The Goodwill Investing Journal - Issue #42

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1. Personal Finance

We all know interest rates are coming down as the BOC tries to stimulate the economy.

This means the interest rate on cash / savings / GIC accounts is also decreasing.

My Wealth Simple interest rate on cash is coming down from 3.75% to 3.25%.

So the question is, do you make any sudden changes to your cash savings?

Short answer, no.

For me, I like to think about my total assets in two buckets.

Bucket (1) - 20% of total assets - short term cash needs, emergency expenses, and money for a future down payment.

For this bucket, I won’t make any changes. Even though the interest earned on this money is getting lower, 3.25% is still better than a boot to the head.

It is also extremely important to maintain comfort that our future down payment money is secured and not exposed to any capital loss situation.

Basically any major expenses required in 6-12 month time frame should NOT be invested in the market because even though stocks generally go up, over the short term, anything can happen. Would feel pretty stupid if my down payment money was lower by 30% when it comes time to buy. Therefore, keep it in the interest bearing account.

Again, wealth simple has a fabulous cash spending account that acts like a chequing account, you can tap with your phone, send and receive e-transfers, etc, and it pays 3.25% interest.

Bucket (2) - 80% of total assets - long term growth portfolio invested in S&P500, private real estate and bitcoin. Long time horizon, ability to withstand the ups and downs of the markets, with the overall view that this is where real wealth will be created.

So, no immediate changes needed. Simply managing towards the 80%/20% target on the portfolio.

Readers may have different goals and dreams, so you can adjust your ratios accordingly.

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2. Stock Markets

With Halloween come and gone, I’d like to remind everyone that the scariest thing of all is the hidden tax called inflation.

In my lifetime alone, US Dollars, the reserve currency of the world, have decreased in value 62%. Over 100 years, a 95% reduction in value.

Imagine working your ass off and keeping your savings in cash only to see it cut in half, or more.

There is a whole industry of Wall Street and money managers exist because of this phenomenon. You not only have to work your ass off, but you must invest in a diversified portfolio of assets such as stocks, bonds, commodities, real estate, derivatives, alternatives, etc. to keep your money from decaying.

Whether the inflation is created by too much government spending or simply turning on the printing press (they are inter-related), inflation is a serious problem.

High or low, it will kill you.

Be that as it may, this is the rule of the game and the the ONLY way you can stop it from cutting you down is to invest.

Find ways to invest your hard-earned savings into investments that earn you a long-term return above inflation.

People and businesses compete, innovate, grow, profit, and earn return on equity.

So, find those real returns on equity.

S&P500 is a great place to start.

Other wise your money will get cut down, slowly but surely.

BOO 😱 

3. Real Estate

I had a reader recently ask for more insights on cap rates. Since I brought it up a few months ago, let's revisit it with a little more depth.

The capitalization rate, or "cap rate," is essentially the net operating income (NOI) of a property (rents minus operating expenses) divided by the purchase price.

In other words, if you buy a property for $1,000,000 and it has an NOI of $50,000, it has a cap rate of 5%.

Think of it like a dividend yield in stocks - essentially the cash flow you get as the owner (assuming an all cash purchase; no debt).

Why do cap rates matter?

→ Cap rates are widely used in the real estate industry.

→ Simple to calculate: you just need the NOI and the purchase price.

→ A useful comparison tool: you can quickly see which properties may be over or under-valued vs other similar properties and comparing those cap rates.

→ Flexible for valuation and analysis – if you have two of the inputs, you can find the third.

In the world of commercial real estate, it is the holy grail. At least as a starting point. All else equal, the equivalent property being sold at a higher cap rate is better value because you get more income on your investment.

But as I highlighted before, cap rates aren't a magic bullet; they come with limitations.

For example,

-it does not include the cost of financing. Cap rate of 5% sounds good but if you have to pay 6.5% on your mortgage, that’s not so great after-all as you’ll have to feed the property with cash in your pocket to cover the shortfall.

-it focuses on net operating income, and there a lot of ‘below the operating line’ costs that properties face that are VERY important to understand in addition to the cap rate. Capex, commissions, tenant incentives, financing, etc.

-since it is a point in time static number, it tells you nothing about how your future cash flow will perform. 

-comparing cap rates in different locations is a no no. You can't compare a grocery store in Vancouver with a 5% cap rate and then tell me the equivalent grocery store in Timbuctoo that has a 10% cap rate is a better investment. Timbuctoo might not exist in a few years, so that 10% cash flow today might mislead you into a property that will end up worthless.

-similarly, saying an office property that has a cap rate of 10% is a better investment than a retail property at a 5% cap is also bad practice. Office requires incredible amounts of capital investment - cash flows that are below the operating line, but still real and effing important - in order to minimize vacancy. But a lot of office product is structurally screwed. Did you know that downtown Calgary has 14 million square feet of vacant office? Imagine all of the downtown Vancouver office buildings - about 16 million square feet - being totally empty.

-so no, office cap rates of 10 or 12% don’t guarantee you a good deal. Perhaps a lot of potential upside, but remember, high yield often means high risk.

In sum, cap rates are a great start for evaluating a property but need to be used thoughtfully, especially when factoring in various risks by market, location, property type, and financing.

1 Quote

A Question

Are you doing anything differently to improve yourself lately?

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Thank you

Eddie Gudewill, CFA

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