THE CANADIAN HOUSING MARKET has been strong in recent years. That strength has been driven primarily by big price increases in the Greater Toronto Area, the Greater Vancouver Area and nearby regions. Prices also have increased at a healthy pace in other parts of the country.
As a result, many of your clients have seen their net worth rise – in some cases, dramatically. But that increase is “paper” profit for an illiquid asset. Clients should understand that these gains may not be permanent and that they should not be counting on these assets to help fund retirement.
Convincing clients that house prices won’t keep rising and, indeed, could drop dramatically can be difficult.
“Through the past 10 years, many people [have come to] believe the return on real estate far exceeds other investment returns in the long term,” says Lisa-Marie Winning, senior consultant with Investors Group Inc. in Burlington, Ont. However, she says, “the conversation has been easier this year” because prices have cooled and, she notes, the Canadian Real Estate Association shows small drops during the summer in her area.
Financial advisors generally don’t encourage clients to consider their house as a source of cash flow for their retirement.
“You always need somewhere to live,” Winning points out. Her clients tend to view their house as being a “lifestyle asset, so selling the property generally is not part of the financial plan.”
Adrian Mastracci, senior portfolio manager with Lycos Asset Management Inc. in Vancouver, agrees: “I get my clients to give me a figure for the value of their house and we put that in the financial plan. But [the house] is considered an asset of last resort; not a generator of cash flow.”
However, not all clients have sufficient retirement savings and may need to access some of their house’s value. Melanie Twietmeyer, wealth advisor at Legacy Wealth Management Inc. in Calgary, has increasing numbers of clients in that position.
That means the house will have to be sold during retirement, so clients must have a realistic view of the value of their home and make realistic assumptions about future appreciation of that asset.
But even clients who can afford to keep their house as long as possible should be careful about what they assume will be the eventual value of their home. If they’re counting on leaving a significant estate for their children but live a long time, these clients may have to sell the home and use at least some of the proceeds for assisted living or a nursing home that meets their expectations, Twietmeyer says.
Advisors differ in how they calculate the value of housing assets and the rate of appreciation of those assets as elements in financial plans.
Some advisors, including Mastracci, take a conservative approach. “Usually,” he says, “the house is valued between the current assessed value [for property taxes] and the price for similar houses nearby.”
Winning keeps a close eye on market conditions as provided by local realtors. Twietmeyer and Mia Karmelic, division director with Investors Group in Toronto, use the current value of houses as determined by professional assessors.
Twietmeyer’s projections rarely assume more than a 1% annual increase in value, and sometimes she suggests assuming drops in the value. Mastracci and Karmelic use the target inflation rate (currently, 2%). Winning uses modest returns.
What matters is the net proceeds from the eventual sale, Twietmeyer says. If a client has had a house for a long time, it may need renovations before it’s sold. Those costs – along with moving costs, taxes, and realty and legal fees – must be deducted to calculate the value of a house used as an element of a financial plan.
Even if there are no plans to sell the home, it can be helpful in managing cash flow – especially in clients’ early retirement years. That’s when people may take long, expensive trips. (See story on page 16.) Taking money out of an RRSP or RRIF to finance those trips may mean a very high tax bill, so using a home-equity line of credit and paying it off gradually could make more sense.
Karmelic encourages her clients to apply for as high a line of credit as they qualify for after they pay off their mortgages and are still working. Lines of credit don’t cost anything unless they’re used and never expire. However, paying back any loans should be part of the financial plan.
Twietmeyer agrees that home-equity loans can work well for some clients, but warns that not everyone is good at repaying loans.
Reverse mortgages are another option, but are expensive – and Twietmeyer seldom suggests them. If your client lives a long time, she says, there may be very little equity left when the client dies or the house is sold.
Renting out part of the home as an apartment is another possibility, Mastracci says. An important caveat is that depreciation should not be claimed when declaring the rental income on the client’s income tax return. If the client deducts for depreciation, they risk losing the principal residence capital-gains exemption when the house is sold.
But, at the end of the day, selling the house and renting an apartment may be the only viable option. Such a move has both advantages and disadvantages, according to Wilmot George, vice president of tax, retirement and estate planning at CI Investments Inc. in Toronto.
Renting can give your clients flexibility and freedom, George says. Renters can enjoy the cash flow from investments made with the proceeds from the sale of their house. Renters can lock up and go away for as long as they want. There are no maintenance duties, gardening or snow shovelling. And renters can move out easily – whenever their lease expires.
On the downside, according to George, there can be restrictions on what renters can and can’t do in their unit. Many landlords don’t allow pets. Heat and air conditioning usually are controlled by the landlord and the temperature may be hotter or colder than preferred. Landlords may not be quick to do repairs. And there’s no end to the rent. Even where there is rent control, the rent still usually increases every year.