If you want to include your home as part of your asset mix, Canadians may not be such bad savers after all.
The net worth of Canadians keeps rising – it reached $199,700 per capita at the end of the fourth quarter of 2012. But that wealth is being generated from our flourishing property prices, something that financial planners haven’t always considered in a retirement planning scenario.
An analysis of Statistics Canada National Households Balance Sheet by Carleton University professors Ian Lee and Vijay Job found Canadians have gross assets of approximately $8.8-trillion of which $3.5-trillion is held in primary and secondary residences and raw land, $3.7-trillion is in cash, mutual funds, equities, and $1.6-trillion is in registered pension plans. Taking away $1.7-trillion in debt, that leaves $7.1-trillion. While they concluded Canadians are actually much smarter savers than we are given credit for, others might see it as violating the No. 1 rule of investing: Don’t put all your eggs in one basket.
“Real estate makes up about half of our total assets, not including debt,” said Doug Porter, chief economist at Bank of Montreal. That’s a pretty high percentage to invest in one sector of the market.
While more than a few skeptics say the piggy bank known as your house is not that secure, prices have not dipped. The Canadian Real Estate Association said Wednesday that while April sales were down 3.1% from a year ago, the average sale price last month rose 1.3% from a year ago to an average of $380,588.
If you are worried that you are overweight in real estate, what can you do to take some money out of it and spread some of the risk around?
If you don’t want to sell there are a number of options you can explore to diversify your so-called savings. If you’ve got decent equity in your home, you can easily get a line of credit on it and use the money to invest and thereby diversify your overall wealth.
“If you have a $500,000 house with no debt on it and you get CPP, most banks will give you a $75,000 line of credit,” says certified financial planner Ted Rechtshaffen, president of TriDelta Financial Partners, adding the rate is about prime plus 50 basis points.
If you take that loan and invest the money, not only have you diversified your savings but you’ve created a deduction for any of the income you earn from the money.
“You can borrow at 3% and invest in something that pays a 5% [yield]. I’m not saying it’s without risk,” said Mr. Rechtshaffen, who doesn’t think over 50% of your net worth should be in real estate. Others in the investment industry suggest between 30% and 50% is appropriate.
“A significant number of people in Canada are well over 50% in real estate.”
Even with a loan you are still exposed to any downturn in real estate but your overall portfolio now has more assets with a larger debt component.
There’s nothing to prevent you from taking the profit from your home outright but if you decide to extract equity and downsize you can expect transaction costs in the 8% to 10% range.
You could really think outside the box and sell your house with a provision that allows you to lease it back from the buyer. A $1-million home that generates say $50,000 a year in rent, or 5%, might be a tempting deal for someone looking for an investment opportunity.
One of the more controversial schemes for extracting wealth from your home is a reverse mortgage, a product which can give you cash today at the expense of drawing down on the equity of your home when it is time to sale.
CHIP Home Income Plan, which is administered by HomEquity Bank, is the only provider of reverse mortgages in the country and originates about $250-million in mortgages a year.
Steven Ranson, chief executive of HomeQ which owns HomEquity Bank, says the average customer takes out about 33% of their equity and the average mortgage amount is $120,000. Consumers can take it up front or draw it down over a period of time like investing in an annuity.
“You get what you pay for. You are not making a payment and the loan is never going to be re-underwritten. You don’t have to worry again what happens in five years.” says Mr. Ranson, about his five-year rate of 5.4% which compares with rates as low as 2.7% available for a traditional mortgage.
You get to live in your house forever so the risk for CHIP is you end up living in your house so long that the equity in the property is worth less than the loan. It rarely happens that way — about 25 of 10,000 mortgages the company has ever written have ended up under water. The average client pays about 50% of their equity at the time of sale to CHIP.
Funny enough, Mr. Ranson is one who doesn’t really think consumers should count on their homes as savings instruments. “There are a lot of stats out there that a generation of people are not saving the way previous generations did,” he said.
BMO’s Doug Porter says the official savings rate was 3.8% in the fourth quarter of last year whereas it was once in the high teens in the 1980s.
“I think it is fair to count your house as part of your savings if part of the long-term plan is to downsize,” said Mr. Porter. “I would counsel that it is an asset and asset price can fluctuate. Until you sell you don’t know what that savings will look like.”
It’s one more reason diversifying makes sense.
Source: Garry Marr, Financial Post