The obvious

Stan and Mary are 62 and 58 respectively, live in a paid-for house he figures is worth $1.1 million, have crappy defined-contribution pensions and want desperately to retire. Or quit and find something else. “Got to be more to life that this,” says a guy who’s worked 23 years in the automotive parts business. (She’s clerking for an office full of real estate lawyers, and sees the writing on the wall. “Way less busy now.”)

Like most, they’ve shoveled the bulk of their net worth into the house, have scrawny, malnourished TFSAs and inadequate amounts in their pension plans – maybe $150,000 between them. But no debt. That makes them financial rock stars, compared to their adult kids. (“Boy,” he reflects, “are they ever screwed…”)

They want to sell the house, downsize and tell their bosses to shove it. Here’s the plan: buy a two-bedroom condo for about $650,000, invest the rest and live large. Then they talked to me. Big mistake, I said. Let’s do the math.

So, ditch the house. That’s a no-brainer, since their pensions plus CPP/OAS will hardly support a good retirement lifestyle in the big city they love. Besides, the place needs serious work over the next few years – the basement’s original, the roof sucks, Mary hates the kitchen and the furnace has a bad ‘tude. Property taxes are eight grand a year now and seem to keep rising. It’s all a drag – besides, there’s a big pile of money sitting there doing nothing.

Selling today (as opposed to three months ago) may yield a million, if they’re lucky enough to snare a buyer this summer. After paying 5% commission, that leaves $950,000. So now, downsize to a nice two-bedroom condo, or rent one?

If they purchase, and find something for $650,000, they’ll have to shell out $19,000 in double land transfer tax in the 416 along with the purchase price (because no bank is going to give them a mortgage as they enter retirement). Now there’s $280,000 left.

If that’s placed in a balanced, globally-diversified portfolio of low-cost ETFs with 60% in growth assets (equities and REITs) and 40% in fixed income (corporate bonds and preferreds, mostly), they should expect about 6% after any management fee (figure 1%, tax-deductible). The income generated from that would be $1,400 a month, mostly untaxed since it’s structured as return of capital payments. But, sadly, condo fees ($500), property tax and insurance amount to about $900 a month, leaving just $500 to party with.

Is renting a better option?

The full house proceeds of $950,000 similarly invested would produce (at 6%) about $57,000 a year, or $4,750 per month. Rent for a two-bedder (a nice one) in that hood is $3,000, and comes with no property tax bills, no monthly fees, cheap insurance and no special assessments. So, if the entire rent were paid for out of the investment returns, it would leave $1,750 a month for living, or actually grow the nestegg by more than $20,000 a year.

There’s also a strong argument that S&M would actually have more financial security by not buying – and likely more emotional stability, as well. After all, their investments would pay the rent, add to their wealth, and they’d still have almost $1 million in liquid wealth – accessible any time if their circumstances changed, if health costs materialized or they wanted to travel like upscale bourgeoisie nomads for five years.

And what of the risks involved with both scenarios? Each contain downside. Investment portfolios fluctuate in value month-to-month, and some people worry about that. But over time returns have been consistent. And while a rerun of 2008 is unlikely, even that storm passed relatively quickly for people with this kind of portfolio – a 20% dip for a year, then a strong recovery.

There’s a good argument real estate now carries greater risk. Asset values are at record highs while interest rates sit at record lows. As that relationship changes, property values will probably decline and along with them liquidity. Could Stan and Mary could get out if they needed the cash? A 20% decline (totally possible) would wipe away more than $130,000 in net worth – with none of the loss deductible. Ouch.

Meanwhile condo fees could increase. So could property values. There could be a special assessment to repair a salt-riddled parking garage, install new elevators or replacement windows. All of this would affect the property value, and none of it could they control.

How’s this even a contest?

It isn’t. Buying is emotional. Renting is logical. The real nut these kids now face is selling.

The unwind

This pathetic blog is not actually about real estate, house lust and your tormented spouse. Rather it’s all about financial security. Sometimes owning a property gives you that. Lately, not so much. Let’s dive off the deep end for a few paragraphs, and yak about what could go wrong. Not just with a home, but everything.

To assist us in this miserable, depressing and scary task we have an outfit called the BIS. Whazzat, you ask? Why should I care?

The Bank for International Settlements is essentially the central bank for the world. Birthed during the darkest moments of the Great Depression, it’s owned by 60 central banks (including the Bank of Canada) accounting for 95% of the economic activity of the planet. Therefore it’s more influential than Justin and the Trivago guy combined!

The BIS has one goal: keep things from getting too screwed up. It wants central banks to coordinate stuff like interest rates and money supply. It also serves as kind of a ER doc to the international economy, diagnosing current conditions and doing interventions as necessary. Right now the BIS says its patient weighs 620 pounds, is grossing out on a super-carb diet, with high blood pressure, diabetes, gout, heart disease and a badass attitude. Only a matter of time, it concludes.

Here’s the scenario. We never really solved the 2008 credit crisis, just papered it over with cheap money. After ten years the amount of new cash created by central banks to buy up bonds and try to stimulate growth is epic. The only way these banks – like families with giant mortgages and nations with big debts – can keep rolling along is if rates (and payments) stay low. Meanwhile all this debt has encouraged humans to borrow massively, which in turn wildly inflated the price of assets – like houses.

Rates have to rise, or ‘normalize’, or the problem grows continually worse. And that’s what the Fed has also concluded. So up she goes. Three pops in the last six months. That makes the over-indebted very vulnerable to ending up in a serious mess as rates across the world move in response. Near the top of the list of looming victims is Canada, where debt ratios are 70% higher than a decade ago (the US, in contrast, is up 29%).

Why a rate hike of 2.5% would mean 'serious trouble'

This is called the “great unwinding.” It’ll come as shocking news to millions of Millennials who have grown up believing they deserve 2% mortgages and the government will never let the cost of money rise.

So what happens if the BIS s right? A new crisis, it says. Serious one. “Unprecedented challenges.” Credit growth in Canada is at red-flag levels, along with Hong Kong, China, Thailand, Mexico and Turkey. If rates eventually rise by 2.5%, then the BIS says we’ll be “in serious trouble.” That would take the Bank of Canada rate from its current 0.5% right up to 3%. For some context, the rate was 4.5% back in 2007, 21% in 1980 and 10% in 1990. So three percent would still be well below the long-term average.

The consequences of a rate-tightening cycle that lasts for three, four or five years are predictable. Debt service costs would march higher, economic activity would fall, stocks would lose value, employment would get harder and houses would tank. Among the places with most damage, the BIS suggests, would be Canada – largely thanks to the property boom which has reshaped society, driven family debt to $2 trillion, wiped out personal savings and concentrated net worth in a single asset.

Meanwhile two billion more people around the world have entered the workforce, keeping wages depressed, while free trade – essential to economic growth – has allowed them to directly compete with workers who live in expensive places, like here. So the response has been predictable on the part of many voters. Build walls of concrete and tariffs. Keep rates low and elect guys like Trump.

How credible is all this doomer talk?

Very. But that doesn’t mean it’s going to happen soon. No central bank wants to destroy its economy, even if this leads to a better place. Having stated that, swelling rates will be with us for years to come. In 2020 nobody will be renewing mortgages at 3%. House prices will be lower down, not higher. People with a one-horse portfolio will regret that in 2017 they didn’t start dealing with the great unwind.

So, sell assets and lighten up on debt. Have a balanced and diversified portfolio of the kind described here so often – which saved people’s butts back in 2008-9. When the TSX dropped 55% and took seven years to recover, that portfolio declined less than half and recovered within twelve months. Over the worst three years of our financial lives (to date) it averaged a positive 5% average annual return.

If you believe the storm will return, prepare. If you don’t, wrong blog.