Financial Facelift

My friend, Eric, got me started on the path to financial independence back in 2009.  By encouraging me to learn about and manage my own investments, he empowered me to take control of my financial future.  Recently I was presented with an opportunity to have him evaluate my finances and provide some helpful tips, so naturally I took it. It’s really time to do away with the social taboo of discussing finances with friends #zerofucksgiven. 

Here’s what I asked:

Yes, this is what I figure: I only work Tuesday, Thursday and Saturday. My commute is 15km (no highways) and my store is relatively low volume. I am almost embarrassed by my lack of ambition, but I am so complacent right now. Working 3 days per week, with a short commute whilst earning over $75k/year seems to be the perfect recipe for happiness. Last night, I had a former Rexall head office employee come into my store to fill a prescription. He was recently fired and stated that “they are literally going from department to department to get rid of people” since the Mckesson takeover. Hopefully they plan to clear-cut head office (they can start with my regional :D) and add more frontline staff. I could never understand how Rexall had to cut minimum wage earning cashiers and technicians, but had ample resources for an ever increasing pool of managers to manage managers. I’m sure it’s no coincidence that we have had conference calls each day this week, as head office workers scramble to prove their worth to the company.

I suppose I could sell my properties, but I like real estate as a productive asset class. Unlike gold which has to be sold to realize a profit, I can collect rent for the rest of my life and still own the underlying (inflation-tracking) asset. The CAP rates make no sense at current valuations (and thus, I refuse to buy anything at these prices), but I am still reluctant to sell. Of course Garth, as a financial advisor, will tell everyone to sell real estate and pay him 1-2%/year to invest the proceeds. But does it make sense to sell real estate at it’s highest level ever to buy into a stock market at it’s highest level ever? I began investing in 2009 so I have yet to experience any major crashes, but I would feel especially horrible if I invested everything right before the next crash. I also think this is also why real estate prices stubbornly high. My store is located in Islington Village, close to the Kingsway and Princess Gardens, areas where house prices have skyrocketed. However, whenever I ask my patients (usually in their 60s and 70s with $2-5 million homes) why they don’t cash out, they always ask “and go where?”. They like their home / neighbourhood and do not want to move to some hillbilly town just to pad their investment portfolios (although doing so would be a boon for the realtors and/or Garth).

Since you were the first person to ever talk to me about investing, and you’re exceptionally savvy, perhaps you can offer your take on my finances: I currently own 3 properties (a condo downtown that my parents gifted me, my townhouse in Oakville and my house in Hamilton). I own the condo outright, but the Oakville townhouse has a mortgage of $72k and the Hamilton house has a mortgage of $154k. Between my RRSP / TFSA / Rexall pension / nonregistered account, I have about $600k invested. My mortgages are currently at ~2% so I haven’t been rushing to pay them down. I have zero interest in buying more real estate so I have been trying to build up my investment portfolio. I figure that if I have $750k invested + rental income, I can reasonably expect to have $60k-70k/year in passive income. This will be vital as pharmacy will continue it’s rapid decline in coming years. Does this make sense? Should I do as Garth advises and borrow against my properties to invest? And if so, what should I invest in? Everything seems to be expensive right now :S

And Eric’s response:

I am glad to hear that McKesson is cleaning house at Rexall. All of those managers deserve to be promptly dismissed and shown no mercy in the process. I hope that McKesson employs a ruthless scorched-earth policy as it purges the Rexall head office and that the freshly unemployed managers have lots of time to reflect on what they did to the front-line store level employees under the old regime.

I think that you have struck the ideal balance between work hours and salary. Consider that I have to work 5 days a week (66% more days) and commute 30 km each way to earn only a little more. And if I factor in income taxes then I am in fact earning very little for all of those extra work days. Like you I feel that I lack ambition. I no longer see the point of trying to earn more money when doing so will make no difference to my ability to ever own a home in this city where the cost of detached homes are continuing to increase by $706 every 24 hours. All that I would accomplish by working harder and earning more would be to increase the tax revenues of our governments who would then use the additional money that I have provided to them to enact policies that will serve only to make my life even more difficult (such as by sponsoring more refugees to further increase the GTA’s exploding population which will only make my shelter more unaffordable and my commute longer). I would rather deprive the government of that additional revenue and use my resulting extra spare time on activities that benefit me psychologically and physically such as cycling, skiing, canoe tripping or simply reading and relaxing. Also, although working harder might allow me to grow my assets faster those assets could one day be seized by creditors, lost in an acrimonious divorce, handed over to a stranger for compensatory damages following a court order or simply lost due to my own poor investment decisions or market conditions that are outside of my control. On the other hand no one can take from me the benefit that I derive by engaging in recreational activities that I enjoy. No future spouse, creditor or litigator can ever seize the health benefits that the exercise confers on me or the joy that I may have experienced by choosing to work less and pursue those activities. Money, on the other hand, can be fleeting.

It is good that you have come to me for financial advice instead of e-mailing Garth. Because, as you know, he would have started off his blog post by publicly and colourfully ridiculing your e-mail and then arrogantly suggesting that you liquidate all of your real estate holdings to hand that money over to him where he will gladly manage it in exchange for 1% of its value annually.

I agree that everything seems overpriced right now (as everything has seemed for a few years now). GTA real estate appears to be overvalued. But the stock markets have also been on a 9 year bull run and seem due to correct or crash with P/E ratios stretched as they are. Meanwhile fixed income assets are yielding very little and are barely keeping pace with inflation. I think that these distortions are due to the unprecedentedly loose monetary policies that we have had since the financial crisis of 2008. So what to do?

I guess my suggestion would be to be diversified since no one can ever know what lies around the corner. Why not simply keep the three investment properties but gradually become more diversified by not adding any more properties and instead growing your financial assets while including a fixed-income component (GICs or bonds). I agree that it does not make sense to liquidate your rental properties as doing so would cause you to incur large transaction costs (real estate agent commission etc…) and would trigger massive capital gains taxes that would only leave you with less capital to invest in other things. Perhaps you could instead funnel your rental income into a diversified portfolio such that over time you are more balanced and less heavily invested in residential GTA real estate as a percentage of your net worth. I think that would be a sensible approach.

As for paying down the mortgages, I would be tempted to do that if it was me. Sure the mortgage rate might only be 2% (for now) while stocks are rising at 20% per year and doing so will cause you to be even more heavily invested in real estate as a percentage of your assets, but paying down the mortgages will reduce your risk and will provide you with a guaranteed 2% return. If the real estate market / rental markets do collapse (as Garth suggests) then having the mortgages paid off will allow you to fare better than your competing landlords who are no doubt heavily leveraged. In such a situation, you could maintain a profitable rental operation at significantly lower rental rates if you had no mortgage while your competitors would be forced to sell their money-losing leveraged rental properties at fire sale prices. Being conservative as I am I would definitely not leverage up more in an attempt to possibly make more money.

But remember that the fruits of your labour can be taken from you by others. So above all, try to enjoy yourself 🙂