Historical article note: This article was originally published on 2018-02-03. Rates, policies, home prices, statistics, product names and qualification standards reflect the environment at that time and may have changed. This archive is for historical record and general education only. It is not mortgage approval, investment, legal or tax advice.
Since entering 2018, whether to buy an investment house has become a topic of discussion among many families. In my office last week, three families with annual incomes of more than 150,000 came to my office and they were struggling with whether to buy an investment property. My unified advice to such a family is: dual-income families basically do not enjoy government benefits, and they have to rely on themselves for retirement. The biggest advantage of high income is to obtain financial leverage. After the improvement of housing loan standards, mortgage loans have become a scarcer resource. They should take advantage of high-income locals to invest in real estate. Use the PHRESE investment method to invest in 6 properties, maintain a certain income, and have the ability to continuously make mid-term arbitrage from banks, achieve long-term holdings, and finally sell the property to achieve the final arbitrage goal.
Real estate investment must have the right time, place, and right people. For example, only international metropolises have the three types of populations needed for real estate investment: locals, new immigrants, and foreigners. We are very lucky to live in the Greater Toronto Area, because only such international first-tier cities have real estate investment opportunities. Salary earners are actually locals. The essence of real estate investment is arbitrage, that is, buying early with the advantage of local people and selling to latecomers N years later for arbitrage. Investing in real estate in a city is to buy stocks in the city, believing that the city's future population will have higher purchasing power. The Ontario government has levied a tax on foreign real estate speculation, the central bank has raised interest rates, and the federal government has tightened mortgage policies, leaving locals wondering whether real estate will slump? I recently read a book, "Real Estate Cycle", written by Ren Zeping. The point of view in the book is very clear: the real estate market depends on population in the long term, land in the medium term, and finance in the short term. The author is known as the prophet of China's real estate. Before the stock market stampede in 2015, when everyone was selling houses and speculating on stocks, he predicted that housing prices in Beijing, Shanghai, Guangzhou and Shenzhen would double. Let’s compare the author’s ideas with the Toronto real estate market.
Look at population over the long term. When the urbanization rate of a country exceeds 70%, it enters the post-urbanization stage, which is marked by metropolitan agglomeration. Large cities have greater agglomeration and scale effects than small and medium-sized cities and towns, save more land and resources, and are more dynamic and efficient. This is the victory of urban civilization over hundreds of years and the basic law of urbanization. The inflow of population into metropolitan areas is the basic trend and law of urbanization in various countries around the world. Taking Canada as an example, as resources, supporting facilities, education and employment opportunities are increasingly concentrated in Toronto and Vancouver, Canada's population flow will separate people and land, that is, people will go to the two major cities, leaving small and medium-sized cities with vast areas and sparsely populated areas. New immigrants have a metropolitan feel, not only to find relatives and friends, but also for the education of the next generation, and better employment and development opportunities. They flock to where there are more people. When people choose where to live, whether they can maximize their potential is the top priority, followed by the cost of living. Toronto and Vancouver are the only two cities in Canada with the characteristics of international metropolitan areas.
Look at the land in the medium term. In China's cities, land is state-owned, while in rural areas it is collectively owned; in Canada, 90% of land is privately owned. Regardless of the form of land ownership, landowners will not, for their own benefit, supply land on a large scale for building housing in a short period of time. This leads to a scarcity situation where there are never enough houses. Toronto, Seoul, and London are the only three cities in the world that stipulate that urban development must not break through the green belt, which further exacerbates the scarcity of land supply.
Look at finance in the short term. Real estate is a symbol of wealth, the mother of economic cycles, the source of financial crises, and the core of major asset allocations. Every economic boom is mostly related to consumer investment driven by real estate, while every economic recession is mostly related to the deflation of real estate bubbles. The formation of real estate bubbles is mostly driven by low interest rates and abundant liquidity, while the bursting of real estate bubbles can mostly be attributed to interest rate increases and tightening liquidity. The short-term real estate cycle refers to fluctuations caused by short-term variables such as interest rates, mortgage down payment ratios, and taxes, which change residents' paying abilities and expectations, causing home purchase expenditures to be advanced or postponed. A complete short-term real estate cycle is: policy cuts interest rates and mortgage down payment ratios, residents' affordability improves, real estate sales rebound, commercial housing is destocked and supply exceeds demand, developers purchase land after funds are withdrawn, accelerate construction investment, housing prices rise, and the increase in the value of commercial housing as collateral will amplify the loan needs of residents, developers and banks. Because; when housing prices bubble, policies increase interest rates and mortgage down payment ratios, residents' affordability declines, real estate sales fall, commercial housing inventory increases, oversupply, developers slow down the pace of land purchase and construction investment, housing prices fall, and the value of commercial housing as collateral shrinks, it will reduce the lending behavior of residents, developers, and banks. In this process, sentiment accelerators, collateral credit accelerators, etc. will amplify short-cycle fluctuations in real estate. Canada's current financial environment is in a period of exchange rate protection. The U.S. tax cuts and balance sheet reduction actions are attracting global dollars to return to the United States. This has put pressure on all countries in the world to raise interest rates and protect exchange rates. Countries that do not follow the U.S. interest rate hikes will experience capital outflows to the United States. Therefore, the Bank of Canada will follow the United States in raising interest rates regardless of the actual situation in the country. In the end, there will be two results: whether it can keep up or it cannot keep up. From 1986 to 1991, in order to protect the exchange rate, Japan caused the real estate market bubble to burst, resulting in a lost 20 years that have not yet recovered. This is the result of a desperate attempt to protect the exchange rate. In 2014, Russia abandoned its exchange rate guarantees to protect housing prices, causing the currency to depreciate and housing prices to skyrocket. In 1997, neither the exchange rate nor housing prices in Southeast Asia were maintained, and both exchange rates and housing prices plummeted. According to the Impossible Triangle, free flow of capital, exchange rate stability and the effectiveness of monetary policy cannot be balanced at the same time. If Canada insists on maintaining its exchange rate and allows interest rates to continue to rise, it will inevitably have to issue a large amount of currency to maintain liquidity, encourage consumption, and promote employment. Judging from the experience of the past nine years, the return on investment in Canada's real economy is lower than that of real estate investment, and the excess currency will flow into real estate, pushing up housing prices again.
The assets of salaried workers, no matter which country they are in, are always devalued in successive rounds of currency over-issuance. Real estate has very typical procyclical characteristics, and since both land and house purchases can be leveraged, the wealth effect can be amplified. However, since real estate is illiquid during recessions, it is not suitable for short-term investment. In the long run, over-issuance of global currencies is a common phenomenon. There are not many assets that can outperform the money printing press. In most countries, real estate in metropolitan areas is one of them and has anti-inflation properties. Conclusion: Wage earners should take advantage of local people and use bank leverage to obtain "virtual capital" for mortgages, invest in real estate, "buy" real estate early, and hold it for a long time. During the holding process, they can arbitrage from the bank through additional mortgages to enhance asset liquidity. With the development of the city and economic prosperity, they can maintain and increase the value of their personal wealth, and sell the property to subsequent buyers with stronger payment capabilities in the future, ultimately realizing arbitrage.
I recommend the PHRESE investment method for salary earners to invest in real estate: Buy, hold, refinance, continue to hold, continue to remortgage, and finally sell. Because the median household income in Ontario and British Columbia is around 80,000, and the median real estate transaction price in the two provinces is around 700,000, it is recommended that investors choose properties below 700,000 to 750,000 for investment. Since the upper limit of a single loan amount is 5 times the annual income, investors need to maintain a certain household income for a long time in order to continue to increase mortgages. When purchasing and holding more than 6 investment properties, the PHRESE method can maximize investment returns. For example, a family with an annual income of RMB 100,000 purchased an investment house every year from 2000 to 2015, with an initial mortgage amount of RMB 500,000. In 2016, the loan balance of the property purchased in 2000 has dropped to 450,000. At this time, you can apply for an additional mortgage on the first property, increase the loan amount back to 500,000, and redeem part of the initial investment principal, thus accelerating capital turnover, improving real estate liquidity, and conducive to holding the property for a longer period of time. By analogy, in 2017, 2018, 2019...continuously increase the mortgage on the original investment house, and realize medium-term arbitrage without selling the property. Salary workers have limited time and energy, and may be overwhelmed by holding too many properties. This PHRESE investment method is the most effective method for real estate investment for salary workers. Later buyers may still be studying, or they may be in a relationship but have not yet decided who to marry and where to live, or they are considering immigrating but have not yet decided which country to immigrate to. Please be patient and hold on to the investment property.
Real estate investment has high requirements on income, down payment, and personal debt management ability. Among the 7.14 million people in the Golden Horseshoe region of Ontario, only 120,000 people own more than one property, accounting for less than 2%. This ratio is similar to the ratio of wealth distribution among the population. The number of people with excess assets is an absolute minority.