Is it Time to Cash Out of this Hot Property Market?
Situation Couple’s Vancouver house has gone up in value 300% in the 22 years they have owned it. Is there an advantage to selling and renting a similar house?
Strategy By selling, they would easily cover their rent of $4,000 a month and have a great deal of extra money for travel or for doing things in retirement
In Vancouver, a couple we’ll call Peter, 63, and Charlene, 62, are considering selling their house. In the city’s overheated market, it has an estimated value of $1.6-million.
The house has appreciated 300% in the 22 years they have owned it. The problem, as many of the city’s homeowners know, is that although they are paper millionaires, their wealth is tied up in bricks and mortar. The house produces no income and, if real estate prices were to fall substantially, as they have in other markets with soaring house prices, Peter and Charlene would have less wealth and, very likely, less choice in how they spend their retirement years.
The dilemma of people who live in houses with big price tags in steamy real estate markets is that, if they capture value by sale, then they have to move out of town, move into something smaller or give up ownership and become renters. It is a tough choice to make.
We would be giving up a house with memories, but we would gain freedom to do more things than house repair and that is so valuable
The peculiar economics of Vancouver’s real estate market are based on a great deal of speculative ownership by investors who buy with no intention of living in the city, and the consequence that it is relatively cheaper to rent from speculators than to buy.
Peter and Charlene have investigated Vancouver’s rental market and decided that they can find a pleasant, equivalent home to rent. Question is — can their assets produce that income without undue risk?
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Vancouver, to work with the couple. “They can rent a house like the one they have now with 2,200 square feet, picture windows to see the ocean and skylights to let in the morning sun,” he explains. “They can get that for $4,000 per month rent, which is a fraction of what the present value of the house can earn in diversified stocks and bonds.”
They would wind up with a similar house in a similar neighbourhood and have lots more money to spend. Of course, they would be giving up their stake in a thriving property market that could continue to rise. The point is, however, that they would reduce risk by broadening their asset base and diversifying.
“In a sense, it is a chance to sell high and then, with care and patience, to buy into something relatively low,” Mr. Moran explains.
Selling vs. Renting
Mortgage free, the $1.6-million house can be said to “cost” the couple the after-tax interest its value could make in a high grade corporate bond, say 4.0% or $64,000 a year. That is a customary benchmark for comparing returns on capital, but they would not be 100% invested in bonds. In fact, they can get 5% to 6% after inflation in a portfolio of stocks that pay strong and rising dividends. However, using the bond portfolio’s 4% return, they would have $48,000 after 25% estimated tax to pay rent which they think would be $4,000 a month for a similar house. They would be selling a house that has memories of the three children they raised, now all middle aged with lives and families of their own, but gaining a great deal of capital.
What the sale would do is free up capital for travel or other things, says Charlene, who is open to the idea of pulling up stakes.
“We’d only need part of the house sale price invested at a reasonable rate of return to pay the rent and we would have the extra cash flow for travel. We would be giving up a house with memories, but we would gain freedom to do more things than house repair and that is so valuable. Most of all, we would not have to worry about our life savings being tied up in an aging asset. In a sense, we would be protecting our legacy for our children and charities that benefit families.”
Their financial base is strong. When each is 65, Peter will have $765 in monthly Canada Pension Plan benefits and $546 in Old Age Security. Charlene can expect $707 a month from CPP and the same $546 from OAS. That’s $2,564 a month or $30,768 a year in government pensions. If they add $1.5-million, which is what they would have after selling costs, to their present $935,000 of financial assets, they would have total investible capital of $2,435,000. A portfolio of stocks and bonds that generates 5% after 2% inflation would produce $121,750 annually in 2013 dollars. Added to the government pensions, they would have pre-tax income of about $152,000 a year. They would have sold a house that produces no income and gotten financial assets that pay the rent and a good deal more.
If the pension income were split to $76,000 per person, they would have a minor loss of about $250 each to the clawback that begins at $70,954 of net taxable income in 2013. If they paid ordinary income tax at an average of 20% on total pre-tax income rich with Canadian source dividends that benefit from the dividend tax credit, they would have about $10,100 a month to spend.
They would be gaining what could be considered a measure of financial freedom by selling at what is clearly a rich price for their house in a hot market, Mr. Moran notes.