Monday, March 23, 2009

How much is your time worth?

I really do want to know because my time is not free given there is not enough of it. So when I look at an investment, be it real estate, stocks, or a business venture, how should I account for my time?

Let’s take a simple example of a couple looking to diversify and add some real estate to their investment portfolio. They talk it over, look at the success and failure stories, think a bit about the responsibilities, and decide to look for an investment property, planning to manage it themselves. After 2 months of searching, driving to open houses and viewings, discussing over dinner, running the numbers, many offers, negotiations, inspections, mortgage approval, negotiation, and signing, and eventual closing proceedings, they purchase a condo with prospects of a cash flow positive rental income.

After countless hours of work they now have a property to rent out. Now comes the easy bit. Rental listings, fielding calls of interest, shortlisting applicants, background checks, interviews, viewings, and the eventual contract signing and logistics of occupancy.

Now the checks roll in. They go to the bank and deposit the cheques. Then there’s the property tax payments, regular reading of strata minutes, (hopefully few) maintenance calls, possibly handling of complaints of neighbours (if they’re really unlucky), and the added complexity to their income taxes.

Then there’s handling termination of occupancy, walkthroughs, and negotiation of damage deposit refund. See paragraph 3.

Every few years there will be some semblance of major repairs. Now there are the contractor interviews, planning, negotiation, reviewing and signing of contracts, oversight, and audit of the work; if they’re lucky not much more than this. Or they can go it themselves and do the plans, buy the materials, work weekends, and hopefully not spend crazy amounts of time doing it.

When they eventually sell this property there are outlays including interviewing Realtors, signing the contract, negotiating, giving tenants notice, employing a lawyer/notary, and the eventual property transfer itself. Never mind the tangible commissions and other taxes and fees.

But still, the property, at least as the cash flow statement indicates, is profitable. But what if we simply look at this investment if we assume we are running a business? Here all costs, including the initial investigation, contract negotiations, operations, accounting, and capital outlays, all must be budgeted for as if employees are paid to perform these tasks. The costs conveniently forgotten on the cash flow statement of a small-time investor start adding up.

I hear countless stories about a property being “cash flow positive” looking at the basic cash outlays: rent coming in, mortgage, maintenance, and taxes going out. Yet if we start including other costs, assuming others were fairly paid for doing this work, all of a sudden, given one’s time has value, the “cash flow positive” investment is anything but. Often I hear the justifications for all this; “sweat equity” is a favourite of mine, putting some intangible return on time spent, but an even better one is that renovation and real estate is really a hobby, a pastime whose efforts would be done for free anyways. Right. To be fair I hear the same for other types of investments too. Investments take time to manage, though some take more time than others.

It is well worth asking how corporate investors, who cannot hide all the "other" costs of managing investments on their balance sheets, make a decent return in the first place. If or when purpose-built rentals become feasible in Vancouver again, what type of yield will be required?

7 comments:

RentingSucks said...

I think "cash flowing" at 25 percent down is a good minimum guideline in normal times because at least you're not bleeding money every month. It gives you a good running start to making money. In a normal market appreciation would likely make up for the rest. As far as I know this has never (or very rarely) happened in Vancouver.

In this market I think there is substantially more risk and that even if you could cash flow at 25 percent it shouldn't be enough. The likelihood of rents going down, interest rates going up and prices going down is just too high. In fact it's likley all 3 things are going to happen.

patriotz said...

I think "cash flowing" at 25 percent down is a good minimum guideline... As far as I know this has never (or very rarely) happened in Vancouver.

Quite the contrary, it was the norm before the 1970's. In the 1930's you had net cash flow of 50% of gross, i.e. rent was twice ownership costs.

Since around 1973 it has been only the case at the bottom of bear markets - the real (flat nominal) bear market of the late 70's, the 80's bust, and the late 90's bear market.

The situation since the early 70's has been driven by a convergence of economic (inflation then disinflation) and demographic factors, and I think we're headed back to the old norm. As usual, look to the US which is a couple of years ahead of us to see what's in store.

jesse said...

"I think "cash flowing" at 25 percent down is a good minimum guideline in normal times"

Sounds reasonable, except what costs are part of calculating your cash flow? Is there any overhead not included?

david said...

ssshhh dont tell people not to rent their places. I plan on renting for the next 2 or so years until the cost of owning is once again reasonable (assuming that happens). So it's good for me if theres lots of people renting out places cause i get more choice and hopefully lower prices. Also if there's no one renting places, where will all of the people who can't afford places right now (see: everyone) live?

RentingSucks said...

Sounds reasonable, except what costs are part of calculating your cash flow? Is there any overhead not included?

For a condo I included both property taxes and maintenance fees on top of the mortgage. This does leave out emergency repairs, your time to "run" the rental and bad luck like tenants trashing the place or skipping out without paying a month or two of rent.

This brings up and interesting question though about a house cash flowing. It is my understanding that you will inevitably pay maintenance fees like a condo but of course you have control over what level of upkeep you want. Typically landlords choose a lower level of upkeep to control their expenses because they don't actually live in the place. But anyway would you want to add +200 to your cashflow to cover regular upkeep?

This is all academic anyway. According to patriotz we have got "cashflow" only at the bottom of bear markets. I almost bought in 1998 which I think was close to the bottom. The mortgage would have been close to my rent by property taxes maintenance fees would have taken me well above. Although if you were careful selecting properties you could likely find numbers that worked pretty well.

jesse said...

RentingSucks, that is true. I would add that, should one want look at an investment including all costs, the other front-end and back-end costs should be accounted for, including the time spent for initial purchase and eventual sale. The time spent before and after the property "cash flows" can add up and must be accounted for when we try to guess when a corporation would be willing to invest in real estate, commercial or residential.

Adding risk and contingency is another related topic but that to some degree is built in to the return a company would be expecting from an investment.

I don't know if it's truly "academic". The time spent managing an investment is real and has value. I am trying to call out that a "passive" investment's returns on paper is not necessarily apples-to-apples to an "active" investment if your time has value and is not properly accounted for.

patriotz said...

it is my understanding that you will inevitably pay maintenance fees (for a house) like a condo but of course you have control over what level of upkeep you want.

Absolutely right, and it is yet another reason why a condo should have a lower price/rent multiple than a house. You do not have control over major expenses, have no recourse if the strata does not perform proper maintenance, and do not have the option of performing work yourself or selecting who to hire.

Indeed, this means that a condo should have a lower price/rent than a multi-unit rental, not the present absurd situation where it's the other way around by a substantial margin.

It's just staggering what poor value condos are at today's prices, never mind the peak prices of last year.