The way the retirement process has typically worked over the past few decades included working at the same company for most of your employable years, investing in RRSP's, stocks and mutual funds along the way and then retiring at age 65 with a full company pension. Fast forward to present day and eroding job security and poorly performing markets have put that process in jeopardy. As a result, more and more individuals are looking to take matters into their own hands and are opting to invest in real estate to make their retirement more secure and comfortable.
In a recent BMO Retirement Institute Report (Oct. 2012) it was stated that "Due to a lack of savings for retirement, Canadians are using their home as a source of retirement income. Interestingly, 41% of Canadians consider equity in their home an option to save for retirement. The reliance on home equity to fund retirement is no surprise, given that 47% of Canadians said their home or primary residence is their biggest financial asset, and on average it accounts for 51% of their total net worth."
In fact, rather than down-sizing, empty-nesters are actually up-sizing homes as part of their retirement strategies. For instance, if a couple owns a $500,000 home with $200,000 in equity, they are selling their existing home and using that equity to buy an $800,000 home.
Over the past decade the Canadian real estate market has delivered double and triple digit returns that have dwarfed other investments such as stocks, bonds and mutual funds. It is no wonder that real estate as a means to retirement has become so prevalent.
All real estate however is not made equal. The major distinction between real estate is whether it is income producing or non-income producing as there are significant differences between an owner occupied single-family dwelling ("SFD") and an income-producing multi-unit residential property ("MURP"). (I have focused on these specific types of properties as they are considered to be among the safest asset classes by banks and financial institutions.) So the question becomes: "What type of real estate is most advantageous for your retirement years?"
To make that determination we will examine some of the most important factors to consider when comparing the SFD to a MURP. While this is an overly simplistic approach, it will help to illustrate the benefits and challenges of each property type.
Round 1 - Mortgage Paydown
While both the SFD and MURP build equity through mortgage paydown, the MURP has a distinct advantage as its mortgage payments are funded by the MURP itself. The SFD on the other hand requires perpetual cash injections for its mortgage payments.
Advantage: MURP
Round 2 - Cash Flow
SFD by their nature do not generate income (assuming there is no rental unit). On the other hand, a good MURP investment will provide consistent and predicatble cash flow.
Advantage: MURP
Round 3 - Appreciation
Both SFD and MURP have historically appreciated over time. MURP's have a slight advantage as appreciation can be forced by cutting expenses or increasing income.
Advantage: MURP
Round 4 - Interest Rates
Interest rate fluctuations can adversely affect both SFD and MURP. As interest rates rise, the value of SFD and MURP's begins to decline. SFD's have a slight advantage as residential rates tend to be lower than commercial rates.
Advantage: SFD
Round 5 - Tax Consequences
When selling an SFD, any capital gains are not taxable assuming it is your principal residence. Income generated from MURP's are considered taxable income and when selling, capital gains are also taxable.
Advantage: SFD
Round 6 - Real Estate Downturn
In times of real estate downturn, SFD values can be severely impacted. While MURP's may see their values drop, they continue to operate and provide cash-flow. In fact, vacancy rates, as witnessed in the US dropped as more people become renters instead of home-owners.
Advantage: MURP
While there are benefits to both approaches, I think the best approach is a hybrid. Refering to the example above, my personal preference would be to keep the $500,000 home and instead of up-sizing, take any existing equity and invest in an MURP. The MURP will provide cash-flow which becomes ever more important as you approach retirement age. If you start off investing at a younger age, you have the advantage of being able to re-finance MURP's every few years and use that equity to purchase another MURP, and so on, until you have a nice portfolio providing great cash flow in your retirement years.
Author: Paul Kondakos, BA, LL.B, MBA - Professional Real Estate Investor - RealtyHub.ca