Client situation
The people
Gene and Vicky, both 31.
The problem
Deciding whether to use their savings to buy a rental property.
The plan
Use the money for savings and paying down the mortgage because the forecast net rental income leaves little room for error. Longer term, a rental property may make more sense.
The payoff
Taking full advantage of Gene’s RRSP and Vicky’s TFSA. Having enough money on hand for Vicky to comfortably take a few years off while their child is young.
Client situation
Monthly net income including bonus: $7,011.
Assets
Cash equivalents $103,000; TFSAs $17,000; his RRSP $10,000; her RRSP $7,300; residence $590,000. Total: $727,300.
Monthly disbursements
Mortgage: $2,033; other housing expenses $810, transportation $360; groceries $480; clothing, dry cleaning $220; gifts $140; charitable $250; vacation, travel $150; personal discretionary (entertaining, dining out, club membership, sports, subscriptions, grooming) $750; drugs, dental: $85, telecom $100. Total: $5,378. Savings capacity: $1,633.
Liabilities
Mortgage $454,000 at 2.15 per cent variable.
Vicky and Gene have been working in London but are moving back to Canada and are about to have their first child. Both are age 31. He works in financial services, she in health care. While they were abroad, they rented out their Toronto house and enjoyed the experience. “We are comfortable with financial risks and love being landlords,” Gene writes in an e-mail. They have saved up a sum of money – $120,000 – that they plan to use for a down payment on a second property. Their primary residence is valued at $590,000 with a $454,000 mortgage. The investment property would cost about $600,000 and generate net rental income of $500 a month after mortgage, taxes and insurance, Gene calculates. “Is it wise to use some of our savings, together with a big fixed-rate mortgage, to buy an investment property at this point in our lives?” Gene asks. They want to remain flexible enough to manage through a few years during which Vicky will be staying at home with their child. “And if not, what do you recommend we do instead with our savings?” We asked Michael Cherney, an independent financial planner in Toronto, to look at Gene and Vicky’s situation.
What the expert says
Vicky and Gene are in a good position for a young couple, Mr. Cherney says. However, whether it makes sense to buy an additional property is unclear.
“I don’t love the idea,” the planner says. The $500 a month is “too small a margin for error.” Risks include a real estate market downturn, unexpected maintenance expenses and a rise in mortgage rates.
As an alternative, they might consider buying a house with a rental unit, say in the basement, or building a basement apartment in their existing home. If they decide to sell their home and buy another one, Mr. Cherney recommends they sell their existing home before they buy a new one given the weakening market. What should they do with their $120,000 in cash?
The first $10,000 will go to setting up their household when they return to Toronto. The remaining $110,000 could be divided as follows: $30,000 to use up the contribution room in Gene’s registered retirement savings plan, invested in a portfolio of no more than five Canadian and foreign stock and bond exchange-traded funds; $13,500 to Vicky’s tax-free savings account to lift it to the maximum of $20,000; and the remaining $66,500 to pay down their mortgage, giving them increased flexibility.
If they decide to switch houses, the $66,500 would help pay for transaction costs (such as real estate commissions, land transfer tax, legal fees and moving costs) with any remainder going to the down payment.
Vicky and Gene are saving about $1,650 a month, about 15 per cent of Gene’s pre-tax income, “which is very good,” Mr. Cherney says.
They could save even more if they wish. They can increase their already admirable savings to between $2,000 and $2,500 a month and use that to fund a combination of Gene’s RRSP, Vicky’s TFSA, a registered education savings plan for their child or children, and paying down their mortgage, he adds.
Looking ahead to when Vicky and Gene retire, Gene is fortunate to have a defined benefit pension plan that will pay him $65,000 per year (current dollars) if he continues with the same company to age 65, the planner notes. With his pension, his RRSP and Vicky’s TFSA, “they are in a good position for a comfortable, and possibly early, retirement,” Mr. Cherney says.
Between now and then, the couple will have some big decisions to make. Will they want to move to a larger house? Will they continue with their frugal ways? Will they opt to send their children to private school? When will Vicky return to the work force and at what income level? As well, Gene’s pension plan could be watered down over time, or he could change employers.
Mr. Cherney is not ruling out the possibility of their buying an investment property at some point in future.
“I just don’t think this is the right time.” If they come across a well-located property at the right price a few years from now, “They may well be able to greatly improve their position,” he says. “They do have the right mindset.”
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