In a moment: are the banks safe?
Let’s set the scene with comments from two blog dogs sitting on opposite sides of the real estate maelstrom. First a poster we’ll respectfully call Dick:
“People, don’t listen to Turnster, he knows nothing about nothing. If you bought into RE 1 year ago, 2, 5, 10, 15, 20 you are golden no matter what. Open your eyes and see for yourselves – RE in Canada will always be of value and will never go down in price. NEVER! There ain’t no bubble here. RE prices simply have caught up with the levels where they should have been in the first place. TO is a major cultural and economic city. I bought last years and it’s gone way up! And always will. And everyone will want to live here. The demand for RE will never dry up. NEVER!”
And here’s a further update from Derek, the dude who blissed out last month when his house went in a bidding war for lots more than he expected: $2.25 million. Then the buyer got cold feet while the other bidders fled. Lawyers are fighting. Derek’s in a funk.
“Well the shit show continues. Buyers did not even respond to our lawyer. We had hoped maybe they would come to their senses but have waited long enough. I just can’t believe peoples mentality. Stick your head in the sand and hope it goes away. So it looks like we are relisting on Monday.
“Really nervous that the market has changed and we will be at a terrible disadvantage now. Dealing with all this and maybe having to sue them is really not the way we had planned on having this happen. Most people I talk seem to feel that I will win if this is the outcome but obviously we are nervous.”
And finally, another dog who just sold for far less than anticipated after an attempt to create a bidding war failed. No offers – even for a detached in prime 416.
“At the beginning of April in this area there was a boat load of sales, before Ontario dropped the hammer. Since then, just four sales. Listings have tripled. Bidding wars being held, but no offers. Condos listings exploding. Now I just got to find a desperate owner willing to take a haircut on rent.”
Yeah, everyone sees reality through their own lens of experience. The guy who bought recently wants nothing more than validation for having made a sacrifice – which is exactly what it takes to buy into a bubble market. So he pumps, gloats and pumps harder. The person who wants to sell and can’t, sees nothing but disaster looming. The guy who swallowed a lump pf pride and took less, rationalizes the action. It’s impossible to know if the market switch has flipped from ‘Insane’ to ‘Scared,’ but something is afoot.
Days ago the savvy investment wonks at Mawer money managers sold almost three million shares in Home Capital Group, squeaking out the door before it shut behind them. The loss would be staggering, and now the company’s chief investment officer, Jim Hall, is saying some serious things about what the collapse of Home Cap might suggest about the whole mortgage financial business and even (gasp) the Big Banks.
Could the looming death of Canada’s biggest non-bank lender cause a run on deposits at other institutions as depositors start to understand their money went to finance a housing market that could blow up?
“The probability has gone from infinitesimal to possible — unlikely, but possible.” He told the Financial Post. “If depositors or bondholders start to lose faith in their banks, well then that becomes systemic.”
Yikes. Spooky words from a guy who manages $40 billion in assets. And while Home Cap’ mortgages represent just 1% of the entire Canadian home loan business, even little wounds are serious when you’re dealing with a system built on confidence. People blindly put their savings into the GICs and high-interest accounts of outfits like EQ Bank and Home Trust because they got a little more interest and were too trusting to ask when the cash went. (Most of it was loaned out to home-buyers who required high-ratio mortgages and didn’t qualify at the bank.) Now many depositors are desperate to get their cash back – and Home had to borrow $2 billion at usurious rates from an insider to stay alive. As a result, its stock plunged and the corporate carcass is now for sale.
See how it works? Not pretty. And fast.
There’s little doubt our big banks are secure, despite their jaw-dropping exposure to residential real estate. (If you want to worry, fret about the credit unions.) But the residential real estate market is just as susceptible to sharp U-turns in sentiment as GIC-holders in operations like Home or EQ.
On Friday US ratings agency Fitch hoisted a red flag over the GTA’s runaway, but conflicted, market. Ontario’s recent 16-point plan will bite, it says, and it could all start with those universal rent controls – since that market (as we’ve been telling you) has become dominated by speckers.
“The proposed rent controls could dampen price growth in the condo market if the rent investors can charge tenants is limited. Investors who are highly leveraged may be forced to sell, which could begin downward momentum that leads speculators to follow suit. Further, if all measures are passed, municipalities will have the power to introduce a tax on vacant units to encourage sales or rentals of unoccupied units, which may discourage speculators from holding onto vacant properties.”
Well, make up your own mind about what comes next. Dick has.
Code red: CMHC says Lower Mainland, GTA in trouble
Source: Canada Mortgage and Housing Corporation.
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Never before have we seen such house price contagion
Source: Teranet-National Bank
By Guest Blogger Ryan Lewenza
For much of my career I have been focusing on how to build wealth through stock/ETF selection and portfolio construction. Over this period I’ve spent little time looking at how one would spend their savings in retirement. That all changed the day I joined Turner Investments as for many of our clients, how much they can spend in retirement is their number one concern. This week we examine the optimal spending rate in retirement to ensure one will not outlive their money, just in case life goes into extra innings.
To determine this we first need to understand some basic numbers around retirement and life expectancy. According to Statistics Canada, the median retirement age in Canada is 62 for men and 61 for women. Unfortunately “Freedom 55” is becoming harder to attain these days with the 2007/08 financial crisis having a pronounced impact on investor portfolios, the labour market, and psychology, all of which has caused many Canadians to delay their retirement.
Looking at life expectancy with major advances in science and a rising awareness and education around health, Canadian life expectancy has risen markedly over the last few decades from 73 years in 1970 to 82 currently – men live to 80 and women 84. But this looks at the average age with many living well beyond this. According to Moshe Milevsky, an associate professor at York University, there is a 41% chance that at least one member of a 65 year old couple lives to 90. So this is what we need to solve for – the withdrawal rate from portfolios that will ensure savings will last at least 28 years (90 minus retirement age of 62).
For our clients we provide a detailed financial plan as they get close to or are in retirement. This detailed plan is a client’s roadmap in retirement which looks at things like how much they currently have, the growth they can expect, their expenses and what they can expect to withdraw in retirement. In order to build this financial plan we need to incorporate assumptions including long-term return and inflation estimates. These assumptions are critical in the projections of the plan and are important factors in determining one’s withdrawal rate.
So using our financial plan software and assumptions we can come up with different scenarios and isolate the optimal withdrawal rate to ensure one doesn’t outlive their assets. Specifically we assume: 1) investors are invested in a balanced portfolio with 60% in equities and 40% in fixed income; 2) over the long run this portfolio delivers returns of 6% after fees; and 3) that inflation will average 2% over the long-run.
Based on these assumptions we look at various withdrawal rates to see the number of years that the money would last. Based on a $1 million portfolio, 6% rate of return and 2% inflation, if one withdraws 4% or $40,000 per year, the portfolio will last over 50 years. For a 5% withdrawal rate the portfolio would last 37 years. And finally with a 6% withdrawal rate the portfolio would last 26 years, or roughly the amount of years that investors should plan for, based on the above life expectancy assumptions.
So based on these reasonable assumptions we believe the optimal withdrawal rate is around the 5% level, which maximizes the amount of annual income from the portfolio while ensuring the money lasts for the duration of one’s retirement/life.
Number of Years Money Will Last
Note: Assumes $1,000,000 portfolio, 6% long-term return and 2% inflation
Source: Turner Investments
Most academic research on this topic suggests 4% as the maximum safe withdrawal rate, otherwise known as the “4% rule”. This field of research was pioneered by William Bengen in his seminal 1994 report Determining Withdrawal Rates Using Historical Data. Based on his analysis of rolling historical return data he determined that a 4% withdrawal rate never exhausted a portfolio in less than 33 years. Based on his analysis he found 5% to be “risky” and a 6% withdrawal rate to be “gambling”. However, it’s important to note that his analysis was based on a 50/50 asset mix versus our preferred 60/40 balanced portfolio.
As people enter into retirement the conventional financial wisdom is that investors should reduce their equity exposure and increase their bond holdings to reduce risk. Often the “age – 100” formula is used to determine one’s equity weight. For example, a 30 year old, based on this this formula should have 70% in equities (30% in bonds) versus a 70 year old who should have just 30% in equities (70% in bonds). We disagree with this outdated premise given the historically low interest rate environment we’re currently in. Bonds just aren’t cutting it these days which is why we believe investors should continue to maintain a 60/40 asset mix well into their retirement years.
So there you have it. Older academic research suggests a 4% withdrawal rate but we believe most investors can safely depend on a 5% withdrawal rate which maximizes the amount they can take out each year while ensuring they don’t run out of savings in their later years. The question then is, can you live off a 5% withdrawal rate when you include other government pension income like CPP and OAS? If not then you either need to delay retirement and save more money, reduce your spending in retirement, or take on more equity exposure and the risk that this entails. We prefer the first two options.
Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.
