It’s spring, which means ‘for sale’ signs are popping up in many neighbourhoods across the country – but while property values once seemed to know no bounds in some areas, is owning a home really a slam-dunk investment, or an investment at all?
As a report from RBC shows, Canadian property values increased substantially in recent years—by an average of nearly 10 per cent per year in both 2016 and 2017.
However, 2018 was a different story. According to a recent forecast, the Canadian Real Estate Association (CREA) projects the national average home sale price to stabilize around $487,000 in 2019, following a 4.1 per cent drop in 2018, which was the largest in almost 25 years.
For those thinking of getting on the property ladder for the first or second time, it may not necessarily be a good idea to bank on real estate continuing to do well, say financial planners. Instead, consider a number of factors to ensure the purchase is a good fit with your overall financial situation and future plans.
For those interested in taking the plunge, Monique Madan, lead financial life strategist at Upotential, says there are three criteria to help you figure out whether a property purchase fits with your financial circumstances. The first is whether you have a down payment of at least 20 per cent, plus an emergency fund.
Number two is the bank’s criteria for affordability: the debt service ratio. This includes total payments on the principal and interest for the mortgage, taxes and heating, which have to be less than 32 per cent of gross income.
The third affordability guideline, says Madan, is that the mortgage should be repaid in full by retirement in the majority of cases.
Nick Hui, a certified financial planner with Vave Financial says it’s also useful to do an ‘apples to apples’ comparison of the annual costs of renting vs. buying, including a ‘buy’ scenario that factors in the interest on the mortgage and annual maintenance costs of approximately one per cent of the purchase price.
Consider the tradeoffs: As a prospective homebuyer, says Hui, it’s also a good idea to consider the opportunity cost of your down payment.
“If you put down a $100,000 down payment for instance, in your house, that money could have been invested somewhere else, like in your TFSA, your RRSP or something like that. So, you have to factor in how much would that $100,000 have made doing something else — maybe making five or six per cent on the market.”
Similarly, says Hui, try not to raid your retirement savings to purchase a property.
“Taking out of your RRSP and TFSAs and effectively robbing your retirement accounts is really borrowing from your own retirement. It could mean not being able to retire when you want to.”
Project into the future: Hui says it’s important to apply your house purchase costs to your overall financial picture – because it’s not necessarily just about the property itself.
“It’s about how does it affect your cashflow, how does it affect how much you can invest for the future, how much does it affect your existing debts,” he explains.
Consider working with an advice-only financial planner, says Hui, who can use software to look at different scenarios — for example, how an $800,000 house vs. a $600,000 property would affect your retirement plans.
Take a look at diversification: Will the property make up a substantial portion of your net worth in your pre-retirement years? If so, this may be a problem, says Madan.
The concept of real estate as an investment, she explains, really only applies to rental properties. Other properties are considered ‘personal use real estate’ — something that will be used and enjoyed but will not generate an income.
“I usually start to get scared when someone’s percentage of net worth in what’s called personal use real estate —your principal residence and maybe a vacation property—exceeds 40 per cent,” says Madan.
Unless you’re one of the few who has a defined benefit pension, says Madan, you need as broad a base of capital as possible to generate income for retirement.
“A lot of Canadians have a lot of house but they’re not very diversified – all their net worth is in their house,” says Hui.
“If you have TFSAs, RRSPs, some stocks, some funds or whatever, your household is not so reliant on whether one house goes up or down,” he adds.
Indeed, this can also apply to a cottage. If you’re getting ideas about purchasing a vacation home, but this move will push you into having a substantial portion of your net wealth in the personal use property category, Madan says it is important to recognize that you are taking money off the table that could generate income.
“So, it’s not, strictly speaking ‘can I afford the property?’ You may still be able to afford the property but locking in so much capital in something that will not generate income for you, we have to double check that you’ll have enough income sources in retirement,” she adds.