Rent vs Buy in Vanity Markets

2019-12-07 09.28.44A vanity market is one where the main benefit you gain from ownership is telling your pals that you own.

Similar to my observation that I was wired to buy a “big” house, there are other purchases our ego gravitates towards: cottage at the lake, ski chalet, big-city pied-a-terre, beach house, farm…

Our ego’s weaknesses depend on our cultural background, childhood memories, current mood and social situation.

My ego can lead me far astray, particularly with non-yielding real estate, and depreciating assets.

I’ve been battling with myself since I first visited Vail, Colorado. I’ll illustrate with real figures from the neighborhood of East Vail. It is a niche market, which I’ve been following for 16 years.

The “buy” => $1 million buys you the opportunity to spend another $375,000 to renovate, and furnish, a property that was build in the 1970s. After your renovation is done you pay ~$25,000 per annum in taxes, insurance, HOA and running costs.

The “rent” => $25,000 to $40,000 all-in rental cost for the same property.

Something we noticed about skiing, most skiers don’t ski.

Put this observation another way… there’s a lot of empty real estate around.

I’m sure every empty place has a history of buyers, who were certain they’d use the property more often than they do.

A useful rule of thumb is to assume that every $1 million, in a vanity property, costs your family $50,000 per annum. Renting makes (some of the) opportunity cost real, and allows you to calculate the cost-per-night of what you’re using.

Above is what you can see and calculate.

What about what you don’t see?

#1 => the option to change your mind, without cost or hassle. This is a powerful argument when framed correctly.

Honey, the kids are going to grow up and leave. When that happens, our life will change in ways that are impossible to predict. We should maintain the flexibility to change our minds.

#2 => the option to buy in a downturn. About once a decade, property values snap downward. Waiting does not feel like a valuable option but it is. I’ve seen brief, 50% markdowns numerous times.

#3 => what I think I will like does not match what I actually like. I am a master at fooling myself. Fooling myself with regard to location, views, amenities, garages, layouts… you name it.

Renting “forces” me into different types of properties. Because mistakes are so expensive, I write down the lessons from every new property.

Here’s the best lesson of all…

Assets don’t create the life you want to lead.

Focus on shared experiences with the people you love.

2019-12-07 13.11.17

Family Real Estate 2019

2019-12-01 17.07.49I like investing in residential real estate for several reasons:

  • The market is dominated by unsophisticated buyers/sellers, who are often driven by external events and emotions;
  • The availability of long-term fixed-rate non-recourse finance; and
  • Favorable tax treatment.

There are some drawbacks:

  • It is extremely expensive to buy and sell => a mistake will cost me 10% (gross), if I am lucky. If borrowing, even conservatively, then I can lose 35-50% of my equity in a year.
  • It is lumpy => if you need the money back then it is very difficult to gradually drawdown your investment.
  • It is illiquid => if we _really_ need to cash out then we won’t be able to cash out
  • Humans are hardwired to over-buy => as soon as I could afford a huge home, I bought one. It took me years to get my capital back. I was very lucky => I purchased with a large margin of safety (no leverage, big site, big building, prime neighborhood).

Taking the above, together, real estate is a useful core holding for money that won’t be needed for 10+ years.

2019-11-14 14.33.15

I follow two types of markets:

Markets where growth in prices is driving by “wealth feelings” in the top 0.01% of society => Vail mountainside homes, Boulder view properties. These properties have done well, appreciating to levels where implied yields are -2% to 2%.

I prefer to invest in traditional markets => markets where price growth is backed by a combination of real-economic growth (ability to pay), construction inflation (replacement cost) and discounted cash flow (net yields above my cost of capital).

Both markets are influenced by the availability of credit. Both markets benefit from scarcity and desirability in location selection.

Remember that even a “cash buyer” is influenced by easy credit. Credit conditions influence the value of ALL assets => wealth effects. These wealth effects cut both ways => highly wealthy people can feel “poor” when their balance sheets are shrinking.

2019-12-02 06.29.25

When I buy, I create a margin of safety by seeking:

  • Land for cheap => is there extra land I could sell off or am I buying in a very desirable location.
  • A lot of square footage for cheap => ideally, I’d like to get the land for “free” by paying less than the replacement cost for the building. Even if you never build, it helps to know building costs.
  • Distressed seller => life happens, often at inconvenient times.
  • Closed credit markets => by ensuring I have the ability to hold through tough times, I can use unallocated capital to buy during down markets.

I’ve been preparing for my next deal by improving my credit worthiness:

  • Building up a capital reserve.
  • Improving my credit rating – paying credit cards early, taking advantage of a 60-month 0% car loan offer, always paying my mortgage on time => taken together these strategies added 80 points to my credit score from 2012 to 2019.
  • Reducing leverage => paying down my mortgage and car loan. Closing out my second mortgage.

2019-11-21 08.02.40

We’ve seen significant house price inflation in Boulder => supported by: (a) rising construction costs, (b) local economic growth, (c) inward migration of wealthy coastal buyers, and (d) easy credit terms.

In 2019, I looked at deals to increase investment in Boulder (buying apartments and renovating houses). In the end, we decided to decrease investment in real estate through a sale-and-leaseback of our home. 

The leaseback costs me some tax (today) and positions me to borrow long at favorable terms. The option also costs me the future capital appreciation of my home, which won’t be mine any more. We retain exposure to the Boulder market through rental properties we own.

I’ve structured the deal with vendor finance, allowing a gradual drawdown of the proceeds. The net monthly cash flow covers our cost of living through my youngest daughter’s high school graduation. Having our cost of living covered protects my ability to control my schedule => highly valuable to my family in a way that’s difficult to quantify.

This is the cheapest way for me to sell real estate and positions us to buy when conditions swing in our favor.

Raise money before you need it.

 

#RWRI Thoughts on the business model and cleaned up notes

RWRI has a fantastic business model.

  1. Make the faculty your friends and investment committee
  2. Get paid to meet for a week each trimester // you have a no-cost central office, you are getting paid to bring your international (virtual) business together for a week
  3. Record your talks to capture new ideas, spontaneous content
  4. Train the students who will take your work forward when you are gone
  5. Receive feedback about how your work is being used in the world
  6. Up-sell your most passionate (book) customers => Robbins model
  7. Create an environment where you expand your network with people likely to engage and help you => HUGE self-selection bias in student population
  8. Invite world-class speakers in areas where you’d like to learn

This business works well for its owners and they are (more than) smart enough to see that.

Keep it small, sell out each meeting, avoid the temptation to expand and remember why you started.

I cleaned up my handwritten notes via the creation of a Google Doc.

Mistakes remain my own.

Considering Wealth at the Real World Risk Institute

2019_HalloweenTo shake up my thinking and expose myself to highly-believable people, I attended the two-day program at Nassim Taleb’s – Real World Risk Institute.

You can find my daily notes here. Cleaned up digital version of my notes here.

What follows is my thinking on wealth inspired by what was presented. Mistakes are my own. I can hear things differently than what was actually spoken, so don’t assume my attributions are strictly accurate.

To prepare for the clinic, I re-read the Incerto and I’m glad I did it. Each pass through Taleb’s work provides additional insight. You can find his lectures and lessons on YouTube => well worth your time!

We live in a world where a single bad decision can have massive costs => a few thousand dollars and four days of my time is a small price to (try to) think better.


One of the aspects of my job is guiding the transition of wealth between generations. This sounds sophisticated but it’s a role played by elders and parents in every family system.

My personal greed makes me too focused on financial wealth. It takes effort to step back to see wealth as including:

  • The ability to say “no” to others
  • The ability to keep promises to myself
  • Control of my schedule
  • Health, athletic functionality and contentment within my body
  • Love and companionship – the ability to share experiences
  • Engagement via teaching (my kids, my students, anyone who’s open to implementing what I’ve learned)

What I’m shooting for is creating a strategy, so effective, so straightforward, that an idiot could execute it and preserve wealth access generations.

This is what Taleb calls “Zero Intelligence Investing” but we are focusing on a broad definition of family wealth, across generations, through time.


The impossibility of prediction

Joe did an excellent job of demonstrating how complex systems (even those built on very simple rules, defined by the observer) can be impossible to predict. More specifically, certain systems can only be understood, defined, by running them forward in time. He laid out a host of reasons, any one of which could prove the folly of prediction.

Consider your own life. Cut your age in half, how would you have defined wealth at that age? In my case (25 years ago) the list might have looked like:

  • Wine, women and song
  • A ton of work that pays well
  • Watching my personal balance sheet grow
  • Being very strong in the gym
  • Travel to new places

There was no way to predict my values (today) without living through the 25 years from then to now (the divorces, the insolvencies, the setbacks, the pain of toddlers, the post-traumatic growth).

Because of the role of time in life, we can not predict the future.

However, we can have useful ideas about what not to do. We can get a handle on what might ruin our families.


So if my goal is to preserve, ideally grow, the collective wealth of my family system what can I do.

  • Be vigilant about ruin (in fat tailed environments)
  • Spot, discuss and remove fragilities
  • Position the family to benefit from positive optionality

One of the things Taleb does best is consider his best ideas across domains, gain insight then translate his insight to the reader via real-world examples. It is the secret sauce of his success.

BUT, reading great ideas doesn’t improve my life! I need to go the next step and tinker with a limited number of outstanding ideas.

Who gets the benefit of your best ideas?

Taleb’s best ideas…

Ruin via the fat tail hitting my fragilities => fancy way of saying don’t blow yourself up! I’ve written about this a lot: Taleb’s written about Russian Roulette => his 1,000,000 chamber gun story in Fooled by Randomness changed the direction of my life.

In the seminar we talked about the non-zero risk of a “zero-risk first cigarette.”  Why does a (near) zero-risk choice have a non-zero risk in our lives?

“In life, you must assume that you’re going to take the risk again, and again, and again.”

This completely changes the calculation with regard to the “first” taste of risks that might ruin you: alcohol, rage, opiates, cocaine, sleeping pills, infidelity, felonies, roulette, recourse leverage, luxury spending, unnecessary capital projects… things with the potential for large and unpredictable downsides. Bad habits are always trying to seep into my life!

So, to preserve wealth, you need a process to remove your fragilities, because these are what’s going to ruin you. My family history has persistent, recurring fragilities that hit us hard.

The first step is to gain control of your schedule and create space so that you’re able to think more clearly about what can ruin you. Simplify.

Another great insight – life is not about avoiding risk…

“Take chances, lots of them, and focus on areas where volatility works for you.”

In an uncertain world, one of the best sources of optionality is non-recourse finance.

My first career (Private Equity) could be described as getting overpaid to hold a call option over other people’s work, using other people’s money, without recourse.

Negative action is powerful medicine, with low side effects.

It’s tempting to ask Taleb “what to do.” I did, twice, and he didn’t seem keen on advising positive action with regard to an unknowable future. That’s probably good, as I’m not equipped to implement, or even understand, his technical advice. However, his negative advice (on what to remove) generated huge wealth for me => my total cost was the price of buying Fooled by Randomness on Amazon ($10.17 in December 2005 – my Christmas 2005 reading list, you can skip the flat earth book, the rest were great).

There are many sources of optionality:

  • where I have limited competition
  • where I understand the domain as well as anyone
  • where the cost to enter is small

A few ideas:

Get married, have kids, then take excellent care of everyone (!) => dementia is in my family tree => doing well by my family is the “cost” of a call option for times of future stress => an option that has a constant payoff in companionship, personal growth and a semi-captive audience for teaching.

Technical education in a robust field => look back in time for Lindy professions => spend time and effort for continuous education

But be careful, the “honors” part of my college education (1st class honors Econ/Fin) proved to be technically useless. However, it helped get me a seat at the table in Private Equity. The overall degree taught me valuable skills with regard to financial accounting, programming, mathematical finance and calculus.

Knowing how to count, and being exposed to the way people seek to cheat you, these are useful life skills to prevent ruin. – quote mine

Other sources of optionality => tinker within your social network, attend conferences (and force your introverted self to speak to people), write (then publish), talk to believable people that disagree with you, donate time to people who might benefit from your technical skills (especially within your local community)…

Your body can be a call option on: future mates, future physical experiences, the ability to lift your carry-on overhead as you age…


So the “how do I stay wealthy” answer is about removing fragilities => cutting back a high cost of living, habits with large potential downsides, physical weakness…

The “how do we best grow wealth” answer is about exposure to opportunities that open up the possibility of growing True Wealth (connection, experience, engagement) => each generation can, and should be encouraged) to, contribute based on their current, unpredictable and changing definition of wealth.

Together the family creates its own definition of wealth.

Each generation re-defines wealth based on its collective values.

I would have learned more if I stayed for the entire week but it’s Halloween tomorrow and I got more than enough from the experience.

Hidden Debt – Hidden Risk

IMG_5565.JPG

This is the debt story of zip code 80301-80305.

As many won’t follow this post, I’ll give you a rule of thumb.

If you are under 50 years old then reduce your social security and defined-benefit pension assumptions by 35%.

…and plan on working an extra five years.

What follows is why.


Back in 2005, I came across covenant free loans => banks lending money without rules or restrictions. That observation, combined with reading Fooled By Randomness, started a process of de-risking my life.

Despite taking a whack to my family’s net worth in the last recession, life has worked out well.

It worked out because I had reserves to get me through the tough years.

Collectively, our reserves are being spent on our behalf.


This fall Colorado is asking voters to approve a modification to TABOR, our state’s “bill of rights” for taxpayers. The supporters have a strong pitch, if you vote in favor then the money goes to schools and roads => I love schools and roads!

At the last recession, I was burned because I increased spending to the top of the cycle. So I’m inclined to keep the state’s powder dry for other uses.

What other uses?


PERA => our public employees retirement fund => we’ve been told the fund was fixed last year. The fix assumed net returns of 7.25% per annum going forward. However…

if PERA’s actual returns are 6.75 percent, the debt grows by $5 billion.

Round numbers, every 1% shortfall in PERA net returns creates a need for an additional $10 billion. As I publish this article the 30-year treasury is trading at 2.24%. A net return of 5% over treasuries strikes me as unlikely.

How does that potential shortfall compare to State Tax & Excise Receipts?

Fiscal year 2019/20 Colorado revenue receipts are forecast to be $12.6 billion.

Now, you don’t need to fund a pension deficit immediately. It can be dealt with gradually with a mix of benefit cuts, increased employee contributions and increased government funding. That’s what all parties did with the 2018 fix.

It’s a safe bet that state taxes are going up and benefits are going down.


In the last recession, my unemployment resulted from the credit markets slamming shut and creating a liquidity crisis…

  • The bank went bust
  • The developer went bust
  • The general contractor (and many of its subs) went bust
  • The management company went bust
  • The equity went to zero (within 90 days)

All of the above, culminated with the CEO going bust.

Chains of debt are lethal in recessions.


Noticing the debt bomb sitting in Colorado PERA, I asked myself, “Where else have people borrowed on my behalf?”

  • School district borrowing => ~$800 million in my district => money very well spent to strengthen our future tax base
  • CU Boulder is my neighbor => ~$1.5 billion on their books => the university has a big impact on my local economy and real estate market
  • City of Boulder => ~$225 million => big ballot initiative coming as they want to borrow big, take technology risk and purchase utility assets on our behalf
  • County of Boulder => ~$200 million at the end of 2018
  • State Level => ~$10 billion at the middle of 2018 => over $50 billion if PERA used a rate of return similar to my own

Sitting above it all => $1 trillion Federal Deficit and $22.8 trillion of National Debt.

There could be some double counting and I might have missed another public entity that can issue bonds on my behalf. The precise numbers don’t matter.

This is what matters…

#1 – there is leverage through the entire taxpayer chain with no consolidated visibility or oversight. No consolidated financial statements for you, the taxpayer. The ratings agencies have the entire debt chain rated as very safe. Does this sound familiar?

#2 – every single government entity that touches me has a debt-financed cash flow deficit and off-balance sheet commitments. This sounds familiar as well.

Debt financed, cash flow negative entities blow up.


I remind myself:

  • As a society, we can’t increase taxes at every level simultaneously. This counters my thought, “it will work out, I’m lightly taxed right now.”
  • 600,000 members of PERA are at risk and probably taking comfort from 2018’s fix.
  • If you are planning on receiving a defined-benefit pension then cut your assumptions and plan on working (at least part time) until you are 70 years old.
  • People are going to be pissed when financial reality hits their benefits.

What to do?

Protect your family by saving, investing conservatively and reducing your “total tax bill” as a percentage of net assets => this limits the government’s ability to hurt you via tax increases. I’ve been doing this since 1990 and it works.

Let’s say that again because your financial advisor will not focus you on this number…

“Total family taxes” as a percentage of “total family net assets” is a number you should manage downwards across your career.

Knowing that the system is highly leveraged:

  • keep personal borrowings low
  • be careful with long term obligations (leases)
  • don’t issue personal guaranties
  • don’t capitalize luxury spending

Being able to take pain => how might these scenarios impact your family?

  • 6 months unemployment
  • retirement benefits being cut by a third
  • social security benefits being cut by a third
  • portfolio value cut by a third

I’ve lost jobs, written down portfolios (65% in 90 days, ouch!), put my employer into insolvency (on my 40th birthday) and muddled through multi-year cash crunches (2009-2012).

Bad things happen and life remains pretty good even when they are happening => my wife’s companionship and leadership got me through.

Be careful out there.

What I Talk About When I Talk About Building Wealth

SuperGirl

When people ask me about asset allocation, I guide them towards family wealth.


Over your life, you will see things blow up.

  • Jobs will be lost
  • Divorces will happen
  • Guarantees will be called
  • Companies will fail
  • Investments will go to zero

Certain habits make us more prone to blowing up:

Debt – fixed obligations can ruin you in bad times.

Lack of emotional control – this runs deeper than, say, anger management.

People who make a habit of rationalizing a lack of control in one domain (elite sport, closing a sale, acting in a client’s best interest) rarely have the capacity to control themselves across domains. If you might get caught, then you’re fragile.

Substance Abuse – it’s more than the cost of sorting yourself out – it is the lost opportunity of a life well lived and the impact on the rest of your family, especially your kids.

Spending vs Cash Flow – personal spending, burn rate and fixed costs => the more spending you have relative to cash flow, the more fragile your finances.

The above is a long way of asking, “What aspects of your life might blow up?

Which is a polite way of saying, “I’m not sure asset allocation is the most pressing issue in your life.

If you work in an ethically-challenged field, have a lot of borrowings, have a high burn rate or are surrounded by peers with issues…

…then tweaking portfolio construction is a lower priority item than immediately removing what might ruin your life.

I’ve done it. You can do it. It’s better on the other side.


How large is your current portfolio when compared to your lifetime portfolio? – AKA you might have more wealth available in your career than your portfolio.

Investing is different at 25, 40 and 55 years old.

The nature of “different” depends on your personal circumstances.

#1 => Consider your Core Capital. The single best thing I did out of college was save four years of personal living expenses, $100,000 in the mid-1990s. It sat in a bank account, while I worked my ass off at my career.

Having that money enabled me to choose better and choosing better became a habit.


Very, very, very (!) few people can be professional investors – AKA can I get rich by beating the market?

Take an honest look at the people that you know in finance. How many of them “got rich” from their own money? Remember these are the experts.

In finance, most people get rich due to the rules of their game and collecting pools of other people’s money (your money, by the way).

With your portfolio, keep it safe, simple and low-cost. A target-date fund makes a nice core holding.

Having my Core Capital enabled me to take more risks in my career path, and life experience => not with my Core Capital.


Once-in-a-lifetime opportunities happen once a decade – AKA great deals happen when credit markets are shut

Here are the assets I own and why I own them:

  1. Index funds => long-term, diversified, not linked to my home real estate market
  2. US Treasuries/Core Capital => 5 to 10 years family expenses
  3. Boulder real estate => A relative value play against California, a cost-effective way to raise a family and a fantastic outdoor life. Think very carefully before locking yourself into any location. As a young man, my lack of ties enabled me to jump at great opportunities.
  4. Cash => my early retirement was funded by three deals I did coming out of the last credit crisis. Once you have your Core Capital (say, five years living expenses) then building up a pool for “great opportunities” is a consideration.

Starting out? Read this PDF.

Be wary of home bias => you can see it in my portfolio => even more risky is having your balance sheet, retirement and job reliant on the success of your employer.


Switching Costs – AKA think carefully before you sell good assets

I have assets in my portfolio that I would not buy at today’s prices. Financial theory tells me I should sell these assets.

  • I have zero confidence in my ability to predict the future.
  • If I sell assets then I pay taxes and commissions.
  • After selling, I have to figure out where to put the capital.
  • I doubt any “new” plan will be better than my current plan, which is simple and low-cost.

Release yourself from constant optimization => good enough is good enough.

Put your efforts into being a better version of yourself.

 

Athletic and Business Humility

kona27

When I think about success, I experience the human quirk of self-attribution bias.

In other words, I believe that my failures are due to external circumstances (those damn flat tires) and success is due to my own efforts (my life today).


parade

In athletics, I played the game of Ironman Triathlon (swim 2.4 miles, bike 112 miles and run 26.2 miles). Two observations about the game, at the time I played it:

  1. Very few people were willing to subject themselves to “proper” training
  2. Most winning times (today, any venue) would have been world-records when I raced

Two ideas flow from these observations.

First, if “winning” is important then find a narrow niche where you enjoy working your a$$ off.

Second, in a field where not many people are willing to do-what-it-takes, be cautious with your self-assessment.

World class is a lot easier when you’re not competing against the world!


thegirls

I was able to play triathlon, because I spent a decade playing Private Equity, in Europe and in Asia.

The only way you can lose this game is by going bust:

  • Gather money every five years => each fundraising created a stand-alone “fund”
  • Split each fund into a dozen deals, invested over 3-5 years
  • Use borrowed money as well as equity
  • Wait 4-6 years then sell the deals and keep 20% of the profits

What makes this game interesting is the “house” received an annual commission (2% of equity).

Over the last fifty years the sector went from ZERO to over $500,000,000,000 annual volume => generating a lot of fee income and creating a buyer’s circle where your competition bid up the assets you already own.

If you think you missed out because you weren’t in finance then you might be mistaken. Similar dynamics have been in play in your real estate market (and sectors touched by venture capital).

From 1980 onwards, rapidly increasing assets under management wasn’t the only tail wind.

There was the long term debt cycle (10-year treasury rate from 1/1/1979).

fredgraph_10.png

Chart looks similar if you use 30-year treasury rate…

fredgraph_30.png

…the debt cycle fed into the stock market (y-axis log scale, SP500 from 1/1/1979).

SP500_40.jpg

I started high school (37 years ago) in the bottom left-hand corner of the stock chart. Is it any wonder that I expect things to always work out?

It is human nature to associate my effort with my results. Some will say this association is obvious!

I am not sure. I know that I ignore external factors and hidden evidence:

  • of people who worked hard and didn’t succeed
  • of crooks and bozos that have done very well

My mantra, “Let’s be careful and remember we are far less talented than we think we are.”