One of the topics from our recent Couples Retreat was vacation property. I needed some time to show-my-work for why I’ve decided to stay variable.
The question, in the context of both buying and not-buying, was…
Will it make a difference?
The question gives me an opening to share some things I’ve learned from 25 years of real estate investing.
1/. I have yet to regret not-buying a vacation property. When vacation markets appreciate, so do investment markets.
2/. The ones-that-got-away have three main attributes: well located, easy to find tenants and decent cash yield. Vacation properties usually only have one attribute… well located.
I’ll share insights about capital allocation:
=> No one in the company is likely to care more about capital allocation than the boss – the CEO sets a cap on how much people will care about capital, and everything else for that matter.
Extend into your marriage, and family….
=> No one will care more about spending and capital allocation than the individual responsible for earning the income/capital in the first place.
Similar to work ethic… the actions of leadership set a ceiling on what to expect. No amount of legal documentation, and pontificating, can overcome this reality.
Don’t waste energy fretting about the way things are.
Be grateful when you’ve been able to create a team that, largely, follows your lead.
Now the math!
I’ve updated my #s for the two markets I follow most closely.
A vacation market with an effective yield of -3% (cost to own). I avoid fooling myself that I’ll be able to short-term rental myself to breakeven.
An investment market that is generating net cash flow of 2% per annum.
To “get my money back” in the vacation market, the value of the asset needs to grow by 2.5% per annum.
Money back does not mean purchasing power back. The “same” dollars in 15 years time will buy less due to inflation – just look backwards to 2005 in your home real estate market and see what your current place was worth.
We have no idea about what the future holds and 2.5% market growth is probably looking tiny when compared to what you’ve seen over the last year (+30% in my zip code).
You could be right.
I do, however, know markets that are just getting back to their 2008 peaks. In a negative cash flow scenario, that’s a painfully long time to hold.
My goal isn’t to predict an unknowable future. My goal is to answer the question “will it make a difference?”
In the get-your-money-back scenario (2.5% market growth):
Take time to calculate your true cost to hold.
Make sure you’re OK with permanently increasing your burn-rate, especially if there’s debt service.
Know your alternative use of funds => the investment property returns $1.75 for each $1 invested & Vanguard’s VTSAX is currently yielding 1.4%.
The vacation property requires an extra $0.45 for each $1 invested. This is before you decide to renovate and burn $$$s on rugs, curtains and furniture!
For that vacation property, here’s what I do…
Take the purchase cost
Make sure I’m OK with annually spending 5% of purchase cost, forever
Consider if I am OK with writing-off the equivalent of 50% for customization, the cost of ownership and agent’s fees
My personal utilization of past destinations has been 15-45 days per annum.
The future risk to my family is we are priced out of our home market (not that my spouse and kids might have to unpack/pack up from a rental).
I tend to change my mind.
One of the challenges with new deals is my feelings are dominated by the expectation of the asset making things better.
I also enjoy the feelings associated with being able to provide for my spouse and kids.
Making things better & doing right for my family => it’s difficult to feel the benefit of doing nothing.
Once I have a good-enough position, the only person who can screw it up is me.
Investment – the potential for reliable cash flow and long term capital gain
To those I would add:
Signaling – an example from my own life. Before my wife was “my wife,” I bought a townhouse in Boulder. It showed her, I was committed to Boulder. It showed her family, I had the funds to take care of their sister/daughter.
Asthetics – worth between “a lot” and “nothing” depending on my stage of life. As I age, increasingly appreciated. I was 50 before I could relate to the concept of a $1,000,000 view.
Community – In my early 30s, I found myself in Christchurch, NZ. The community was an excellent fit for the life I wanted to live (sharing outdoor activities with friends, elite triathlon). The South Island of New Zealand has always felt “right” to me. On the other side of the equator, was Boulder, Colorado. There I found love and decided to establish my family.
I didn’t need to own real estate for love, community or family. some qualities work best when inverted.
Location inverted => The principle here might be don’t invest anywhere your spouse won’t live.
Asthetics inverted => Absent financial duress, locations you can buy cheap tend to stay cheap.
You can extend to secondary markets.
My family loves Vail.
Rather than buying a 40 yo condo for close to a decade’s worth of core living expenses… we allocated 2% of the capital and joined a world-class ski club.
My annual family ski budget, including club and rental housing, is about the same as what the old condo would cost to own. The principle => don’t capitalize luxury expenditure.
I made this decision because I’m not confident about my life 10 years from now – when I’ll be an empty nester.
In making a decision to “not buy” I have maintained: (a) a cheap option to change my mind in the future, (b) I’m still debt free, and (c) my capital is available to be used elsewhere.
About elsewhere… I am very confident that my children are going to be grateful that I kept the family invested in the Boulder real estate market. Hedge the risk your family will be priced out of the place your kids grew up.
Of course, this assumes you are living in a place you don’t want to leave. It’s not just your spouse you should pay attention to…
The above components can work against each other.
For example, signaling vs return on investment. I’ll give an example…
After we married, I bought a very large house, not far off the size of a small school. The bills, and constant yard work, took the fun out of ownership. Being a big shot turned out differently than I expected.
This experience nudged me into a principle, apply the minimum capital to achieve the goal and pay attention to the cost of ownership (money, emotion, time).
And that’s really the point I wanted to make.
In a hot market
Consider the need you are seeking to fill
Pay attention to the cost in time, emotion and ownership
Remember that capital is precious and leverage can trap you in situations where a renter can easily exit
If your time horizon is less than a decade then rent
All of this is easier to see when you’ve been through a few recessions. At the start of 2009, I promised myself to never opt-in to avoidable financial stress.
The tough part is building the capital and credit capacity to be able to buy.
Whatever you were seeking to achieve, you achieved it BEFORE you purchased.
The picture is what it cost to send a first class letter when I married my lovely wife. The 55c cost today (+34%) is a reminder that inflation ticks away one penny at a time.
When it comes to inflation/deflation, I like to maintain a neutral position. More broadly, I seek to avoid the need to pick winners.
I also avoid making predictions about an unknowable future. Most importantly, because it’s impossible (!) but also because I have no idea what my life is going to be like ten years from now.
What follows is present-focused.
Quantify Your Exposure
Start with your core cost of living – that’s what’s going to inflate and outliving your money is a key risk.
What’s in my Core Cost of Living?
Healthcare ($19,300 of premiums and $7,200 to a family HSA for a plan with a $14K family deductible) – this sector is ripe for disruption, I get little for my spending
Taxes, Utilities, Car Costs and Insurance
Food, Clothing and Kid Activities
Childcare – a massive line item 2009 to 2019, now a source of income for the family, our middle-schooler is a sitter
Mortgage, rent, car loans – my main project from 2010 to 2020 was getting this down to zero – once that was achieved, I went a step further and turned it into a source of income
Next, consider your sources of passive and active income. Rents, royalties, dividends, interest (at least in the good old days), consulting and any other forms of income. Write it all out.
Compare your Cost of Living with the Sources of Income and calculate your net burn rate, or your net annual surplus.
Net annual surplus gets routed to discretionary spending, luxury items and/or new investment capital.
The best investment decision I ever made had nothing to do with asset allocation. From 1990 to 2008, I routed 50% of my gross income to new investment capital.
In my early 20s – healthcare costs were peanuts, no childcare costs, living in a shared apartment… I saved a ton. Good thing, too. I had no idea how much my cost of living would pop when I had kids.
My 40s (2009 to 2018) saw unexpected unemployment combine with a big jump in childcare, healthcare and housing costs. This resulted in a burn rate that forced us to make a series of changes, and choices, which proved quite useful in hindsight.
Also write out your balance sheet – assets and liabilities.
Include a liability called “deferred tax and agent’s fees“. Estimate this liability as 6% of the gross value of all the real estate you own plus 25% of all the capital gains in your portfolio (exclude the exempt portion of the gain on your primary residence). Making this number real will help you avoid incurring unnecessary expenses by tinkering with your assets.
I started thinking about this with negative-yielding sovereign bonds. When something makes no sense to me, I pause and reconsider my assumptions.
The phenomenon, of not being able to understand buyers, has now spread across markets and asset classes. In markets I know well, I’m being out-bid by 20-25%. Missing by a lot, makes it easier to sit out.
The goals and incentives have shifted, and it’s taken me a long time to notice.
A big chunk of global capital sits as a hedge against the value of money declining. A decline in the value of money:
is seen as a risk for the financially wealthy – a very human trait of worrying about wealth that’s far above one’s requirements for a meaningful life
Over my lifetime, we’ve shifted to a society where wealth is controlled by:
People managing Other People’s Money, with access to debt and options on gains
Fewer and fewer people, managing more and more money
Toss in near-zero rates and we’ve reduced the incentive for investment discipline.
A shift away from treasuries is painful when they are yielding over 5%. Less so, today. The shift in attitude has happened very slowly – it took more than a decade.
For a species that worries about $4.99 shipping charges (when they save TIME from leaving the house)… Cash Returns Matter – the absence of cash returns gives an incentive to devalue safety.
With negative 10-year (!) rates, the European incentive (to flee safety) must be extreme.
It’s emotionally easier to own marginal assets when cash yields nothing (and you are seeing paper gains across most asset classes).
Risk has been rewarded and reinforced across a generation, maybe two generations.
While it started with good intentions, recent monetary policy has had the unintended consequence of rapidly inflating the assets of the already (super)wealthy. When I think about the resulting incentives for risk tolerance, government spending and borrowing, that strikes me as bad policy.
I’ve no idea how, or when, this play out. Fortunately, I’ve set my life up so I don’t need to be correct with uni-directional bets.
Careful with margin-debt and recourse leverage, it’s been one heck of a run.
With yields this low, there is tremendous leverage built into the system.
I’ll be back posting in 2021 – it’s been a solid year of writing.
I’m not young enough to earn it all back, nor am I old enough to lock-it-in and forego further capital appreciation. I checked our joint life expectancy and we’re 50/50 to get another 40 years.
Given that I’m debt free, I’m hurt more by a doubling, after selling, than a halving, and still owning.
Think that through – it goes against every emotion I have with regard to money (and I’ve had a lot of training).
Married, at 51, I need to be taking a 30-50 year view.
Accept the reality of my personal situation and remember the financial reality of near-zero rates.
Lean into severe downturns
Maintain options, and skills, to add value-added work
Stay debt free – while this is a great time to borrow against cash flow, borrowing against margin is nuts – at some point, the debt cycle will snap back and I do not want to get closed out in a sell off
Keep my spending choices in check – know that every choice I make sets a baseline for my kids to follow AND creates a cash flow requirement for the rest of my life
Here’s the key lesson from my early retirement => If I’d gotten spooked and sold out (I get nervous in rapidly rising markets) then I wouldn’t have had the capital to buy back my existing positions, which remain “good enough” for my needs.
In a Free Money Era, the risk many of us face is acting on our fears and being priced out of a portfolio we never needed to leave in the first place.
Control your risks by focusing on skills, spending, relationships and daily exercise. These are things I control. Global macroeconomic policy, less so.
Tomorrow, why the heck are people buying non-, and negative-, yielding assets at current pricing?
Sorry about the dud link yesterday at the bottom – it was the same as the one at the top of the page, which worked. Here is is again, it’s the link to a calculation which led to some major changes in my life. Putting a price on my time.
Yesterday, I described the forces creating rapid lifestyle, luxury good and financial asset inflation.
What to do?
Aspire to skills, ignore asset-driven status.
Near-zero yields have created a very different world than I grew up in.
The skillful can easily lease their needs, at a tiny fraction of the cost to acquire.
Businesses, like property management, that charge based on a %age of revenue are bargains, for both sides of the relationship. Managers can scale valuations at PE ratios over 50x net earnings. Owners pay 0.1-0.25% p.a. (of capital) for expert services. Both sides of this equation were unimaginable 30 years ago. Another way to look at this => “Vanguard” pricing is moving across asset classes.
In a world with tiny cap-rates and huge PE ratios, Human Capital is very, very valuable.
Let’s look at an example.
I like to follow real estate, particularly Luxury and Vacation markets. In these markets, there are many people who own $1-10 million places.
Annually, these places cost $15,000 – $100,000 p.a. (cash) to own and, often, sit empty. The cost to hold is not a big deal for these owners because they can afford it.
I’ve always wanted to visit Jackson, WY so I jumped on Airbnb and had a look around. I can lease a Jackson Hole penthouse, roughly equivalent to my net worth, for a few days.
My cost is…
1/20th of the annual cost to own,
1/1000th of the capital cost, and
maintenance is someone else’s problem.
Thanks to Airbnb, there’s real value here, especially as I am the one who keeps his freedom.
freedom to leave
freedom to change my mind
freedom to allocate time, share of mind and capital elsewhere
This will be rolled across every under-utilized (negative-yielding and/or depreciating) asset class within our economy. Airbnb’s $100 BILLION market cap, Free Money and the 1000-fold increase in VC gains will make it happen.
Don’t get caught up in the ridiculous valuations we are seeing – what’s important is understanding the process of change.
In a micro-yield world, it costs me 1/1000th of the capital value to get all the annual consumption I desire.
The only reason to buy is to show off, and that’s what humans do. Actually, there is another reason to buy and I’ll touch on that in a couple days.
Given we will stay human, I do not see these changes as a bearish case for asset values, which are driven by the price of money, mood and scarcity.
However, I do think it changes the mental calculus for a young person. In a highly mobile, rapidly changing environment, the assets your (grand)parents aspired to own are a lousy place to put your financial capital.
Tomorrow, some nitty gritty for 16-21 year olds.
PS – I didn’t book the penthouse. I went for a (refundable) 3-bed condo across the street from a playground. I make most decisions assuming they will be multiplied (x3) by my children when they grow up. I like to leave my kids room to (hedonistically) improve on my choices.
Watching DoorDash and Airbnb go public this week, brought home how much markets have changed from the 90s.
Big deals are up 1,000-fold in 40 years.
I graduated university in early 1990s, and was born in the late 1960s => part of the first generation to come of age after the very inflationary 70s.
The mentors, and wise-old-men, of my early career had been heavily influenced by their experience with price-inflation. In turn, when those vets had been young stallions, they were influenced by survivors of the Great Depression.
I received a very conservative financial education.
These days we’re told we don’t have enough inflation.
I’m not sure about that => the price to buy $1 of cash flow has skyrocketed.
I’ll post the last 40 years of price inflation below.
Watching Airbnb/DoorDash/Bitcoin/Tesla, and looking at luxury real estate, I see inflation at work, but differently.
Inflation is not necessarily a bad thing – there’s never been a better time to be world-class at solving problems for people. More on that later.
I see a tsunami of money.
At market tops, it is easy to find people congratulating themselves for their vision. A favorite quote (from a very successful friend of the family) is “some see, others saw.”
Something I failed to see, when I was on the inside, was the benefit received from:
The global money tsunami
Constantly dropping long term rates (the current 30-year rate implies a PE ratio over 50x)
Increasing investor allocations to our sector
Add non-recourse leverage, ring fence the deals/funds and there was no way to lose.
Of course, we didn’t see it that way => we were smart, we worked hard and we were visionaries.
Now, I’m not so sure.
Tomorrow => what this era might mean for my kids, effectively, two generations behind me.
What strikes me most about COVID is how little we’ve been asked to do.
For those of us who avoided unemployment:
Stay at home
Wear a mask
Spend a lot of time with our children
I embraced all three, eventually.
Seven months in, our youngest can run her home school:
Print daily schedule
Follow links to online classes
Turn in her work
Make lunch and snacks
It’s not ideal but it’s good enough given the underlying reality.
An interesting part of the underlying reality is how well the top of tier of our society has been doing.
The noise of the election has been drowning out this story.
I made three financial decisions this year.
Sale & leaseback of my house (January)
Roll two years cash flow from bonds to equities (March 18-24)
Ski local, reallocate ski money into a new car (Q4)
Similar to 2009-2012, I expected to do a lot more.
However, I’ve done enough. Enough to set up the next decade and enable me to focus on what matters.
That’s a lesson.
If you’re focused on “what matters” then there’s not going to be many decisions to make. Most of your focus is going to be on the day to day (exercise, family, admin, relationships, marriage).
If, like me, you are someone who likes getting stuff completed then you’ll do well to create an outlet (other than churning your portfolio) for this aspect of your personality. Otherwise, you’re going to run up a lot of expenses, pay excessive fees/taxes and greatly increase your chance for unforced errors.
In your larger life, if you don’t give yourself something useful to do then politics, social media and petty pursuits will fill your time.
I need to watch out for these distractions => they bring out of the worst aspects of my personality.
Pay attention to who, and what, brings out your best.
The best investment I made this year was the month I spent weaning myself off social media.
It’s difficult to see the net negative return of Facebook/Instagram until you are outside of their feedback loops.
At its core, Facebook makes it easier for bullshit to reach me.
For others, Facebook makes it easy to argue.
For all of us, the algorithms reinforce confirmation bias and reduce our ability to think clearly.
The algorithms are everywhere – they live in every web interaction we have.
Instagram stimulated my desire to buy stuff and reduced my satisfaction with who I am.
Both platforms are pleasurable but what’s the source of the pleasure? The source is external validation on appearances.
Far more powerful is an internal validation for the actions I take, daily, for myself and my family.
True power is the capacity to create a feeling of goodness for the actions you take, daily, in your own life.
What was your biggest problem of 1, 5 and 10 years ago?
Can you even remember?
The biggest challenge of my last decade was a little girl who doesn’t exist anymore.
She’s gone and has been replaced by someone who’s an absolute star.
The difficulties of COVID enabled her, and me, to shine.