Brandon Donnelly

Daily insights for city builders, delivered every morning at 6 AM ET. I’m Brandon Donnelly — a Toronto-based real estate developer and founder of Globizen. I’ve been writing here since 2013.

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Tag: finance

  • The case for speculative asset bubbles (and happy new year)

    This is an interesting perspective. It is from Fred Wilson’s annual what-happened-this-past-year post:

    But here is the thing about speculative frenzies – they are generally directionally correct but off in their order of magnitude. And they finance the trend that they are directionally correct about. It may be the case that Tesla’s market capitalization is too high, but that allows Tesla to raise $10bn without diluting more than a few percentage points. And that $10bn will go towards accelerating the conversion of the auto industry from carbon-based fuel to renewable energy. And that is a good thing for society.

    When I first read this my mind immediately went to tulip mania. Was that directionally correct? Did tulip bulbs ultimately rebound and maintain their value over the long-run? I actually don’t know.

    But if you think about the dot-com bubble, that was directionally correct. Sure, infamous “companies” like Pets.com never ended up going anywhere, but the idea of tech and the internet becoming dominant was absolutely right.

    Fast forward twenty years and you can be sure that many people are now buying their pet supplies online, along with pretty much everything else. Sometimes we simply overshoot and get the timing wrong.

    This is perhaps a good thought for all of us to consider as we welcome 2021 and say goodbye to what was one weird and terrible year.

    Being directionally correct means that it’s okay for there to be bumps, mistakes, and speculative frenzies along the way. They are expected. What matters is the path forward.

    Happy new year, everyone.

  • Thinking exponentially and the rule of 72

    I came across the above Twitter thread last night before bed and I thought it was great. It’s about the importance of thinking exponentially, as opposed to linearly, when it comes to finance and investing.

    In it, the author provides a quick rule of thumb to help reframe our mind when it comes to compounding. It’s called the “rule of 72” and it works like this.

    To calculate the approximate number of years to double your money, simply take 72 and divide it by the annualized rate of return (%). For example, if you had an annualized rate of return of 10%, this rule of thumb would tell you that you’re going to need 7.2 years to double your money.

    If the annualized rate of return were to increase to 18%, it would now only take you 4 years to double your money. Of course, this rule of thumb is an approximation. It only really works within a certain band of returns.

    If the annualized rate of return were 100%, this formula would spit out 0.72 years, whereas an annualized rate of return of 100% actually means that you’re doubling your money in the span of one year.

    It’s a rule of thumb. The reality is that compound returns are incredibly powerful over the long-run, not only for finance and investing, but for life in general. Worthwhile things take time. If you’ve got the patience and discipline, the long-run curve ends up looking pretty sweet.

  • Non-consensus thinking

    The venture capital industry likes to talk about the importance of investing in ideas that are and turn out to be both non-consensus and successful. The idea here is that if an idea or opportunity is already consensus, then there’s too much money flooding into that space and it becomes too difficult to make money. This is particularly true in venture capital where a select few companies usually end up generating most of the returns. This is a high risk business. Supposedly, even the best VCs end up having to write off a big portion of their deals.

    But I don’t think that this logic need only apply to venture capital. In real estate development, you are often faced with similar situations. For example, if an area is already consensus — that is, it is already considered to be highly desirable — then capital is going to naturally flow into it and land prices will be relatively high. These high land prices might be justified by the revenue side of your pro forma, or they might not be. I know many developers who avoid “core” locations simply because the land is too much and the margins are too little.

    On the other hand, if an area is non-consensus — that is, you’re not sure people will want to rent or buy new space in the area — then the land prices should reflect this. But here’s the thing. What you’re doing is trading, among other things, a lower land price for greater market risk. Because the non-consensus bet could turn out to be either successful or unsuccessful. People will either want to occupy space here or they won’t. And remember, by definition, it being non-consensus means that most people believe they won’t — or at least not at the prices you might need in order to make the math work.

    What all of this means is that if you’re right about something that most people think is wrong, then you have the opportunity to do quite well. (Though I am not suggesting that you need to follow this framework in all situations.) This is on my mind right now because it feels to me that there are certain consensus opinions emerging as a result of this pandemic. For example, opinions around the demise of office space and the demise of downtown living. If you’re a regular reader of this blog, you’ll know that I think these death-of-the-city predictions are largely bullshit.

    I could be wrong. Or I could be right.

  • The future is unknowable

    I am sure many of you are getting tired of the news. I know I am. But it turns out that when you’re in a global pandemic and you spend the entirety of your day looking at Zoom — while fidgeting your leg, I might add — there’s only so much else you can talk and write about.

    One of the more interesting things you could read is Howard Marks’ memos. Howard is the co-founder of Oaktree Capital Management and, from what I can tell, he’s been writing since 1990. Some years it’s an annual memo and some years — like this year — he writes a bunch more. His most recent is regarding, “Knowledge of the Future.”

    If I had to summarize it: The future is unknowable and none of us can say with any certainty what the next quarter or the next year is going to look like. In Howard’s words: “These days everyone has the same data regarding the present and the same ignorance regarding the future.”

    Most of the time, he explains, we simply extrapolate from the past and then apply our own biases to come up with a prediction. Howard describes himself as more of a worrier, whereas I would describe myself as more of an optimist. I believe, to a certain extent, in creating self-fulfilling prophecies.

    Notwithstanding our inability to predict the future (which isn’t a new phenomenon), I think it’s important to have opinions and take positions. Any decision is better than no decision, right?

    For a full archive of Howard Marks’ memos, click here.

  • Landed is helping teachers buy homes

    The average salary of a teacher in the United States was approximately $61,730 last year. This can make homeownership in high cost areas a challenge.

    Here is a chart from Curbed:

    Landed is trying to solve this problem by offering downpayment assistance to “essential professionals” — starting first with teachers — so that they can buy homes in and near the communities that they serve.

    The way it works is pretty simple.

    They’ll contribute up to half of a traditional 20% downpayment — so 10% of the value of the home — in exchange for a 25% share in any future gains, or losses.

    Put differently, for every 1% that Landed contributes, it takes 2.5% of any future appreciation (or depreciation). However, on an equity basis, they are actually putting up 50% of the required cash (in the maximum scenario) in order to get 25% of any future gains.

    There’s no monthly payment associated with Landed’s money, but it does need to be repaid at the end of 30 years or when the homeowner exits the agreement, whichever comes first. Homeowners are free to repay Landed at any time should they decide to sell the property or they just want to pay them out.

    Landed pitches the service as another version of “the bank of mom and dad.” And for many prospective homeowners, I am sure that it makes all the difference in the world.

    At first glance, it would seem that each homeowner also benefits from a kind of positive leverage. They only put up 50% of the required equity, but they get to enjoy 75% of the potential gains. However, each homeowner is also responsible for 100% of the carrying costs.

    I ran a couple of quick return scenarios, assuming a $500,000 purchase price and a 10 year hold, in order to test whether Landed or the homeowner would receive a higher IRR once the property gets sold.

    I didn’t carry any transaction costs, but I did factor in principal recapture, as well as utilities, insurance, and maintenance.

    My rough numbers suggest that it depends on the annual rate of appreciation. If appreciation stays close to the rate of inflation, it could tip in favor of Landed because they don’t put out any money after t = 0.

    But at higher rates of appreciation, the homeowner starts to benefit from the favorable 75/25 split at the end of the hold period.

    Either way, Landed is providing a service to people who may not otherwise be able to afford to buy a home. That has value. Here’s some more information on how it works, in case you’re interested.

  • The Apple Card fine print

    Apple announced a number of new products and services this week, including Apple TV+ and a new Apple credit card, which will initially only be available in the US.

    It all aligns nicely with their goal of growing their service/subscription businesses and weaning themselves off of an over-dependence on iPhone revenue.

    Below is a video summary of the new Apple Card. In typical Apple fashion, it sounds and looks like an elegant solution and I already want to one.

    I thought this topic would make an interesting follow-up to my recent post about whether cities should be banning cashless businesses so as to not discriminate against the “unbanked.”

    Because embedded in the above credit card is the following cashback reward structure:

    • 3% back on Apple purchases
    • 2% back on purchases made with Apple Pay (iPhone)
    • 1% back on purchases made with the (optional) physical card

    And so what this “card” will do is pay you to always use your phone. The cashback reward system is also instantaneous and you’ll be able to spend that Daily Cash (that’s the name) just like you would actual cash.

    Do you think this would change how you pay for things? I think for most people it will.

  • How impactful will the new First-Time Home Buyer Incentive be?

    This week’s federal budget announced two measures that are intended to improve housing affordability.

    The first is a modification to the Home Buyers’ Plan. This is a plan that gives first-time home buyers the ability to do a tax-free withdrawal from their RRSP (it does, however, have to be repaid within 15 years). The withdrawal limit was increased from $25,000 to $35,000.

    The second measure, which is the one that got everyone’s attention, is the new First-Time Home Buyer Incentive. Through this program, CMHC will offer first-time home buyers (who have the minimum down payment required for an insured mortgage) the option of a “CMHC shared equity mortgage.”

    What this effectively means is that CMHC will give first-time buyers an interest-free contribution for 10% of the purchase price of a new home (5% in the case of a resale). There’s no interest, but it does need to be paid back at the time of a sale. The higher percentage for new build homes is intended to stimulate housing supply.

    It is still not clear whether CMHC will be expecting to participate in any increase (or decrease) in the value of the properties. But presumably, yes, since it’s called a “shared equity mortgage.” All of this is expected to come into force by the fall.

    Here’s an example of how this program is intended to work.

    If a first-time buyer purchases a new home for $400,000 with a 5% down payment, the insured mortgage amount would normally be $380,000. This is the highest loan-to-value you can get with CMHC mortgage loan insurance. With this new measure, the mortgage size would reduce to $340,000 and so the purchaser’s monthly debt service would drop accordingly, thereby helping with overall affordability.

    The caveat to all of this is that this incentive will only be available to first-time home buyers with a household income under $120,000, and the insured mortgage and incentive amount cannot be greater than 4x the participants’ annual household income.

    What this means is that this program really only touches the sub $500,000 market. And in highly desirable cities like Toronto and Vancouver, that market isn’t all that big.

  • And we’re back

    Welcome to 2019.

    I am currently in transit and catching up on some internet reading and email on my way back to Toronto.

    At this time of year it is, of course, common to reminisce (or lament) about what happened over the last year, as well prognosticate what may come.

    Over the last few years, I have done a bit of that on the blog. But I clearly didn’t do that this year while in Brazil (and away from any semblance of a workspace).

    So here’s what others have been writing and thinking about over the holidays:

    – 2018’s tech trends and tribulations in 14 charts. Recode. Link

    – 2018 was the year of the YIMBY. CityLab. Link

    – A cool girl’s guide to Toronto. Vogue. Link

    – Amazon’s annual Christmas press release. Link

    – Best travel posts of 2018. Design Milk. Link

    – Here’s (Almost) Everything Wall Street Expects in 2019. Bloomberg. Link

    – Here’s what to expect in cybersecurity in 2019. TechCrunch. Link

    – Naive to hope Toronto can change in 2019? That means we have work to do. Shawn Micallef. Link 

    – The 10 largest US venture rounds of 2019. TechCrunch. Link

    – What is going to happen in 2019. Fred Wilson. Link

    – Will a recession hit in 2019? Alan Murray. Link

    – Year in search 2018. Google. Link

  • Two sides of the same bitcoin

    Warren Buffet recently said in a Yahoo Finance interview that when you buy cryptocurrencies you’re not actually investing. Instead, you’re speculating – speculating that “somebody else will come along and pay more money tomorrow.” Investments need to generate a return. And nobody is at all clear on how to value these crypto-assets. This is noteworthy, of course, because it’s Buffet.

    But I thought Fred Wilson wrote a good rebuttal on his blog where he points out that, while, yes, a discounted cash flow model isn’t going to be very useful in helping you determine value in this instance, what we are actually seeing is, “the creation of a new internet, built upon protocols that allow for decentralized networks to form…” We’ve talked about this many times before on the blog.

    So where I stand on this debate is that I agree with both Warren and Fred. I don’t see crypto-assets as something I want to start putting a lot of money into right now because I don’t know how to calculate what the IRR may be. But at the same time, if crypto-assets are creating decentralized infrastructure that will one day power the “new internet”, I am positive this new internet will eventually create businesses that will fit into Warren’s definition of an investment. 

  • More than a real estate company — a state of consciousness

    Matt Levine’s most recent Money Stuff article is classic Matt Levine. It is both entertaining and informative. This one is on WeWork – the coworking startup that has committed to 14 million square feet of office space around the world and will have $18 billion in rent payments due over the next decade.

    Here is an excerpt:

    WeWork Cos. is a real-estate company with a couple of innovative twists on the model. First, rather than owning its buildings, it rents them: It leases office space from regular real-estate companies, adds … beer? … or whatever, and then subleases the space to tenants at higher rates. And second, rather than being valued like a real-estate company, it gets valued like a hot tech startup — “the sharing economy,” ping-pong tables, etc. — so it can raise gobs of money from SoftBank Group Corp. at a $20 billion valuation without ever getting particularly close to profitability. And look at all these words:

    “Indeed, to assess WeWork by conventional metrics is to miss the point, according to [Chief Executive Officer Adam] Neumann. WeWork isn’t really a real estate company. It’s a state of consciousness, he argues, a generation of interconnected emotionally intelligent entrepreneurs.”

    Really, what sort of multiple would you put on a state of consciousness?