Investment Properties and the Baby Boom

A conversation I recently had with a friend about his parents has been insightful for me about another dimension of the real estate market as the population ages.

First a little background. My friend was born in Asia and immigrated to BC 20 years ago. His parents immigrated about 20 years ago and are professionals educated in Asia. When they arrived in Canada their degrees were not recognized and they spent the subsequent years eking out a living for their family. They bought and sold properties at various times and rented in between over the years, depending upon the needs of the family. Once their kids graduated university about 10 years ago they had a mostly paid-off property and an investment property with reasonable equity, both in the Vancouver area. They did not accrue much else in the way of savings.

Fast-forward to today and the parents are approaching retirement in about 5 years or so. The father has finally had his professional degree recognized and is working but not at a high salary. The mother is not working. On the property front, they sold one of their properties a year ago and are living in the other with a small mortgage, about $200K, that they plan to pay off in 5 years one way or another. They just refinanced at about 3.3% 5 year fixed. They now have about $700K cash in the bank and a mostly paid-off house worth about $500K with five years left until they plan to retire.

Now the conundrum for my friend. They are planning on retiring but do not think they have enough saved up to provide enough income to retire. They now need to put their $700K to work for them and are looking at the current investment environment. They have dabbled for brief spates in other investments but for the past 20 years they have saved most of their money through real estate. With this background in mind, they are now looking at what to invest in. Fixed income is returning little and they see other higher yielding investments as “too risky.” That is, they aren’t comfortable doing it.

Readers can probably sense where this is going. They are thinking of investing their entire savings into an investment property. They are currently looking at a local multi-unit property (8 units or so) for about $1MM, which purports to produce about $70K revenue annually. Subtract expenses and they think they can conservatively clear $25K per year on $500K after mortgage re-payments (which are low in the current rate environment). The revenue is expected to increase roughly with inflation as rents are raised over time, which suits their need for fixed income.

I talked to my friend about arguments whether or not this is a bad idea. Taking a step back, the parents are putting their entire nest egg into a single property, which seems bad. The nominal returns, however, look decent in the current environment for something they consider reasonably low risk. Part of the problem he has arguing with his parents is they can’t seem to fathom the risk they’re taking. It’s hard to explain to someone how he’ll be alright 95% of the time but 5% of the time he’ll be cleaned out. It doesn’t register; the risk seems to be entirely “under their control.”

My friend used the Mark Carney “interest rates will likely go up” argument. Their answer is that worst-case they can downsize their existing paid-off property and refinance to keep the cash flow “acceptable” with a downgrade in lifestyle.

The long and short of it is retirees like my friend’s parents are starting to do the math on retirement and the traditional mix of investments just doesn’t seem to offer the income required to fulfil their expected needs in retirement. Important points:

1. They have to resort to riskier ventures to fund retirement than has been the case in years’ past.
2. The way risk is meted out in real estate is often in chunks. Producing an expected value scenario that makes any sense to them is next to impossible: many of the aggregate risks we know exist with real estate seem remote enough to be fully discounted. The so-called “long-tail” risk is set to zero.
3. Many have put so much of their retirement savings only in real estate it’s hard to leave their comfort zone and make the switch to other investments.
4. Retirees have time on their hands to help offset ongoing investment costs in case of problems.
5. Multi-unit properties, while experiencing a boom in values, appear to produce headline returns that don’t look horrible in the current interest rate environment.

We often wonder who is buying in today’s market and chalk it up to speculators and irrational owner-occupiers. I now know one family who are doing this as a cash flow investment, i.e. not relying on the property’s future value and not planning on living in it. We may step back and call this family crazy for investing but, as the chips lie, given their comfort level with various investment types, and given their ability to handle some of the investment’s inherent risk by sacrificing some of their free time in retirement (and for my lucky friend, their children’s time), the alternatives are deemed inferior.

115 Comments
newest
oldest most voted
Inline Feedbacks
View all comments
andrew
andrew
9 years ago

It is not worth it. In my experience, commercial properties worth less than 1 million are not good investments. That's because they are too small, their profit margins are too small, and they are too risky. If you have one unit empty out of 8, you already have 12.5% vacancy. That's the whole net income gone. If you need to redo the roof, it's going to cost you 2 years worth of net income. If you want to spend time and money on renovations, you can't because it would eat ut the net income. With bigger properties with bigger revenues there's much more room for vacancy, capital expenditures, and room to still make money if things go wrong. But the most important point is this: the ROI is already fixed at, say, 5%? That ROI defines the value of the… Read more »

MB
MB
9 years ago

To add what others have already said, Yes the 8 apt unit building is a terrible idea. Aside from the 5% ROI, the (obviously) older building maintenance requirements, collecting rents, dealing with dick nobs and maintaining occupancy; there may be one bright (eeh?) point.

The rent to purchase ratio is 14.29 (purchase price/annual rental income), where most of the GVRD is over 20. The US averaged close to 25 when their bubble collapsed, according to Moody's, 16 is the long-run average.

Thoughts?

TPFKAA
TPFKAA
9 years ago

@serferboy: But how long can they sustain that belief? How much will they put up with in order to live that belief? Will it come down to living on just enough money to put food on the table, shopping at thrift stores for clothing, owning no car… or even worse? This is an important question, because the level of house poverty that the Asian population of greater van will endure will have a huge influence on the extent to which RE prices can rise. If they will take on three jobs, live three to a room, and pay 80% of their incomes on a mortgage, this bubble has a long, long, long ways to climb yet, and Flaherty's new regulations will have virtually no effect. If Asian parents will pour all their savings and HELOCs into houses for their children,… Read more »

Renting
Renting
9 years ago

@Anonymus:

That is not the topic, their background is irrelevant.

It is actually very relevant and a big part of the topic. That is why it was put it in there. If you don't like the discussion go somewhere else.

patriotz
9 years ago

@space889:

I don’t think immigrants are automatically granted PR status to qualify for students loans.

I think you're a bit unclear on the terminology. An immigrant is someone with PR status. As opposed to someone who is in the country temporarily as a student, temp worker, tourist, etc.

A PR has all the rights and obligations that a citizen has (except for voting and some government jobs) and they are entitled to the same social programs, in all respects, as citizens.

serferboy
serferboy
9 years ago

Nice to see some changes, but it's too little in my opinion. Should have gone 25 year amortization, 25% down…wait a minute, didn't the world work that way before? As an Asian, I completely understand the culture and pressure to buy. – Doesn't matter if it's a 600K bungalow that would generate rent for $50 a month – Doesn't matter if you spend all your income on the house and eat KD every night The parents would still think its a good deal. In their mind, they don't even factor in property tax, vacancy or repairs in the investment/rental equation…all that matters is: – I can tell friends I own a home – RE never goes down (except when it goes down) —————————————————- On another note, seems like people are comparing RE returns to the 1.5% risk free bank deposit… Read more »

WFT?
WFT?
9 years ago

@Boombust:

Flat prices should drive out the speculative demand that has been estimated as 50% of all purchases. Why would you want to be cash flow negative with flat prices?

Anonymus
Anonymus
9 years ago

Best place on meth Says:"The topic includes: First a little background. My friend was born in Asia…bla bla"

Are you that dumb. That is not the topic, their background is irrelevant. They could be Marsians. Their education is irrelevant. it is in the past and it can not be changed. What is relevant is should they sink saved 700k into multi-unit building as retirement cash flow.

space889
space889
9 years ago

@Lilypad: I don't think immigrants are automatically granted PR status to qualify for students loans. But let's assume they are. Also I'm not saying no one does it. As you say there are those who do and succeed. I have met some of these mature adult students doing undergrad/grad when I was in university. However, what % of all immigrants are these people? What are their backgrounds and what risks they take? A lot of the skilled immigrants are not stupid or lazy or got where they were in their home countries if they are the type who like to use excuses to avoid doing something. The simple fact is that when you have 1 or 2 kids to support, monthly rent and bills to pay, and food to put on the table, it is very risky to say hey… Read more »

Best place on meth
Best place on meth
9 years ago

@Anonymus:

The topic includes:

"First a little background. My friend was born in Asia and immigrated to BC 20 years ago. His parents immigrated about 20 years ago and are professionals educated in Asia. When they arrived in Canada their degrees were not recognized and they spent the subsequent years eking out a living for their family."

Anonymus
Anonymus
9 years ago

Patiently Waiting Says: "Check the topic of this thread."

Yes I have read the topic. Topic is about soundness of investing $700.000 in multi-unit building for retirement cash flow.

And now you go and re-read what you are writing about. duh.

paulb.
paulb.
9 years ago

New Listings 292

Price Changes 62

Sold Listings 119

10294

space889
space889
9 years ago

@taylor192: I agree in principle with your suggestions. It is definitely a lot better for immigrant to find out about these stuff before they came to Canada and find to their shock they can't work in their field. However the problem isn't simply just that some countries training aren't up to Canadian standards. The problem is also with Canadian companies and various professional associations themselves. A lot of qualifications aren't set by Canadian government but by the various professional associations and they don't/aren't willing to recognize foreign degree for fear of competitions and wages dropping. I think the most glaring example I read is that Harvard medical grads don't have their medical degree recognized in Canada and will have to jump through so much hoop and re-education to practice here that most wouldn't even bother. Yet, Canadian medical degrees are… Read more »

Patiently Waiting
Patiently Waiting
9 years ago

@Anonymus: Check the topic of this thread.

coastal
coastal
9 years ago

Flaherty's weak attempt to cool the market is the signal for all the big money to head back into the stock market. He has capped the gain potential for houses,thus the big money has to go somewhere to make growth for clients,like it went to housing after the tech crash.

Hedge funds have barely invested since the crash, there is lots of upside if the US economy shows some further signs the worst may be over. Real estate is dead for a generation, get used to your 35 year ball and chain.

Patiently Waiting
Patiently Waiting
9 years ago

Speaking as someone who grew up in Vancouver, I've watched most of my university-educated friends leave to pursue careers. They went to Ontario, US and East Asia. They didn't do this just because its fun (and it can be) but because there are few professional career opportunities even if you're fluently English-speaking and Canadian-born.

The ones who stayed in Vancouver went into the Trades or started their own businesses.

If you come from city with ten times our population and come here expecting to find the same mix of jobs, its too bad for you that you didn't do your research. Excuse me while i find my tiny violin.

Anonymus
Anonymus
9 years ago

Please people no more talk about immigrants, education system after 40 or any other irrelevant topic. Let's focus on Real Estate and big news from Flaherty today.

Boombust
Boombust
9 years ago

"It’s pretty safe to say the days of real estate appreciation are over."

That BMO bigshot on BNN this morning expected prices to remain "flat" BECAUSE of the changes…

Seems to me that prices will be going DOWN as people, noticing RE is no longer appreciatiing, will start to hold off.

Let's revel in the unravelling.

raggedyrenter
raggedyrenter
9 years ago

@Anonymouse

"Alternatively, you could get a firm job offer from a Canadian employer and get a work permit. Once you’ve been in the country for a couple of years you then apply for PR via the Canadian Experience Program. The points system isn’t the only way."

Yeah but this is a very rare case. All foreign job applications we got are never considered. Obviously companies need to fill their workforce right away and you can't wait in uncertainty.

Unless you are one very few people in the world with a very select set of skills/knowledge that can't easily be replicated. I happened to know ONE immigrant out of hundreds who came into Canada that way. The employer was jumping over the hoops to get him.

Either that or your inlaw wants to hire you.

Royce McCutcheon
Royce McCutcheon
9 years ago

@Ha ha ha:

Forgive my ignorance, but is that $6900/month pay take-home (i.e. net)? And if it is… doesn't that seem a bit on the high side for an average family out here? I mean, I didn't realize that the average person here had 82k in take home pay. I mention it because it seems to me that the maximum mortgage possible for the average Vancouverite would be substantially lower than 440k.

In the same vein: is the rule regarding 1/3 of pay towards shelter meant to be taken from your pre-tax, etc. pay or your take-home? I always assumed it was the latter.

french
french
9 years ago

@ anonymous “Alternatively, you could get a firm job offer from a Canadian employer and get a work permit. Once you’ve been in the country for a couple of years you then apply for PR via the Canadian Experience Program. The points system isn’t the only way.” I agree. But if you think that a serious Canadian employer will make you a job offer on the other side of the ocean, out of the blue, unless you are some sort of internationally known scientist or celebrity, you are deluding yourself. This “job offer” immigration scheme is a way for established immigrants to get friends and family (other than what can you bring through family sponsorship) here in Canada. I would guess that they even might get money from their friend for doing it. They put some adds to prove that… Read more »

raggedyrenter
raggedyrenter
9 years ago

I am a pretty recent immigrant as well. Really sad to see my cohorts not doing well one way or another. I always try to help them by fixing resumes, teaching interview skills, and other things to understand/learn. From my observation it's not the "Canadian experience" issue. I don't believe it's racism as well. It might be foreign education is some areas like pharmacy or medical fields. But in the business world, it usually comes down to the soft skills (language, customs and culture, communication skills). Some are very smart and hard-working but when it comes to communicating, their English is understandable (and I found that Canadians are very accomodating), but very robotic. Can't make jokes, can't understand jokes, can't respond to jokes, don't follow the (local) news, can't read people, can't debate/argue, can't deliver presentation, don't know who Kesler… Read more »

Anonymouse
Anonymouse
9 years ago

@Anonymous:

"Are there any of those people left? I mean if you fell for it last year and rushed in to buy before the rules changed (and HST came shortly after) then they won’t be around this year. Besides the down payment is the same, I could understand a rush if it had been moved to 10% but I think that’s over. There might be a blip of sales but too much demand was brought forward last year."

Sales were quite low towards the end of last year, but so was inventory. So there wasn't much choice available to buyers out there. There could still be another wave of potential buyers out there, who were disappointed with lack of quality product for the last few months and decided to wait until spring.

M-
9 years ago

A broker I know thinks the 85% equity for refi is a big deal. Anybody who buys with a 5-yr fixed mortgage can't refi to a variable rate until they have at least 15% equity. Two things: it keeps people paying "high" fixed rates to the banks, and squeezes a loophole around last spring's tightening. Let's look to see where this can be a problem: -A buyer wants a mortgage, can afford a low variable rate mtg, but can't qualify at the 5-year posted rate (~5.2%). -To get around the 5-year posted rate, if they sign onto a 5-year fixed rate mortgage (~4.1%), they might be able to qualify, but their lifestyle would be cramped. -The buyer really wants the free-money variable rate. -Immediately refi into a variable rate mtg (~2.8%), so that it doesn't matter if you fudged some… Read more »

Anonymouse
Anonymouse
9 years ago

@french:

"Our immigration policy with respect to skilled immigrants is a complete farce. First you have to qualify on a point system based on the studies you have done in your own country then when you come in Canada your diplomas are simply not recognized, you have to go back to school."

Alternatively, you could get a firm job offer from a Canadian employer and get a work permit. Once you've been in the country for a couple of years you then apply for PR via the Canadian Experience Program. The points system isn't the only way.