Do You Recognize the 7 Early Signs of an Investment Disaster?
The market for real estate investment is treacherous, as reported by Jennifer Wells in TheStar.com - Mad about Harry.
Ms. Wells' article debunks the myth that real estate is all about location, location, and location.
The owners of investments made in the condo hotel at 1 Kings Street West now know that real estate investment is all about taxes, taxes, and more taxes. Here is a detailed quote from Ms. Well's article.
"In mid-September, Piers Hemmingsen received his tax bill from the City of Toronto for the 560-square-foot condominium he owns at 1 King. In company with more than 400 other unit holders, Hemmingsen had placed his condo in the hotel pool, eagerly awaiting a return on his investment.... In Hemmingsen's case, his tax bill was a whopping $11,264.19, reflecting a commercial tax rate in excess of 4 per cent. Bob Verdun's tax bill: 16 grand.
To all affected taxpayers -- and this group includes David Mirvish -- the inequity is clear. While those units placed in the hotel pool have been taxed commercially, they have been valued residentially -- in Hemmingsen's case, a valuation of $294,000. "Traditional hotels are valued on an income approach," says Peter Milligan, a lawyer at Miller Thomson and counsel to the Greater Toronto Hotel Association. The Municipal Property Assessment Corp. makes its assessment on a hotel's pro forma income statement, based on its actual performance. The difference: on a per room basis, the taxes paid in an upper-end hotel room similar to 1 King are less than half what the 1 King condo owners currently face."
A full review of the article reveals 7 early signs of an investment disaster, which were evident from the beginning.
1. Not reading the disclosure document, or having competent counsel do so. "Did Piers Hemmingsen read it? "Oh my God, it was like a 100-page document," says Hemmingsen. (It's 58 pages.) "I thumbed through it." He says he did not understand that the nature of his investment had changed, nor that he could be facing a seismic tax hit."2. Misunderstanding the legal nature of a guarantee. A guarantee does not make an economic venture less risky, it simply puts another player in line to be sued. Individuals continually misunderstand this, "A woman we will call Helena, who asks that her name not be used, purchased a unit at 1 King with her husband. "We have put most of our life savings into it," she says. "We've been in the country 15 years. I worked so hard. The thought of the guarantee made us sign on the dotted line." Neither she, nor her husband, read through the package."
3. Not understanding their legal rights because they didn't comprehend the disclosure document. The marketing of the condo hotel units involved the use of a rental pool - money was distributed to investors based upon the rental of all the units, which makes the investment a security. It was late in November, 2004 when the Ontario Securities Commission ruled that all the investors were to be provided with a new disclosure document and a 10 day period in which to cancel the contract. View if any did, at that time. Why? Well as Ms. Wells' reports, "The package itself bore the hallmarks of Stinson's salesmanship. The first page was a newspaper column -- from this paper, as it happens -- about 1 King and its architectural contribution to the city's downtown. Pages two and three consisted of a letter from Stinson himself: "The physical structure of One King West is now very real, and by all accounts has become a widely admired landmark on the Toronto skyline." And so on. In the third paragraph Stinson says the enclosed memorandum "will provide a better understanding of subtleties [sic] of the financial and legal structure of the leasing program." He then devotes two pages to the building's management team, followed by a page of colour photos of a sample hotel suite. Sure enough, after that, comes the all-important disclosure memorandum."
4. Reliance on claims made in the advertising as constituting material terms in the deal. Mr. Stinson was constantly advertising about "the appeal of owning such a residential property, leased as a hotel room, was Stinson's promised return on investment. Under the "Canadian Plan," by example, "an owner receives a fixed rental income equal to a 10 per cent return on funds invested." This representation was explicitly excluded from the prospectus, which was approved by the OSC in late 2004. But by then the damage had been done.
5. Being, in effect, a financier of a project that you have no control over the risks. If you are lending money to an individual or group, then knowing their success rate is important. As Wells wrote, "anyone who has followed Stinson's career, or invested in one of his developments, knows that Stinson is always looking to raise money from individual investors, conventional bankers having little interest, Stinson has often said, in providing any backing." This doesn't mean Mr. Stinson will fail, it does mean that brighter and more conservative minds have looked at the project and passed as too risky. Why are you accepting the risk.
6. Being first in the market. Being first is great, if there is a contest. But generally novel ideas are best left to individuals who can afford the risk.
7. Taxes, taxes, and taxes effect the value of your investment. In this case, the difference between the residential rate and commercial rate is significant. The taxes on the properties might be more than the mortgage carrying costs, with no effective relief.
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