Tools

The moister moaning has been munificent over the past months since the stress test came along. Maybe 20% of buyers have been punted. And rightly so. People without enough money shouldn’t buying houses.

But what about the wrinklies? They’re the crusty folks Mills love to hate – the ones who bought years ago and now sit on towering piles of windfall equity. However, the stress test may be taking a toll here, too. When house-rich, cash-poor people head into retirement with chopped income they face a choice: sell the house and disrupt life, or borrow against it to buy kibble and edibles.

The trouble? With lousy cash flow they can’t pass the stress test. Nor will the banks hand them HELOCs, now that lending requirements have been stiffened. So what happens?

Yup, reverse mortgages. They’ve exploded since the stress test arrived. Just shy of $4 billion is now owed, and the total’s grown by more than 26% in just 12 months. Staggering. Especially when you consider this money is being borrowed at the rate of  5.86% – or twice the cost of a conventional mortgage.

To refresh your memory, a reverse mortgage allows people in their fifties and beyond to borrow a whack of money against their home equity. The cash comes in a lump sum or through regular payments. There are no repayments involved, no tax on the income and the money is only returned to the lender when you sell or croak. That makes it a seductive vehicle for those who don’t want to move and lack the dough to live on. No wonder such growth is happening.

But there’s a downside. A big one. Reverse mortgages cost a lot, and the high interest rate means the outstanding balance grows every month. Fast. After a few years you can owe a lot more than you borrowed, wiping out equity and robbing your estate (and those sad, Millennial inheritors). So as a retirement plan this costs a bundle, compared with selling the property, investing and living off the income stream while retaining capital.

So why would anyone do it?

Let me share an email from a long-time mortgage broker, answering exactly that question:

The stress test has had the biggest impact to Canadians approaching retirement.  In the case of retirees, the test could be deemed discriminatory in the sense that the increased qualifying criteria impacts a retiree the most when their income decreases when transitioning from pre-retirement to retirement.

Traditional banks are not kind to seniors with abbreviated incomes.  Line of credits are no longer an option since the qualification for them have become harder.  Reduced income scenarios coupled with the stress test for a line of credit (amortized calculation) product make it impossible to access for seniors.

As seniors live longer and want to maintain the same living arrangements due to familiarity of neighbourhoods and homes, the reverse mortgage acts as the only option without a payment obligation.  We cannot be surprised with the growth of the product as wealth planners are now using this product as a tool to manage their golden years.

Well, mortgage dude, this wealth planner’s not buying it. A reverse mortgage is expensive, costly to set up, subject to rising rates, equity-sucking and at the very bottom of the tool chest, down there with the corroded AAA batteries and dead stink bugs. There are far better options.

And consider this strategy, from the same broker:

We recently saw a client with a $3,000,000+ home utilize the product to advance $1.1 million and used the proceeds to purchase thee condominiums (to eventually pass down to  each of his three children at some point) and they are all cash flow positive and he gets to write off the interest against the rental income.  The product has become a wealth planning tool.

This undiversified senior was talked into buying three more properties with leverage at twice the rate of a conventional mortgage to secure a trickle of income, fully-taxable, plus deductible interest. Will his three kids want used condos in a few years in a taxable deemed disposition? How is ending up with four properties instead of one an example of de-risking? Does an old retired guy really want to be an amateur landlord, fishing iguanas out of the toilet and scraping mold off the grow-op room floor? Would it not be better having a cash flow-producing portfolio of lowly-taxed dividends and cap gains? Isn’t it better for ‘wealth planning’ to have a balanced approach instead of putting all the eggs in one (real estate) basket plus shoveling on debt?

This is why mortgage brokers are not financial advisors. And sorry about that $4 billion in inheritance, kids. Bummer.

 

Lessons from Anon

The real estate establishment’s in high gear. CREA says sales and sentiment have returned to normal. Re/Max issued a media release stating cannabis has been good for housing prices (at least in the weedopolis of Smiths Falls). Realtor boards in Toronto and Vancouver are pumping ‘balanced’ markets. And apparently there’s an election on, with politicians promising joy to every moister making an offer.

But here at GreaterFool we’re no rubes. This ain’t our first rodeo. We’ve been around the block.

Residential real estate is no financial panacea. It’s not a retirement strategy. Not even a financial plan. Putting all your eggs in the housing basket can yield losses as quickly as it can profits. There’s a reason this pathetic blog is always yammering on about diversification and balance – it works. Here are two blog dogs to give you their stories…

“Please leave me anonymous,” says Mr. Anon, who now lives in Ontario. ”No suck up, either.

Between 2001 and 2007 he owned a house in Fort McMurray, Alberta, the jewel of the oil sands and scene of a typical property boom and bust.

“Here are some specs from my experience.

1. 1983 Sold new $110,000.00
2. 1992 Sold $130,000.00
3. 1996 Sold $130,000.00
4. 2001 Sold $220,000.00 to me (scared shitless).
5. 2007 Sold $549,900.00 Bought by a nice couple with no money down, a 40 year mortgage insured by the CHMC. It cost them $50,000.00 in insurance. He had to replace a fence all around the property with vinyl ($$) and a 100’ x 5’ wood retaining wall with brick ($$).
6. 2013 Sold $638,000.00 Very fortunate to get their principal back after all costs.
7. 2019 October Sold $400,000.00

“Just thought I would share this…”

Hmm. Reminds me of the motto of this blog – the fool who follows is the greater fool. Real estate valuations are determined primarily by demand, which is often based on buyers’ flimsy grasp of economic and financial realities, sautéed in emotion and sprinkled with spousal angst. This must be the only commodity (other than gold) which people crave more as it rises in price. Bubbles breed buyers. Busts are lonely. And never think the Fort Mac experience is unique, with no lessons for other places, like the LM or 905. It’s not.

Now, speaking of the centre of civilization, here’s a blogger with a lesson from 416. “Thought you might find this exercise interesting,” he says. “If you choose to write about it, anonymity is requested.”

What is it with this secrecy thing? Sheesh. Anyway, here’s the report…

“My wife and I were considering buying a co-op or condo for my mother-in-law, mostly to give her some stability and a break from the vagaries of the private rental market in Toronto. I sat down over the weekend and crunched the numbers.

“Current rent: $1,470 / month for a one-bed in a central area of Toronto, where she is away from the downtown chaos, but has easy access to subway and streetcar.

Assumed cost of the condo: $500k
Downpayment: $125k (we have the cash to buy outright, but could not see the logic in even contemplating this in the current interest rate environment)
Amortization: 20 years
Mortgage rate: 2.8%, assuming increases of 0.5% at each five-year renewal. Might be pessimistic, but who knows, we’d still be in a pretty low rate environment at year 20 under this assumption.
Assumed annual 3% increase in real estate values (again, who knows…)
Assumed 4.5% investment return net of fees
Assumed 27% capital gains rate / average 30% tax on investment portfolio (likely flawed, since I accrued the tax liability on the portfolio annually, whereas much of the tax would be deferred as capital gains, but still…)
2.5% annual increases in property tax and condo fees
2% annual increase in rent
15% upcharge on condo fees to assume some kind of special assessment over the 20 years

“Long story short, owning under this scenario is an absolute train wreck horror show.

“Factoring in interest, principal, condo fees, taxes, opportunity cost of the money not invested (both downpayment and the delta between monthly carrying costs), capital gains on the sale of the condo, land transfer tax, real estate commissions, the full picture, there is a $600k shortfall between owning and renting, in favour of renting.

“Yes, at year 20 the condo is mortgage free, but there is no scenario in which that $600k hole reasonably gets filled back in.

“We’re happy to own our house in Toronto, even though it’s now even clearer that it makes no financial sense to do so (we have an approx. $3.5 million house in Toronto, with a $750k mortgage that we could pay off tomorrow but feel that would be irrational when those funds can stay invested). Our house is significantly less than half of our total assets, so we are lucky enough to be able to afford irrationality, but for those who can’t I was really struck by just how toxic real estate is to financial health.”

And that about sums it up. (a) If you won the birth lottery and got into real estate ownership a few decades ago, be thankful. (b) If you managed to buy property on the cheap before mortgage rates crashed and the hormones erupted, fall to your knees in gratitude. (c) If you think this experience will be repeated, give your head a shake. There are times when it makes sense to borrow a bundle and shoulder the huge costs of buying and keeping a home. This is not one of them.

No matter what the realtors tell you or the politicians fabricate – and even with mortgage rates in the ditch – buying a first home in a major market is a dodgy proposition. Do it because you’re smitten, emotional, nesting or pushed into it. Just don’t call it a plan.