Todd and his wife have this problem. Fortunately, the Doctor is in.
“My wife and I luckily bought our house almost ten years ago. After doubling up our mortgage payments and hitting all our lump-sums we have managed to pay the sucker off!!!! Woohooo!!!! Unfortunately the house also represents most of our net worth. I think we should sell, hold our cash and buy back in when house prices fall. The Wife thinks our area is hot and will be hold its value, is there any truth to her argument?”
I have no idea, since Todd neglected to tell me what city he lives in, let alone what hood. But a woman who thinks real estate is hot is apparently getting a lot more common. This week BMO popped a new survey showing (according to them) that “leading the pack” among new homebuyers are women between the ages of 18 and 34. Also: women (says the bank) want renovated houses, “where there is no extra work.” Even scarier: 52% who own houses think property values will be higher in two years, while 84% are “confident that housing values will hold in their area.”
You bet. It’s different here. Wherever that is.
Back to Todd & The Wife:
“If we were to stay here we are looking to renovate, to get the house where we want It would be a full gut. I don’t want to go back into debt. Any advice you have would be appreciated.”
So, Todd, tell me more about you.
“Both the Wife and I are in our early 40s, we have a 10 year old child. I believe the house is worth over $600,000 and we paid $322,000. To keep the house we are looking at putting over $100,000. Together we earn around $120,000 a year gross. Although our earnings have been steady I work on a freelance basis and have no income guarantee.
“Our net worth breakdown is as follows: House $600,000 (or more, hopefully); RRSP $200,000 (Combined); TFSA $10,000; RESP $20,000; Cash $50,000. So, what do you think?”
Well, of the total net worth at present, the house accounts for almost 70%. If T&TW are like more Canadians, their RRSPs are sitting in a bunch of do-nothing bank mutual funds; the RESP’s in a dead-end GIC; and the TSFA is moulding in the orange guy’s shorts. In other words, the 30% of the net worth in liquid assets is earning low single-digits while (if real estate corrects) their house has already seen its best-ever gain.
In fact, 70% in a house at age 42 is too much. Using my Rule of 90 (subtract your age from 90 to get the correct percentage of net worth in real estate), it should be more like 48%. And if they gut the place using $100,000 in capital to do the work, then suddenly the house represents 80% of their wealth. Bad idea.
A move like that would tie their financial future to the real estate market at a time when it’s obvious big change is coming. By hanging on and dumping more money into the property, they risk losing all or part of the fattest tax-free capital gain they’ll likely ever see. If they sold, they’d have close to $850,000 liquid (after costs), which could generate an income of almost $5,000 a month if invested to get 7% – enough to rent a better house, and still grow the portfolio. Better still, rent and finance that with earned income, invest the money for five years and have $1.2 million, assuming the same rate of return.
Or, keep the house and reno the poop out of it, ending up with a 5-year-old renovation, real estate worth (at best) $600,000 and about $200,000 in mutual funds and savings. Then T&TW are nearing age 50 with a kid about to spend his way through college, which means a looming retirement crunch, since most people don’t have corporate pensions (especially freelancers). So why is this even being debated?
One reason only: emotion.
Emotion makes us believe what’s happened in the recent past (like higher house prices) will go on forever. That’s called recency. Emotion leads us to believe bad things happen to other people more than us. So it’s different here. Emotion makes us fear and vilify the unfamiliar. So stock markets must be rigged. Emotion blinds us to actual risk. So a house trumps financial assets. Emotion makes us buy high and expect higher. As it pushes us to sell in losses.
Emotion’s the enemy of success with money. And emotion drives real estate.
But I did not say women are to blame. That was BeeMo.