West coast couple stakes it all on property – Alternative Analysis from a Mortgage Broker

I came across this article today in the Financial Post, in which a financial planner breaks down the situation of a volunteer reader. He delivers an opinion that I am inclined to disagree with. Although I am a mortgage broker and not a financial planner, I will attempt to explain my thoughts in detail with regards to the article.

Mortgage Borrower’s Background

The couple in the article are independently wealthy, having $2.4 million in equity spread out over a dozen rental properties and owning several small businesses including a consulting business. Most of their net worth is tied up in real estate currently. Their $2.4 million of equity nets them just over $17,000 per year despite the fact they are in the lowest interest rate environment in the history of Canada and they are in variable rate mortgages on all the properties.

Where I Agree With The Financial Planner’s Analysis

These mortgage borrowers are obtaining a very poor return on investment in their real estate holdings. This is not surprising considering their real estate holdings appear to be in the Greater Vancouver Area. Although cashflow from investments is not a primary indicator of the quality of investment, I tend to believe that if you invest in real estate that cashflow is of greater importance than the appreciation in the value of the property. Although they have likely done well for themselves by purchasing their properties and having the value increase, they will likely be under duress in the coming months due to the recent rate increases to the Bank of Canada prime rate.

Where I Disagree on the Analysis

The financial planner who analysed the readers financial situation for the article to a large extent provided a largely self-serving analysis to the couple’s financial situation, as he suggested they liquidate their real estate holdings and invest the funds in a Real Estate Investment Trust (REIT), a product that by coincidence is offered through financial institutions and investment houses (like the one he works for). He suggests that they could make 7% on the investment.

Liquidating their assets would be a good idea due to the poor return they are currently getting on their investment…but I do not think that they need to get out of real estate ownership. Although I am not a realtor, I have been able to see prices and cashflows on properties in the Greater Vancouver Area…and they generally are not very good, particularly for residential properties such as detached homes or condominiums. However, commercial properties are quite a viable option for those with the equity that this couple has. Further, they can rid themselves of the management of the property altogether by hiring a property management company to administer the building. This could also allow them to buy property outside of the lower mainland and provide even more cashflow and greater returns.

However, lets assume they buy a sample property in the lower mainland. It is quite possible for them to buy a multi-unit residential property with a capitalization rate (net income / property cost) of 6%. Assuming they put down 50% for a purchase of a $4.8 million property with a 5% fixed interest rate and 25 year amortization, I estimate they would cashflow approximately $120,000/year out of such a property after mortgage payments and would additionally be paying down their mortgage at the same time.

These numbers are very simplistic and rough, but they are realistic and on the conservative side in this market. If they were to buy outside of the Greater Vancouver Area, it is possible their returns would be even much better. I am also being conservative on the rate as rates are currently lower than 5% for a fixed rate at some commercial institutions for multi-unit residential properties.

In this case, I do not believe that real estate is a bad investment for this couple, but the type of real estate they are investing in is not the right one for them particularly at this time.

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