Geographic Reappraisal – Real Estate October 2017

This business insider article about an SF Bay Area house that sold $1 million over asking caught my eye.

Here in Boulder, we’re up 100% over the last seven years. Most of the increase has happened in the last 2.5 years.

Notwithstanding our big local increase, the “coasts” and luxury vacation markets look expensive from here.

The coasts look even more expensive when I factor in…

Schooling – Can I use the local schools? If not then my cost of living jumps by $25,000 per kid, per annum, after tax see the linked article – public, in-state education will save my family $1 million per kid.

Tax Base vs Legacy Liabilities – How heavily taxed is the location? How large are the legacy liabilities (health care and pension) from former city, county and state employees? The large cities of the oldest parts of the US look awful in this regard.

Other costs of living – Cali always surprises me when I run the numbers. I suspect it’s similar in places like New York and Seattle. Costs are 50% more expensive for the rest of my budget.

I am not recommending that you sell. I’ve made a decision to hold through the next recession.

However, the relative trade into “states with great lifestyles” strikes me as attractive — North Carolina, Montana, Idaho and Colorado.

If you are considering taking-the-leap…

Live where you don’t need to leave — can I create a long-term, year-round, local life here?

When I worked in international finance the “top guys” had homes in three or four countries. That kind of overhead has two negative impacts on your life: (1) your ethics are easier to purchase; and (2) you’ll need (at least) an extra decade of full-time office work.

Kill your commute — can I live within an easy walk, or a short ride, of where I spend my time?

When I was thinking about moving to Cali, I plotted my life in Google Maps. I did the same thing for my prospective life in Palo Alto. That gave me two geographic “triangles” and I calculated real estate and family costs inside the triangles.

Finally, surround yourself with people that live a life you’d like to follow. I do best with an active, outdoor life in a location with abundant sunshine.

This last point is important — know what you want — know where you do best.

What Makes Real Estate Assets Cheap – Tame Your FOMO

Because we are hard-wired to be poor investors, your family’s best bet is dollar-cost averaging in low-cost index funds. Consistent investing, over your working life, it’s as close to a sure thing as you can get.

Despite, and because of, the above truth, many people are going to dive into the real estate market.

When the masses get into trouble, you can do very well by applying this post.

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Wait for…

FINANCIAL DURESS — Once a decade, debt markets rapidly contract and everyone has a freak out.

DIVORCE — Corporate, professional or personal — vendors will hurt themselves to damage former partners

MOMENTUM — Collectively, our long-term memory is about three years long. The Great recession ran from December 2007 to June 2009. It took three years years for us to “forget” the asset price run up of 2005-2007.

If you don’t have two-out-of-three then wait. Discounts are coming!

Do work…

INFORMATION — I assume the vendor knows far more than me, and probably you

How can we improve our knowledge?

Wait & study — while waiting for the next crisis… live in the location where you’re thinking about buying. The cost of the rental will pay for itself through better information.

Fundamental Value — do this with every large investment (or purchase)…

A./ What is the net cash flow the asset can generate after current taxes, all operating costs and the investment required to keep it producing cash?

B./ What is the total capital required to purchase? Include every_single_dollar.

C./ How does the implied yield (A/B) compare to the yield on 30-year US Treasuries (currently ~3%)?

Example… across 2014 and 2015, I was unsure if I should sell, or hold. The common wisdom was long-term rates were going to rise and prices would stagnate. Tempting to switch asset classes…

I calculated my cash yield was roughly equal to the, then, 30-year rate.

I considered…

1./ My sites were exposed to the upside from Boulder County economic growth

2./ My alternative investments had lower yields than my existing investments

3./ I would crystalize significant deferred tax liabilities

4./ My existing position was good enough to meet my goals

I decided to sell a negative-yielding asset and hold the cash generators.

NOBODY predicted what happened next, long rates fell by a third, and local real estate values rose by 50%.

FWIW, long rates are back up but fear of missing out (FOMO) is driving the market upwards.

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When is our margin of safety highest?

  1. Let prices, and transaction volume, fall for two years
  2. Look for a distressed seller
  3. Look for a deal where the cost to own is less than the cost to rent
  4. Confirm your taxed, net cash yield is greater than the 30-year treasury rate

Your FOMO will tell you that the above will NEVER happen.

WRONG!

Since I graduated university (1990), very favorable conditions have happened FIVE different times where I was living.

It takes a long time to build capital and two great deals (in 50 years) will let you meet your goals.

Tame your FOMO and choose wisely!

Effective Real Estate Ownership

When you buy real estate, what’s your goal?

We want to live in a fabulous place, while getting rich on asset appreciation.

It sounds great but the choice of moving into an affluent community increases expectations, and cost of living.

“So what?”, you say.

The hidden cost can be time for our kids and marriage.

In the Great Recession, I changed course…

We aim to create a portfolio of assets enabling us to live for free in an effective public school system that’s close to nature.

In your teens, you will start to make investment decisions… how much to work, spend, save, donate and borrow. You have 50 years to create your portfolio!

Live for free:

  1. In high-school: with your parents
  2. As a young adult: a place where your roommates subsidize your cost of living
  3. Next: a house with many bedrooms — the first place I owned had the capacity to support me via roommates
  4. As soon as I “could afford it” — I made a mistake with a large, expensive to own, flash property!
  5. …but I found myself unexpectedly unemployed and we couldn’t afford it
  6. Eventually, we wised-up, downsized our home, and bought rental properties that covered our mortgage and healthcare.

When my wife is 65, the mortgage will be paid off, the kids will be educated and her retirement self-funded by the residual real estate portfolio.

How much of our cost of living can be permanently covered, or hedged, by this decision?

Most people aspire towards material goods, appearances and spending.

I urge you to patiently buy time, personal freedom and shared experiences.

Most of effective investing is learning, saving and waiting.

 

Regime Change

2016-11-24-19-02-19A friend asked for my thoughts about “what he should do” regarding the changes that are about to happen within the US Government.

My quick answer was “do nothing.”

2016-11-25-16-16-29..but there is a lot we can do.

I spent the days after the election teaching my kids to read, helping with math and working on the family’s open water skills.

My advice to “do nothing” is based on the following…

#1 – if you are adjusting strategy more than once a decade then you don’t have an effective strategy // if you truly feel the need to change then there is a structural problem within your family plan

#2 – you should consider tweaking strategy when your life changes (not the ruling party) – unemployment, impending retirement, new dependents, less dependents, major illness, wealth transfers // external surprises are going to happen all the time — spend your emotional energy preparing yourself to stay-the-course, not feeding your fears

#3 – the best time to sell high-quality assets is “never”

2016-11-25-16-31-59#4 – all the emotional energy and financial wealth spent on elections is better allocated to the next generation of your family

#5 – the richest people in America are about to feel a whole lot richer // stay invested and, if you sell to rich people then, raise your prices

#6 – with Elaine Chao’s appointment, the pieces are falling in place for a major domestic infrastructure initiative — this strikes me as a whole lot better (for everyone) than nation building via Asian land wars

#7 – don’t build capacity, or leverage, to the peak // the next recession is likely to be large

#8 – there will be excellent buying opportunities in all our futures // I’ve been researching my next major purchase since before the last recession

2016-11-26-10-29-40The hive-mind has been wrong all year. Glaringly wrong!

I ask myself, “Have they ever been right?!”

Spending time infecting our minds with media noise is the worst thing we can do for clear thinking. Turn off the media, learn persuasion psychology and study history.

Know that the largest gains in your family’s human capital come from self-improvement, ever stronger marriages and educating the next generation.

  • Financially – stay the course
  • Individually – incremental positive change

2016-11-25-16-33-30

Financial Planning for Long-Term Success

2016-09-07-12-05-16November 1st is the start of open enrollment in the US healthcare sector. To celebrate, Unitedhealthcare notified me that my premiums are heading up by 25%. I wonder how the total compensation (salary, bonus, private jets, security, stock) of their senior people will compare to the next president’s cabinet?

I overreact to unexpected, but manageable, loses.

Perhaps you are the same?

2016-10-14-17-33-43It takes effort to make myself more rational, and avoid exposing my family to unnecessary suffering. Here, I include loss of happiness from worrying about the small stuff.

The antidote is to always frame negative surprises in the largest possible context.

Our premium change is…

  • …less than 1% of the increase in our net assets over the same period
  • …less than 0.25% of my family’s net worth
  • …less than 5% of my family’s core cost of living

The premium shock motivated me to take a deep dive into family assets, liabilities and expenditures.

We measure core cost of living in terms of healthcare, total taxation, education, food and housing (mortgage, taxes, insurance).

Our key discretionary items are childcare, vehicles, vacations, college funds and gifting.

2016-10-14-14-56-00When you’re looking at a budget, or a business, go deeper and consider…

  1. Sources of large changes in income // unemployment, vacancies, new initiatives
  2. Sources of large increases in expenses // lease rates, insurance premiums, tax rates
  3. Prudent future planning // long lifespans, persistent lower investment returns

What can go wrong? What can we do, when inevitable shocks arise?

What can go right? How can we increase our exposure to large positive outcomes?

  • Children
  • Education
  • Capacity to help others with high-value work
  • Equity investments
  • Voluntary simplicity – our greatest wealth creator

2016-10-15-09-42-33While no one can predict the future, the 30-year bond (2.5%) is indicating that prospective returns are likely to be less than any of us have seen across our adult lives.

Historically, financial freedom targets net assets equivalent to 25 years of core cost of living. While that might be true historically, have a careful look at your joint life expectancies and quantify your longevity risk.

Young couples need to consider 50-year retirements, with 0.5-1.0% real rates of return (before taxes, fees and expenses).This possible outcome is far different than what I was taught in school, or even considered five years ago.

High Finance

2016-09-24-10-14-55Keep your ears open this week. There will be a rare opportunity to learn about finance.

For my international friends, many of the American techniques (in the news) are available in your home countries. I have been applying finance, across four continents, for more than 25 years.

2016-09-25-18-48-42The overall financial system works great. However, when I try to explain certain shortcomings to my friends, their eyes glaze over and I lose them.

I wish I was more skillful.

Whether your favorite billionaire is a Cuban, a Koch, or a Buffett, we can learn a lot from insiders. A constant refrain from wealthy insiders is “complexity creates opportunity for the system to be gamed for economic benefit.”

Finance is a complex system. The system has been gamed extensively.

  • Offshore accounts (Panama Papers type stuff)
  • Thinly-capitalized investment vehicles, with lots of debt
  • Applying non-cash losses today, while deferring cash gains to tomorrow
  • Receiving preferential tax rates on gains associated with financial work
  • Using trusts to avoid estate and generation skipping taxes
  • Using special accounts to shelter income and gains across generations
  • Income reclassification to avoid income and payroll taxes

If the collective wants to run the system like that then I’ll bow to its will. However, I’m not sure the collective knows what’s up.

2016-09-28-10-43-49-1Like professional sports, my beef isn’t with the system. What irks me is the lack of integrity when insiders pretend the system is different than reality. The politics of the people I named above are different but their observations are often similar.

I’m grateful I can explain my personal reality without fear of banishment or loss.

Living a life you can disclose saves a lot of suffering.

Breaking Down Family Risks

2016-06-09 17.39.38In May, I wrote about a misplaced sense of entitlement being our family’s greatest source of loss.

There are two components implicit in the article’s discussion of loss.

#1 – permanent loss of capital

#2 – loss of purchasing power over time

A wise advisor will keep these two factors front and center when discussing the risks associated with your assets, income and spending.

Unfortunately, wise counsel runs counter to human nature which likes to discuss…

Prediction of the future – we love stories about how our decisions will do better than other people’s decisions.

Fear of price volatility – nearly all price movements represent noise that can be ignored.

Two phrases for you to repeat daily….

No one can predict the future.

Volatility is not loss.

2016-06-09 21.25.10Instead of scaring yourself witless with the news, do something useful.

Turn your electronics off (ideally, for a week) and consider…

#1 – Where is the family exposed to permanent loss of capital?

#2 – Does our life situation protect us from the loss of purchasing power over time?

Consider further…

#3 – Where are our uninsured catastrophic risks – health, life, fire, earthquake, flood, asset concentration, counter party, addiction, fraud, abuse…

#4 – What is our ratio of net assets to core cost of living – how many years, months or weeks do we have?

#5 – What is the ratio of net assets to actual annual spending – most families have significant discretionary spending that can be cut in crisis. If necessary, do we have the ability to change and extend the years, months and weeks of cushion?

#6 – What percentage of our cost of living is covered by passive income (rental income, dividend income, interest income)? How does this income change over time?

a – rental income // an indexed source of income based on local economic growth, there’s also a potential capital gain associated with the land value, However, there is the potential for vacant periods as well as the need for occasional large investments with the building

b – dividend income // in a low-cost index fund, this source will be indexed based on national/international economic growth. There’s no potential for capital calls and you will have the ability to sell in small increments

c – interest income // this is fixed source of income, where the best you can do is get your money back at the end of the loan period.

If you put a number beside each of a/b/c and lay out your other sources of income (employment, pension, social security, partnership) then you will see how you are funding your annual spending.

Most families will have concentration in income, as well as assets. Concentration is a source of risk.

Are we acting on the right things?

Change slowly.