COVID-19 Coronavirus Portfolio

This is a COVID-19 coronavirus portfolio of trading ideas generated in the last two months. The portfolio aim is to identify and invest in new trends in commodities or sector ETFs generated by either government policy monetary policy response or “shelter in place” lockdowns.

Covid-19 coronavirus portfolio - world map - 20200416

This collection of trading ideas was setup somewhat quickly as a tactical portfolio in response to the COVID-19 Corona Virus situation. The fundamental portfolio theme is that the market has been almost instantly split into winners and losers, Some industries have simply been decimated overnight that they can’t function as viable businesses for the immediate future. For example, even Warren Buffet completely sold all Berkshire Hathaway’s US airlines in April 2020. The aim of this tactical portfolio is to think about trading ideas that can generate winners in the “new normal”.

COVID-19 coronavirus portfolio – Option Volatility

Volatility is very high in most commodities and sectors, so it is critical to use option trading strategies for high volatility environments. Specifically Implied Volatility Rank (IVR) is in the range of 75% to 100% for many ETFs this month. Simple one leg option strategies such as buying out of the money calls in high volatility products will likely not do well. The “go to” trade on ETF options has typically been to buy long dated deep in the calls (LEAPs greater than 9 months out). This means that the majority of premium paid is intrinsic not extrinsic (time) value – the extrinsic value will likely reduce over the course of several months as the current volatility premium likely goes lower. To help with any downside, call spread overwriting and put butterflies on the same ETFs. There was also call spread overwriting in major tech indexes to hedge some downside in tech ETFs that do not have any options. Where no ETF options were available, actual ETF equity positions were taken, but sized appropriately at less than 10% of portfolio size.

COVID-19 coronavirus portfolio – Trade Ideas

The exact thinking behind the ideas need more detailed separate blog posts to fully justify their inclusion. However this tactical portfolio blog post is just to give the trade ideas, their high level implementation and any hedging strategy. This following ideas show the sector, idea rating (buy/hold/sell), the conviction level (low/medium/high) and a high level idea description.

New trades with “Buy” where started in the last 45 days. If a “Hold” is included in this portfolio that means it was already owned, but think performance would improve because of COVID-19 Corona Virus environment. The aim would be to hold most of these for 2020, or until stopped out.

Each paragraph describes a trade idea within a sector (including trade direction), rating (Buy/Hold/Sell) and overall conviction level.

Real Estate and Liquidity

Real Estate (Long). Hold/Buy. Medium. Select international opportunities mostly due to strong USD creating weaker local currencies and lower prices on local real estate. Here “local” means local to a target country in question, specifically Canada and UK whose currencies have been beaten up quite a bit due to flight to safety buying of USD. Keeping liquid in USD to maybe a currency conversion later in 2020 for a property purchase. Not rushing into anything. Actively writing a new Ebook for US investors on future opportunities with international real estate in 2020 and beyond.

Metals

Gold (Long). Buy. High. Gold is one of the best performing assets YTD in USD, and rebounded very quickly with after an initial March 2020 sell offs. The rebound was a direct response to the FED stimulus packages for the general economy. Gold is trading at 7 year highs in USD (near $1700) but importantly gold has made already made new all time highs in just about every other major currency such as Euro, UK Pounds, Canadian Dollars (etc). Select currency and 20 years on this Bullion Vault to chart historical gold price in each currency. Bought deep in the money calls on physical gold ETF (GLD) with an approximately 90 delta for Jan 2022. Aim is maintain a gold position, to ultimately replace with some actual physical gold, when the current spot to physical price premium subside. Aside from just the physical metal, gold miners should benefit from lower oil prices and therefore have reduced input costs, that should increase earnings per share in 2020 and beyond. Gold miners are up about 30% since purchase of Jan 2021 deep in the money calls in both major (GDX) and juniors (GDXJ). These are potentially multi year longs.

Silver (Long). Buy. High. The gold/silver ratio is at about 113 which means that silver is historically very undervalued compared to gold. Interestingly the silver price is approximately tracked the Dow (DIA) year to date, being down about 15% – so it does have more of an industrial market supply and demand component. Gold tends to function as a true safe haven, but silver can influenced by industrial supply and demand from economic conditions. Silver can definitely sell off in a general market downturn, where as gold is holding its value better. However if there is to be a significant gold bull market, silver will tag along for the ride, but may take more time to turn around. Trade was bought physical silver and silver metal (SLV). Bought deep in the money calls with an approximately 85 delta for Jan 2021.

Uranium mining stocks (Long). Potental new uranium bull market for 2020s. Uranium producers and explorer stocks have been one of best performing sector and are up YTD – beating general indexes. Uranium equity could definitely get caught in a wide market downtown, but has tracked higher physical uranium prices that have increased from low $20 to $32 in last month. Ideally this is a very specific sector mining play that should be a play on the physical price of uranium, and should not be correlated to the general market. We play this with a small position in a very small ($4 million market cap!) and brand new ETF of uranium producers URNM. This could be a multi year trade, but the risk reward setup seems good.

Energy

Oil drillers (Long, short vol). Buy. High. Added new full size positions in OIH. Made bullish call last month on OIH was trading at around $4. In OIH sold cash secured $3 puts in July 2020 and Sept 2020, because the implied volatiliy was insane (over 100%), and combined with half a position in long OIH stock. This position bounced nicely, so bought back the short puts for good profit, then hedged the remaining stock with a wide put bufferfly in July 2020. Sold 40% out of the money call in July 2020 to help finance the put butterfly a bit. This is neutral to long ish bias on OIH until July, but it has run up a lot in April so it is sells off in May (seems likely to take a break) then the put buttefly will make some good money, even if the OIH stock loses money. Note that OIH has had a 20:1 reverse split this month, so the $ option strikes mentioned above will need to be multipled by 20 to compare to a current OIH chart.

Oil explorers (Long, short vol). Buy. High. Added new full size position last month on XOP (same timing as OIH trade). Bought a deep in the money for Jan 2021, then overwrite with call spread for May 2020. The call spread recently had both legs in the money and was only 2 weeks to go to expiration. Therefore overwritten call spread was rolled to Jun 2020 for a minor debt. The aim is to maintain the deep in the money Jan 2021 call, and keep overwriting for the rest of the year. If XOP goes up a lot we will capture majority of move. If stays same we can get some income from the high volatility in the call spreads (if they expire worthless). If goes down we will lose, but much less than stock. One advantage is if XOP price goes down fast the implied volality will go up, and so the deep in the money call will stay bid. Note that XOP has had a 4:1 reverse split this month, so the $ option strikes mentioned above will need to be multipled by 4 to compare to a current XOP chart.

Natural Gas (Slightly long, short vol). Hold. Medium. The natural gas etf (UNG) is hard to hold long stock for several months, due to the current contango in natural gas futures. Contango is when near month natural gas futures trade lower than far month future prices. (UNG) maintains its natural gas price exposure by constantly rolling contracts – specifically buying more expensive far month futures contracts, by selling the expiring (and cheaper) near month contract. This enforced rolling built into the product, creates a long term drag on prices while natural gas is in contango (look at any multi year chart of UNG). This is a less extreme version of the same problem with USO contango this week – when the oil price went negative (!). Since owning (UNG) stock is not a good idea, the setup is usually buy a long term calendar call spread, and also selling near dated call spreads on (UNG). This takes advantage of high implied volatility with limited risk, but can still benefit if prices are higher or neutral. This does sacrifice large profits if (UNG) spikes higher quickly and cannot roll fast enough into the price increase.

Natural Gas Producers (Long). Buy. Medium. US natural gas equities have been beaten up in 2020. Clearly there are is a huge over supply of natural gas and a massive worldwide demand shock for energy. (FCG) tracks an equal-weighted index of US companies that derive a substantial portion of their revenue from the exploration & production of natural gas. Approximately 15% of its portfolio is in MLPs and the remaining 85% to equities. Interestingly the (FCG) attempts to recovers some of its 0.6% management fee by securities lending, and it does have a dividend yield but that will likely disappear to much smaller amount in 2020. However to place this in some historical context, many US natural gas equities are trading at the lowest price for 20 years. For example, buying natural gas producers index (FCG) for $5.50, when its all time high is about $155 in July 2008. The US natural gas producers sector at these prices is low enough to be a binary trade. Either the majority of the US energy complex is going bankrupt and this is a slow grind lower for many years (“lose”). Alternatively some energy demand returns, the survivors consolidate and a restructured sector operates at higher price levels at some point in the next few years (“win”).

Equity

Cloud Computing (Long). Buy. Medium. More e-business activity (e.g. Shopify) for starting new businesses and tools for people working for home. This is long equity ETF but focusing on cloud technology (CLOU). Actively trying to ignore struggling parts of economy (e.g. airlines, manufacturing, automative, consumer financing etc). Positions in CLOU and other tech ETFs will be actively hedged with QQQ OTM call spreads.

Mortgage REITs (Long). Buy. Medium. MReits were trading at significant discounts to book value in April 2020 This was definitely a speculative buy with high yields around 11%, especially because dividends could be heavily reduced in next year. However if MReits can simply maintain their value, and allowed to DRIP for a number of years (even at these levels), then they can add some welcome yield and maybe some capital appreciation. MReit ETF (MORT) is a high yield trade great for a portfolio position in an IRA, because it can be allowed to DRIP long term. This is relatively risky play, and only medium conviction. There is no simple way to hedge this using options, so will only take a half position size to manage the risk.

Solar ETF (Neutral). Sold. Medium. Fortunate enough to sell Solar ETF (TAN) around $34 after the bounce back up to $37 in early March 2020 (not the top, but about 20% off the high the way down). This was a risk off trade, which preserved some capital initiate some of the other new ideas in this portfolio.

Emerging Market Equity (Short). Buy. High. Emerging market companies that have debt denominated could have a hard time paying it back, with economic shutdown and currencies depreciating against USD. Emerging market equity like Brazil (EWZ), Mexico (EWW) and India (INDA) have not bounced back as fast as the main US equity markets. For example Brazil has traded in an approximate range of $21 to $26 over last month, down from a Feb 2020 peak of (this is a “L” market chart, not the “V” market chart). Two trades here were 1) out of the money Long Put EWZ butterfly in May 2020, fully financed with short call spread on India market (INDA). This was neutral to bearish. 2) in the money Long Put EWZ butterfly in May 2020 for a debit, and no short call spread. This was more bearish. Brazil equity market has proven to be weaken than India in April 2020 so that seems like a good trade choice approaching May 15th 2020 expiration. INDA trade should expire worthless. Brazil trade already in the money and likely to still be there closer to expiration.

High Yield Corporate Debt (Short). Buy. High, now Medium. Corporate credit quality is being impacted by an unknown amount due to corona virus shutdowns, so that uncertainty would cause high yield corporate bond ETFs to trade significantly lower in the next couple of months. Entered an in the money (ITM) put butterfly as a limited risk reward way to short high yield bond ETF (HYG) on 17th March. HYG was at about $77 then went down 10% in a hurry to around $70. The risk was managed with the limited risk trade structure of an ITM put butterfly, but still got “taken to the cleaners” by the announcement that the FED would be buying junk corporate bonds. This policy announcement caused a huge HYG rally in April from about $70 to $80. Unless there are signs a sharp move down in high yield this week, it will be closed this week approximately 10 days before 15th May expiration – losing about two thirds of original trade capital this week. This is to preserve one third of the remaining principal from a losing trade, as a put butterfly that is now out of the money will decay much faster into expiration. A classic example of a good initially profitable good trade entered for the right reasons, but taken out by unprecedented policy decision. Trade was a loser, but have successfully managed the short risk by not having an unlimited short risk trade on.

Crypto

Cryptocurrency (Long). Hold. High. Bitcoin (BTC) and other alt coins (e.g. XMR). Holding not adding any more.

Liquidity and Hedging

Peer to peer lending – Lending Club (Neutral). Sell/Hold. High. Already dialed back risk here several years ago due to lending club management issues. However this month turned off auto re-investment of cash into new notes. Definitely do not want any more exposure to consumer credit for next year or so. Peer to peer is a small position, but turning off re-investment seems prudent until can figure out what is going with the general consumer lending (does not look good in short or medium term).

Cash (Long). High. Long USD for investment opportunities and saving up to get properties with low LTV. On existing international property businesses we are looking to open small home equity line of credits on properties with low LTVs in local currency (assuming local bank allows it). A small amount of debt exposure in local currency is effectively a long USD position (since we are based in USD). If the local currency for a country where we own property declines significantly we may consider paying down mortgage principal from USD cash.

Hedges (short, combined with underlying positions). Buy. High. Index call spreads overwriting out about 2 months. similar idea to covered covered calls, but with limited risk reward so that if the market does go massively higher are not losing so much (and can probably roll out of it in following months). Selectively combining put butterflies with hedges.

COVID-19 coronavirus portfolio – Summary

This tactical portfolio was created relatively quickly. The main themes were long metals and energy, with some technology and potentially some real estate later in the year. There are also some relatively aggressive hedging and other complimentary short positions. This is a long/short portfolio, that would be much more heavily hedged if world goes “risk off” again. Having good entry points in April 2020 should definitely help holding positions for longer term. The other main theme is keeping very liquid and not over allocating to make sure money is available for opportunities. In summary, only trade if you want to, not because you have to.

Halifax Houses Market Data

We have in the last 4 years been involved in buying Nova Scotia real estate and we’ve had to analyse the market to look for criteria we wanted. However we found the real estate broker websites in the Nova Scotia area generally did not good market overviews like absorption weeks and overall property inventory numbers.Therefore we felt we need to write our own Halifax Houses Market Data tool to quickly visualise and compare market trends.

The previous Real Estate Market Data Visualisation Tool was written about 3 years ago for locating individual properties for potential purchases. Now that we have some properties, the new Halifax Houses Market Data tool was developed in 2019. This new tool is for reviewing general trends and market analysis, so we can monitor the existing property investments.

So how do you use Halifax Houses Market Data tool ?

The tool instructions are relatively straightforward:

Halifax Houses Market Data tool - Halifax Nova Scotia - Instructions - 20191010

1. Select vertical axis with one of the many market data variables available.
2. Optionally select the horizontal axis with a market data variables, but for most cases it is simply better to maintain “Statistics Date” settings to get a time based chart. If you want to do scatter plot to see data correlations between two variables, then it can be useful to select something other than “Statistics Date” for the horizontal axis. However generally maintaining “Statistics Date” is better to keep a time series.
3. Move mouse over chart data points – left hand side is 2011 and right hand side is now. A tooltip popup will give you the “Statistics Date” for that data point. The vertical axis gives the value ranges for the selected market data variable and the actual value is given below in the market data pane (beneath the select boxes). The chart always plots the selected vertical market data variable against the selected horizontal market data variable.
4. View the market data pane to see all variables for that date. The market data view changes dynamically as mouse moves over different chart data points. Each data point on the chart represent a date has all the market data variables that appear in the market data pane. The two selected axis variables are highlighted on the market data, so it can be easily seen what is selected when moving the mouse over the chart data points.
5. Repeat from point 1 for different market data variables.

The tool can be quickly used to identify long term yearly trends in the market, hopefully to predict best times to buy and estimate future market direction.

Low absorption rate

Absorption rate is the amount of time it would take for all open listings to be purchased (assuming no further listing were added). The absorption rate calculation here is defined as the total number of available homes divided the average number of sales per week. The absorption rate is a number of weeks, specifically the number of weeks it would take for all current housing inventory to be exhausted.

This screenshot shows how the market absorption rate (in weeks) typically moves in a predictable seasonal range with lows in the summer (less houses available) and highs in the winter (more houses available).

Halifax Houses Market Data tool - Halifax Nova Scotia - Absorption Rate Weeks - 20191010

From 2012 to approximately end of 2016 absorption rate went with seasonal moves, from average lows of about 40 weeks, to winter highs of on average about 60 weeks. This pattern repeated each winter from 2012 to 2016, even though there were some 2014 data points with some very significant highs around 100 weeks. Some of the 2014 data points maybe “bad” data points, but the take away is that there was a huge amount of unsold inventory on the market at the time.

However at the end of 2016 absorption rate started a downward trend that is still continuing. The absorption rate has declined with usual seasonal patterns, but importantly seems to be trending lower every year. This would indicate that market conditions are a lot tighter now, with a houses being purchased quicker so that it reduces available market inventory. A faster absorption rate often reduces the amount of quality houses for a buyer, simply because the demand picks off the better priced deals first. From a final high of 65 weeks at the end of 2016 the absorption rate has declined to a low of 17 weeks in Oct 2019. To put this another way – Halifax housing inventory would be exhausted 3 times as quickly in 2019 compared to only 3 years ago. This implies a significant move from a buyers market to a sellers market.

Active Listing for Single Family

Halifax houses market data has been separated into a single family category (removing condos and vacant land) because that is our target property for rentals. This can include multi family up to four units. This deliberately excludes condos, because on average the monthly charges on condos make then inefficient rentals.

The screenshot below shows the number of active listings for single family homes from 2011 to now.

Halifax Houses Market Data tool - Halifax Nova Scotia - Listing Active Total Singlefamily - 20191010

The number of active listing for single family homes has peaked from a high of approx 4,000 in mid 2015 to a low of approx 1,500 in Oct 2019. This would indicate that market conditions are a lot tighter now, with a reduced amount of single family houses to choose from. Similar to absorption rate, this implies a sellers market in Oct 2019.

Data Integrity

Most variables are available from approximately July 2011 to present dates. Some data points for some variables are missing from 2011 to approximately 2013, so there maybe incomplete data points with blank chart data points during those time ranges. Occasionally data points are obvious outliers that can be ignored if they appear way below or above the usual chart curve. The aim of the tool is to look for trends, not get the data absolutely perfect.

Protecting Foreign Real Estate against FX rate moves

Protecting Foreign Real Estate against FX rate moves is important if you own overseas property.
Protecting Foreign Real Estate against FX rate
We currently own one cash flow positive property with no mortgage in Canada, and are in process of buying a 2nd property. Basically we are looking to achieve a few things:

  1. Diversify away from US dollars (USD) using foreign currency in a stable country
  2. Get long some oil using the commodity currency Canadian dollar (CAD) as proxy. This works because crude oil and CAD are positively correlated.
  3. Get some relatively cheap real estate in a different country, to diversify away from a high cost US area where we live.

Our home currency is US dollars (USD) and the properties will be run in Canada with all local Canadian dollar (CAD) income and expenses. The plan is to take a commercial mortgage in Canadian dollars (CAD) across two houses at 50% Loan To Value (LTV). From a US dollar (USD) perspective this is essentially long / short CAD in almost equal amounts, where the house equity is “long” Canadian dollars and the mortgage is short Canadian dollars.

Obviously this still has all the usual real estate risk locally, such as local economy downturn, vacancy periods, high maintenance expenses (etc). This assume that both property will be cash flow positive (they will) and because we have a local property manager, they essentially run themselves. Again here we made sure both properties are initially cash flow positive so should be able to hold long term – we are have given enough margin of safety with 50% equity that we can safely (hopefully) assume that should not be forced to sell even if local property prices were to significantly decline. There are no planned foreign exchange (FX) conversions planned in the day to day running of the Canadian properties.

In summary the 2 properties would be exactly 50% long 50% short CAD (house equity/mortgage) with built in equity cash flow (the rent minus expenses).

Risks

Below we can see that there are a few risks to owning foreign properties. We will focus mostly on FX risk for this discussion, but it is worth highlighting the others below.

  1. FX risk. With our 2 properties if the CAD USD FX rate declines so much, we would have a paper loss in USD due to the original equity we have in the properties – even if all other factors like local house prices and monthly operations are constant.
  2. Local real estate risk. The local economy could have a significant downturn, we could have issues with vacancy periods, property may require higher than estimated maintenance expenses. These are the standard real estate risks, just that they need to managed remotely by our property manager.
  3. Pay Bid/ask spread on any FX transactions. Every time money is sent to Canada we have to pay the bid/ask spread on FX conversion. We use a currency dealer who gives decent spreads (approx 0.7%), which is not great, but significantly better than main street banks.
  4. Local company regulations to run a real estate company. There are initial company setup fees, annual province (state) filing fees to maintain a Canadian holding company to own the real estate. Need to maintain a Canadian based accountant who is familiar with Canadian tax law. There is an annual cost of holding real estate in a Canadian entity, however these pro-rota into annual property expenses and are covered by the rental income. The company does not require extra money to be added annually to cover these costs. However this require effort to ensure compliance with regulatory, legal and tax obligations for owning property in Canada – however the because it being held in full Canadian based entity paying Canadian taxes crucially . Most importantly no tax is withheld on rental income because the company is considered a Canadian resident – so there are benefits to doing the extra paperwork.
  5. Bankruptcy risk on company operations. The cash flow is not sufficient to maintain operations and/or a unforeseen event occurs that makes your real estate business operations not viable. However because this was setup inside a company structure, then this limited only to the real estate itself, not your personal finances.
  6. Sovereign country risk in Canada. Economic issues such as lower oil prices or a recession could make real estate prices decline or make it find to locate well qualified local renters. This is the same in any real estate investment, however the Canada economy is typically more tuned to commodity cycles than the US economy. Current central bank strategy between are different US and Canada – where US Federal Reserve is raising rates, while Bank of Canada is holding rates. Canada was also in a technical recession for last 2 quarters (but has lifted in latest quarter) – USA has been steady so is currently relatively more attractive. However the Nova Scotia economy is separated from the larger cities of Vancouver/Toronto/Calgary – it will be impacted by economic cycles but traditionally they don’t tend to have huge commodity boom/bust cycles. CAD is commodity funding currency, so about 80% correlated to moves in Oil. Oil prices have moved down from $110 to $40 ish. Importantly it is worth noting that currencies are also relative not absolute – even with a recession, if Canada does “better” than USA then its currency could rise versus USD. CAD USD FX Rate is not as correlated with standard equity markets, more commodities, but it has a full service based economy (essentially tied to the US economy) and its not Brazil (e.g. not just taking a punt on an emerging market currency just as a commodity play).

US v. Canada mortgages

There are some differences between Canada and US mortgage markets for primary residences and rental properties. Mortgage interest is not deductible on primary residence for an individual in Canada (as distinct from US where it is), however mortgage interest is deductible on rental properties. Although there is no capital gains tax (or gains limit) on primary residence.

Given that, some Canadians do rent their primary residence and buy rental property, rather than necessarily buy own home. Essentially this can be a viable option because of the tax code. Long term renting where you live (and buying rental property investment with the spare cash) could make more sense. Whereas in the US, the tax code is massively skewed to buying your primary residence.

Plus most Canadians banks keep mortgage loans on their books – that is they don’t securitise or resell loans straight away to other banks like they have in US. Therefore a Canadian bank is highly motivated to make sure their own underwriting is effective, because they could be carrying the loan for up to 25 years (which explains why big bank lending can be relatively cautious).

This explains the relative historical stability of the Canadian housing market. The differences between the US and Canadian mortgage market explain some of the slightly more cautious lending practices, but frankly that makes it more attractive as an investment. Canadian mortgage market is actually slightly different to the US market, but in a good way for investments.

We found commercial mortgage underwriting standards very strict, maximum they would do was 65% LTV (and they were still debating that..). Other banks would do higher LTV, but they require a significant financial deposit or savings to be with the bank before the loan would be advanced (sometimes up to 50% of actual loan size was required to be on deposit!). Local credit unions had more flexible terms underwriting terms than the big banks.

FX Rate Risk – Historical Moves

Now let us have a look at the historical moves of USD CAD FX rate to see what risk we are actually taking on. We will look at historically what was the largest FX move where Cad strengths (moves against you) on an annual basis in percent terms. For example the total percent depreciation was -24% in last 5 years (% move where start date is T-5 years and end date is today). However that is not typical and is a significant down move, however that is why the the investment opportunity exists.

Below is historically what what were annual USD CAD FX moves in percent terms since early 1990s. These have been calculated from a spreadsheet that uses average monthly prices (for each month) from Jan to Jan – it is not 1st Jan to 31st Dec – but they give an indication of expected historical annual moves.

In the following table a positive percent means USD weakens against CAD (investment makes money). A negative move means USD strengthens against CAD (investment loses money).

Year
Percent move
19901.44
1991-0.02
1992-12.05
1993-3.96
1994-9.68
19954.64
19961.58
1997-8.85
1998-8.23
19997.28
2000-5.38
2001-9.77
20025.94
200324.47
20047.19
20056.54
2006-1.71
200716.61
2008-21.68
200918.39
20104.89
2011-1.93
20122.06
2013-10.11
2014-10.5
2015-9.6
2016 (YTD)8.5

Based on this you can see that there were typically price movements in the annual range of -10% to 10% volatility, however the last 3 years have been double digit declines every year (which is unusual).

FX Rate Scenarios

This section will look at USD CAD FX rate scenarios where it stays the same, goes up or goes down (think we covered every possible angle in the investment world there!).

  1. Stays the same or goes up. If the CAD stays the same or appreciates we would probably just hold. If it appreciates very significantly it might be worth send back any cash flow in appreciated CAD into depreciating USD. This return of cash flow would act as a psuedo annual dividend. Ultimately in several years if there is significant FX rate appreciation it could be worth just selling one or both properties and converting it back to USD. It is completely possible you might make limited local real estate gains but significant FX gains due to FX rate appreciation. Importantly FX gains are not taxable, but obviously you have pay local Canadian taxes on any capital gains. The mortgage will be a greater debt in USD so you would not want to use USD to pay down the mortgage, just use local CAD cash flow for that.
  2. Goes down. If the CAD depreciated further the total real estate investment starts to lose money mark to market in USD. This is probably not a problem in local CAD currency to manage monthly operations, however it is still a mark to market loss that we might wish to reduce. Additionally with a significant move of say 10% or more we would consider paying down some mortgage principal (in CAD) with strategic annual USD to CAD transfers (as the rate is in our favour). Since a major risk to our investment is if the FX rate declines, in the next section we will look at some possible strategies to help manage that scenario. These strategies will be to pay down the mortgage or hedge the FX rate.

FX Rates risk management – hedge FX rate

The main question we have to ask is, do we technically even need to hedge with a 50% / 50% split of mortgage / equity all based in CAD currency?

The mortgage is in CAD and we are amortized principal payments in CAD. So on one hand we are long 50% in CAD exposure due to the real estate value (at 50% LTV). But on the other hand if you are taking a loan in CAD, you are short 50% CAD because you benefit from the USD strengthening. The exact 50% / 50% split of an asset in CAD vs liability in CAD, gives a built in natural hedge.

Also if we are going to hedge how aggressively should it be done ? There is a fair amount of equity (long CAD) position in the real estate, however as an investor it is better to take a view and hedge less. There is no value in hedging away all the risk to invalidate the actual investment idea.

It is possible to use /6C Canadian dollar futures put options to “disaster hedge” the FX rate. We are already holding a 5% OTM put 6 months or 1 year out for contracts of /6C, hedging at about a 0.25 delta on average. These are then rolled up or down after a few months as necessary as the FX rate moves. Additionally it is then possible to sell OTM call spreads against FX rate for income, to slightly offset the cost every month. If FX rate declined 10% would probably recycle that money into CAD mortgage and re-hedge. As long as keep long term OTM hedges in place this can be relatively cheap less than 1.5% a year of total investment – and that assumes zero gains from short call spreads which is not likely if rate declined. This is managed in a trading account along with other spreads (eg Long gold, short oil etc). Ideally it would just lose a small amount of money each year (which other spread can make up for) which is what happened so far this year. Fundamentally we would see this real estate investment as a married put strategy (long 2 houses in CAD, with long contracts on /6C futures put) on a dividend paying stock (small monthly rental cash flow profit plus paying down mortgage).

If rate went down 20% in a year you would lose money mark to market, but it would probably lose only say max 5% to 10% in a year (depending on option rolls). This assumes no other variables change, and assuming no gains from overlay trades and ignoring mortgage paid down which is about 1.25% of principal risked in first year. But point is that now the investment is not undefined FX risk. Any profit on hedges could either kept as cash or Fx back over to pay mortgage.

The issues are that it costs some money to hedge, but we are used to managing it as a trading account anyway. Leverage on those options is very good in a rate crash scenario. There are also cheaper / limited risk reward ways to keep short delta eg put calendar and ATM call spreads. As long as the “disaster hedge” with the 3 contract /6C put is always in place (in case the floor falls out again) should be ok. For example, when FX rate crashed in Jan 2016 that put option made significant USD dollar amount. Hedges are based in a USD trading account.

Ultimately in several years time you have 2 houses and lower mortgage principal, so over time your FX risk (CAD principal) increases so might have to increase hedging size later on.

FX risk management – pay down mortgage

If rate goes down 10% against CAD, the mortgage can be paid back with more valuable USD dollars. Any significant mortgage principal reductions early in the lifetime of a mortgage can have reduce the ultimate pay back time.
Therefore it would seem sensible to do a small principal payment (say between 1% to 10%) each year to reduce the mortgage if the FX rate is consistently in your favour.

However don’t want to pay down too much of mortgage, because you are increasing your long exposure to CAD each time you do that. Effectively you might be removing your hedge against a depreciating currency when you might need it most.

Conclusion

Even if the CAD currency is beaten up due to a lower oil price, Nova Scotia is a relatively diversified local economy on multiple sectors (not heavily oil related like some western Canada economies). Historically steady not commodity boom and bust (even in 2009). Also real estate is reasonably priced even in local currency, and it’s a buyers market there. Don’t need to make a killing in local landlord market, just need to keep lights on. Worse case mortgage is paid back in 25 years (typically commercial mortgage length in Canada) not 30 years like US residential mortgage. Plus ultimately own 2 houses at the end of the investment, which should more than match any FX move.

We decide to hedge, but keep it light. Hedging is an art no right or wrong answer. Since basically we were looking to diversify a bit from USD, want to get long some oil (via CAD) and own local real estate it is a good transaction. We only hedged approximately half our exposure, so if there is a strong oil rally you win on the original investment idea, and don’t lose too much hedging. Also if the FX rate moves significantly against us then the hedging will help and we could pay down the mortgage more. There is “no free lunch” (is there ever?) but the risks can be managed, and a significant move in the FX rate in either direction can still hopefully be managed to our advantage.

Real Estate Market Visualisation tool

We have recently been involved in buying Nova Scotia real estate and we’ve had to analyse the market to look for criteria we wanted. However we found the real estate broker websites in the Nova Scotia area generally did not have enough filtering criteria to narrow down the exact requirements we had.

Therefore we felt we need to write our own charting tool to quickly visualise and compare different properties attributes.

Priceproperty asking price
Price Per Sq Ftproperty price divided by livable internal living space (sq ft)
Living Spaceinternal living space (sq ft)
Land Sizeexternal land that coming with the property (sq ft)
Miles from Centrephysical distance from
Walkscoreproperiety walk score (taken from real estate broker website). 100 = very walkable and 0 = not
Transitscorepublic transport score (taken from real estate broker website). 100 = very easy to get around and 0 = not
Bedroomsnumber of bedrooms
Bathroomsnumber of bathrooms
Days on Marketimportant in a buyers market with lots of inventory - can focus on longest sitting properties
Building AgeAge of building in years - dont want a maintanence headache for rental properties.

You can access the live demo version of the Real Estate Market Visualisation tool or just look at the following screenshot:

Real Estate Market Visualisation tool- Halifax Nova Scotia - 20160203

So how do you use it ?
The tool instructions are relatively straightforward:
1. Select vertical and horizontal chart axis
2. Move mouse over chart and click on any blue data point to display quick property detail
3. Then click MLS link (beneath chart) to see property listing
4. Repeat from point 1 for different axis comparisons

The result plots one property attribute against the second property attribute and displays the graph. Each data point on the chart is a property.
Please note: although all the URL were originally working, over time the URL links to original listings are often no longer available on the real estate brokers website (for example if the house has been sold or taken off the market).

What did we have to do to build the tool ?

1) Define a specification of the property attributes we care about
We wrote an IT focused detailed specification to read the HTML for an individual property listing and define exactly which property attributes to extract into a spreadsheet format. We simply choose Comma Seperated Values (CSV) spreadsheet format as the output because it is very simple to read and edit.

2) Write a website reader to download all property attributes
Gave the above specification to an IT contractor on an outsourcing site. This work was ultimately outsourced on upwork.com but anything similar would be fine.
The contractors job is then to take a download snapshot of all housing listing from a target real estate website, saving all required fields into one CSV spreadsheet for the current download. The real estate website is currently Remax Canada at www.remax.ca. Currently no user login is required for the website. The delivery was a Python program (with specified .py modules) executed as a command line interface. The website features main listing (of all available houses) and individual detail listing (for each house), both of which will need to be scrapped to produce the CSV spreadsheet. We ended up calling this part the “house scrapper” CSV code.

3) Write a simple webpage to read the CSV spreadsheet and nicely visualise the data into a graph. You can easily review this code if you like by looking at the Real Estate Market Visualisation webpage, then right clicking on “View Source”.

How did it go?

Overall the tool implementation was a relatively cheap and quick success. The approximately cost was about $100 to hire the programmer who wrote the house scrapper that downloads the CSV data source. Then about 12 hours total effort of our own time to write the house scrapper spec (4 hours) and create/fully test the HTML webpage (8 hours) that uses the CSV data.

This is not exactly an out of the box solution for us, but it was worth it because it helped us visualise the market nicely in graphs. Ultimately we made a decision and bought a house from it, so it was definitely worth the relatively cheap money and effort put into it. This could be extended to other markets were other websites are not as good. However this might not be necessary in the US if websites such as Trulia and Zillow do everything you need.

However its good overview of how to roll your own Real Estate Market Visualisation tool, if you end up searching for real estate in a market that doesn’t have the full analysis tools you want.

Nova Scotia Real Estate

If you have any spare US dollar (USD) capital ready for real estate investment, you may wish to consider Nova Scotia real estate. The idea is to convert USD to Canadian Dollars (CAD) and invest in Canadian residential real estate, initially in Halifax, Nova Scotia. The main investment drivers are the local property market (relative cheap price per sq ft for residential real estate compared to other North American cities), cash flow (can achieve positive rental yield on a fully managed property), market timing (favorable USD/CAD exchange rate) and potential price appreciation (linked to growth from Halifax downtown development projects). Essentially in Oct 2015 relatively cheap property in a large metropolitan area, that is about to get significant future investment, can be bought for approximately 75 cents on the USD dollar (at current exchange rates). In summary, the investment strategy is to take advantage of real estate’s well documented tax and cash flow benefits and use the exchange rate to buy more house for the money.
Continue reading

Multi family property investment calculator

If you plan to live long term in a high cost metro area (such as New York, NY) buying a multi family home might be a good solution to consider. If you can afford the larger down payment, this could be advantageous because generally you pay less per sq ft than a single family house, when you factor in the potential rent from renting out the other side of the multi family.
Continue reading