first
What I’m trying to say is, don’t just follow the crowd into buying additional property to your home without doing some SERIOUS freaking analysis of your exact incomings and outgoings and think deeply about your ‘why’ first. Look around at your friends of all ages and observe what life events have happened to them as they age and acknowledge that some of that will be coming your way too, at some point. Because failing to do so will just have you trapped into a cycle of debt repayment for decades to come, with a life out of balance in my opinion. Investment property owners are always looking to the future ‘when’ their property cash flows, ‘when’ the value goes up so they can peel off some equity and do it again, When when when. What about now? The rhythm of life will not stop just because you have chosen to take on hundreds of thousands, if not millions in debt.
Fear Of Missing Out
The FOMO comes from news outlets running headlines crowing about the rise in property prices and then they think better of it and run a headline about some wannabe first home buyers left on the sidelines at auction after auction after the property is snapped up by someone buying their second or third property because they have heard that this is how you grow wealth.
How about they instead run headlines of:
Mathematician predicts the majority of Kiwis are in over their head with their investment property!
Poor math and FOMO drives the housing market!
If you want to win with property, buy a bank!
The elephant in the room
So, in regards to our property market, what about confronting the elephant in the room? In my opinion, the outright greed of individuals in New Zealand, who are your Mum and Dad, your siblings and your colleagues and perhaps even yourself are all trying to profit off of their peers in the only way they know how, by buying property to create an income, despite their inability to do math. And regardless of the social impact on our country.
I spoke with someone last week and we talked about housing, with my view being that I wished the property market would drop to enable everyone to take a breath and create a more even playing field and move a house from being a cash cow to a home. He wanted it to roar on for at least another year. Why? Because as it turns out he was working on a real estate deal of his own and he was planning on cashing in his chips mid-year and was hoping some sucker would pay top dollar for his piece of dirt. And I often hear that sentiment, it’s people who get on the first or second rung of the property ladder, forget how hard it was to get started and they then kind of ‘pull up the ladder’ behind them, preventing others owning a home of their own because the price of entry is too high. And that only works until the day this person’s kids decide they want to buy a home but are priced out because of the greed of the parents. I’m sure a psychologist would have something to say about that?
Is there an answer and what’s my point exactly?
I honestly do spend a considerable amount of time thinking about the wellbeing of my peers as well as of my immediate family. I would far rather own the one house we have and invest in the share market and support a myriad of New Zealand companies that provide meaningful work and income to thousands of New Zealanders than shoulder a hefty mortgage on my own that supports only my banker while I settle in for the long wait of capital gains. I get that not everyone wants to buy a home, it suits them to rent, so we do obviously need rental housing, but personally, I want people to have the option to buy a home that is in line with their income if they want to.
It is because I speak with so many people who are either suffering as renters and who are constantly being told “I’m putting the house on the market” or “we are putting your rent up” so the landlord can try to cover their mortgage OR from landlords who have massive mortgage debt and are focussed on one asset class only and their only way to stay afloat is to keep wringing money out of their tenant. It is stressful for both of them! Many are feeling swamped by their choice to leverage (even with cheap debt) but that they need to endure it because they want to grow wealth and that property is the only way to do it. All of their life choices are made around this property and the eye-watering amount of debt they have taken on because they think it’s the only way. I think that’s unfortunate, to say the least.
So, my point is that we all need to really dig into the math behind property as an investment and also dig into how it will impact your whole life while you have it. Do more research by taking the people you know who have property out for a coffee. Don’t let the only person you speak with be your banker. Talk to people who have just purchased a second property, to those who are five years in and to those who have owned them for 20 years. Talk to them about both the positive and negative events that have happened in their personal life and how they coped. Round out your thinking with actual MATH to forecast if this could work for you. Then talk to people who have grown their wealth without property, ask them how they did it. And then look at the current housing market we find ourselves in and the prices people pay and the debt they are willing to shoulder and ask yourself who is actually making money here, the individual or the banker? And please, for goodness sake think about what life might be like for your tenant. Remember that an investment property purchased today bears little comparison with the investment made by your parents 20 or 30 years ago so in my mind it is flawed thinking to follow people down the path they took, expecting to get the same results yourself.
And finally, diversify. Diversify your thinking into how an investment property fits in with your overall plan for your future because for me, waiting 30 years for something to finally pay me the rent is not a future I’m keen to imagine. Don’t put all of your eggs in one basket. The saying holds true.
If you choose to buy a home to live in, pay it off as fast as you can making sure that you have money available to also invest in your KiwiSaver. Always have money set aside for an emergency event because give it enough time, you are going to need it. When cash allows you to start to invest elsewhere, instead of rushing to more property and heaps of debt, instead use the income you generate already from your job or business to invest in the share market, index funds or ETFs are an obvious choice and they provide a better income than an investment property I can tell you that much. If you ‘love property’ as many claim to do then by all means buy, but do it from a strong and diversified base first and that way you will earn an income and be a decent landlord. Enjoy going to work each day, either for an employer or for a business you own and know that one day the gloss of working will wear off. When that day comes, enjoy the feeling of freedom you will get when you realise that because you have built up a varied and stable financial life, you have options and choices that you can make as your life changes and none of them need to take your bank manager into account. That is freedom.
