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.