Safe as Houses? Not for this 52-year-old Who has 84% of her $1.7-million Wealth Tied up in Risky Real Estate

Andrew Allentuck
Top heavy in property, Nancy's good life could crumble if her bet goes sour — especially if she quits her steady job to sell real estate.
Situation: 52-year-old corporate manager considers swapping secure job for real estate sales
Solution: Evaluate risks and compare retirement income and savings in new career with present job
At the age of 52, a woman we’ll call Nancy has made a good life for herself.   Single, she has a take-home income each month of $4,639. She lives in a $900,000 fully paid home in a pricey area of Toronto and has a $600,000 rental condo under construction on which she has already made a deposit of $200,000 with $400,000 more to go to completion. She will need to borrow that money. Her net worth, $1.77-million, is substantial, but, looking ahead, she is troubled by cancer, now in remission, the duty she feels toward a disabled sister, and a wish to be free of her daily grind in the bureaucracy of a large manufacturing company.
“Do I have enough of a financial cushion now to quit my job and try selling real estate full time?” she asks. “What would that move do to my finances?”
“She has done an excellent job of accumulating assets and paying off debts,” he says. “But the problem is that her home is 51% of her $1.765-million net worth and if you add the rental condo, which is not far from her house, her commitment to property is 84% of her net worth. That’s a huge bet on one sector.  If she moves into selling property, almost all of her finances will be in the property business in one part of one city. That’s jeopardy, not a cushion.”
Nancy’s Current Finances
Risk management is vital for Nancy. If the condo investment is not profitable, her fairly tight budget with almost no room for added costs without reducing a total of $874 she puts into her RRSP and TFSA would be squeezed.
The condo will thus be a make or break investment, Mr. Moran says. Some revenue and cost projections are in order.
If Nancy can get $2,800 a month rent from the condo and if she pays $416 a month for property tax, $500 a month for condo fees, and $1,000 a month for interest at 3% on a $400,000 mortgage she will take out when the condo is ready for occupancy, she would have $884 net rent. That works out to $10,608 a year or a 5% return on her $200,000 equity. That’s a poor return on an illiquid asset leveraged by 66%. If Nancy wants to keep the property and cannot get rent up to $4,000 a month, at which point the property would generate $3,084 net rent a month or 12% annually, then she should consider either living in it or selling it for a profit. For now, the condo promises to be an albatross dragging down her retirement income prospects.
Planning Retirement
Nancy’s preparations for retirement apart from the condo investment are based on a company defined contribution plan, essentially an RRSP, to which she contributes $5,000 a year through a payroll deduction. She has been with her employer for two years. If she works another 13 years to age 65 and obtains a 3% return after inflation, the plan would have $96,000. That growth is at risk if she quits her job. Her present RRSP contribution, $416 a month or $5,000 a year, to her $230,542 balance plus her Locked In Retirement Account (LIRA) balance of $160,038, total $390,580, will grow to about $654,000 at her age 65. Add the $96,000 from her present employment plan and she would have capital of about $750,000 at 65.   If the accounts continue to grow at 3% a year after inflation, they would support an income of $41,800 a year in 2014 dollars for 25 years to her age 90.
Nancy’s tax-free savings account has a balance of $32,643 and gets $458 a month or $5,500 a year in new contributions. If she maintains her contributions for 13 years and continues to get a 3% return after inflation, she would have $136,400 in 13 years at age 65. That sum would support tax-free income of $7,600 for 25 years to her age 90.
Nancy is likely to have earned Canada Pension Plan benefits at $12,460 dollars at age 65. Her income would then be $61,860 in 2014 dollars. At 67, she could add Old Age Security at $6,765 a year for total income to age 90 of $68,625. She cannot split pension income, though she can make use of the pension income credit so that after 20% average income tax she would have $4,575 a month to spend.
Her home is paid for, but the rental condo and the potential change of career are wild cards in the calculations. If the rental condo breaks even, neither losing nor making money, these retirement income estimates will be valid. A change of job is a larger risk factor. Nancy would do well to stick with her present job. Without its income, her savings plans would be wrecked.
Nancy has a financial reserve in a life insurance policy for which she pays $800 a month. Its death benefit, $1.5-million, would support her dependent sister for life. Nancy should investigate the cost of shifting to a less costly term policy, but she may not be insurable given her experience with cancer. Her job provides about $175,000 of death benefit coverage, which is not sufficient for her sister’s needs. She would lose coverage if she quits. So keeping her life insurance coverage is necessary in spite of its cost, $9,600 a year.
The principal risks to Nancy’s financial life now and in future will be abandoning her present job and secure income for a sales job with unknown income and, of course, in extending her commitment to real estate to the tune of having 85% of her assets in two properties not far from one another. Finally, having a job and her assets in one industry in one city is piling one risk on another. A crack in the growth of Toronto property market could shatter her sales income and drive down the value of her assets. Her present job, unrelated to the property business, is a hedge against that double jeopardy.
Nancy can reduce her risks and commitment to real estate by selling her house and moving into her condo when it is finished. Her house might provide $850,000 after selling and moving costs. That would pay off the $400,000 balance of condo costs due for payment on completion and leave $450,000 for investment. At a steady rate of 3%, the cash would then contribute $13,500 to her income in 2014 dollars indefinitely. That would boost retirement income to almost $82,000 before tax or $5,340 a month after 22% average tax. The extra capital could be invested in diversified stocks and bonds through diversified exchange traded funds. At Nancy’s death, the capital, which would have been left intact, could go to her sister.
“Diversification is its own reward in terms of risk reduction and total wealth growth,” Mr. Moran says. “If Nancy takes this conservative course, she is likely to be no worse off in her investments than keeping both condo and her house and probably better off in terms of how much money she has in 10 or 20 years.”
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