Podcast Episode 37: Buying a Second Property | Sense & Sensibility

We’re doing another episode on investing in real estate, but it’s not a repeat of previously espoused wisdom. This time we’re offering our perspective on an entirely different kind of real estate investment…the property that *isn’t* your primary residence. It’s a whole new world.

Episode Transcript

BARENAKED MONEY PODCAST: EPISODE 37

Buying a Second Property | Sense & Sensibility

BARENAKED MONEY PODCAST: EPISODE 37

Buying a 2^nd Property | Sense and Sensibility

Announcer:
You’re about to get lucky with the Barenaked Money podcast. The show that gives you the naked truth about personal finance with your hosts, Josh Sheluk and Colin White, portfolio managers with WLWP Wealth Planners/iA Private Wealth.

Colin White:
Welcome to the next edition of Barenaked Money. It’s Josh and myself as per the semi usual. We’re going to have a chat today, a bit of a planning topic, and we’re going to talk about real estate. I don’t know if we could call this pandering. Josh, would you call this pandering to have another podcast where we discuss real estate?

Josh Sheluk:
I would say, no. We’re taking a bit of a different look at it this time. We’re talking about how it can actually make sense for you this time around and not being that critical as we have been in the past of some of the real estate decisions that are being made. Right?

Colin White:
No. And that’s fair. Again, we’re trying to put a twist to it, but what this has been born out of is, I get a question and the team gets a question on the semi-regular about, hey, I’m going to pick up another piece of real estate, I need some money for a down payment. So that question, I think probably comes to me at least once a week. And the reasons for this can be many, it can be anything from, I think this is a good investment opportunity to, hey, I found the house I want to retire in. I’m not ready to retire quite yet, but I want to pick it up now so that I have it in the future, or it’s maybe a cottage for the family to hang out in. There could be a whole bunch of different reasons for it and depending on the reason as to what may be the way forward. So Josh, are there any other examples you can think of why or how this question gets asked to you? Or does that pretty much-

Josh Sheluk:
I think, just to be clear, we’re mostly talking today about buying a second piece of real estate. This is not so much looking at buying your family home, but more so buying a second piece of real estate whether that’s a vacation property, rental property, somewhere in between. So, I think you’re right. I think the way that it usually gets asked to me is either, does this make sense? Can I do this? Can I actually handle it financially? Or like you said, hey, I need some money for this because they’ve already made a decision.

Colin White:
Yeah. No, and that’s absolutely fair. We’ll come at this from a few different ways just to get all of it out. So I guess at the outset, one of the first things to understand that informs all of the advice that we’ll give, is this kind of a temporary thing? Now I’ve had it, I’ve had it a couple times last couple weeks where people have found their retirement home, not quite ready to retire, but they want to pick it up because they found it. And so they’re going to hold onto it for a year or two or three, maybe rent it out and then sell off where they are now and move to the property.

Colin White:
That’s not an atypical thing, a lot of people think like that and move like that. And it largely does… It doesn’t have to change your overall financial plan per se. If you have roughly the same amount of money tied up in real estate before and after the transaction, then you’re probably not disturbing your overall plan too much. So you’re really dealing with something that’s a timing issue. So then the question become, if you have resources to either buy the property or write using investments, or how much of a down payment do you put on? Or how much do you finance? Or one of the options there, is that something that comes across your desk ever, Josh?

Josh Sheluk:
Yeah, for sure. And I guess the first thing that, when we’re talking about timing the first thing, that I think about is, okay, how much time are we talking about? Are we talking about six months or are we talking about six years? Because, just to challenge one thing that you said, Colin, I think if you’re talking about years, then I think it does change the financial circumstances almost without a doubt. That’s a long time to carry two properties. Even if you’re just going to borrow temporarily to pay a very low interest rate mortgage right now, and then pay it off when you sell your primary residence or your current home three years down the road, that’s still going to change things a lot for you financially because, not only do you have mortgage payments at interest, but you also have your property tax, you have renovations, you have utilities, you have a whole bunch of things that may come up that cost you money over that period of time, that are really new expenses for your financial circumstance.

Colin White:
Oh no, you’re absolutely right. It’s a continuum. The longer the timeline, the more impactful that it could be now. In the situations I’ve had last couple weeks, the attention’s been, hey, I want to pick it up. It’s a really tight rental market right now so I know I can rent this out for two years.

Josh Sheluk:
Sure.

Colin White:
Therefore, I may get a little bit further ahead over that time period. So yeah, you’re right. There can be nuances and again, I’m speaking of broad generalities for sure. And, oh wait, we didn’t start with the disclaimer. Don’t take any of this as advice. Do not listen to this podcast and do anything other than call your advisor and have a conversation about your situation. The proper use for the information you’re going to receive today is to think about… Formulate a question and maybe some plans and go see an advisor. We really should have started with that, maybe Catherine could put that back at the start.

Josh Sheluk:
I think there’s a disclaimer there that reads something along those lines anyway, Colin.

Colin White:
Yes. So anyway, again, in the situation then maybe we should just take examples. Maybe that’s the best way to go through this. So the way that was very top of mind for me, last couple weeks this has happened to me twice, is exactly that. It’s a two to three expected year time horizon, and it’s, hey, should I cash out my investments to pay cash for the property? Or do I take a small mortgage? Or what do I do? So, there’s a couple of things that don’t often, or don’t immediately, spring to mind for people because if you’re sitting in a property that’s largely paid for mortgage free, you can access the capital in that property by using a line of credit and use that to fund the second property. And from an accounting perspective, there’s a principle of matching, if you’re matching your debt to an asset and there’s some efficiency to that.

Colin White:
So if you’re expecting a yeah, I’m going to liquidate this property in the next two to three years, put a line of credit against it that’s going to be paid at the eventual sale. Then you’ve got carrying costs, call a 3% ish over that time period. And that can be a relatively efficient way, to that some people don’t think of that. So I don’t have any money out of my house until I sell it. No, easy. You can access that and it’s a rather efficient and effective and cheap way to borrow. And that is one option that you have.

Josh Sheluk:
I can just add some numbers to that Colin, just to maybe make it a little bit more real for people. Well, let’s say your home today, that you’re living in, is a million dollar hold and you have zero debt on it, but you do have a line of credit. And I know you’re laughing because you’re like, wow, this guy must live in Toronto, a million dollar hold. I know exactly what you’re thinking.

Colin White:
That’s less why I’m laughing. The Toronto partner’s going to talk to you now.

Josh Sheluk:
I used that because it’s a nice round number. Anyway, maybe 500,000, maybe it’s a million. Let’s call it a million for simplicity’s sake. You have a million dollar hold fully paid off. You have a line of credit on that property. You’re looking to buy a cottage. You can use the equity, the line of credit that you have on your current hold, to pay for that second property. So let’s say it’s a $250,000 cottage. You borrow 250,000 on your line of credit on your home. Pay for that second property. When you sell your home, you pay off that $250,000 line of credit and you bank the rest of the money. That’s exactly how the mechanic worked, right Colin?

Colin White:
Yep. The numbers can change, depending on where you are in the country. But yes, Josh speaks the truth and I don’t want to go too far in the weeds because this could turn into a five hour podcast. This even works if you have a small mortgage against the property. So if you happen to have a million dollar property because you live somewhere close to Toronto or Vancouver and you’ve got a hundred thousand dollar mortgage against it, you haven’t quite paid off and you go, no I can’t borrow [inaudible 00:08:07]. You can take some of that equity out to do that. Now again, the benefit to that is that again, you’re matching up the debt with the… You’re doing it at an inexpensive rate, for sure. It’s tends be the cheapest way to borrow money. And it’s the most flexible because with a line of credit, if your plan doesn’t work out and things don’t happen exactly in two years, you’re okay.

Colin White:
If they happen in six months instead of three years, you’re not locking yourself into anything. One other way people will sometimes, when they get in front of their mortgage specialist, they’ll say, oh, I’ll take a five year mortgage. What you just did was lock yourself into a five year obligation and if you decide you’re selling the property in three years, you could face early payment penalties. So again, that’s why we talk about using line of credit because clients tend not to have things happen exactly the way they plan and the best laid plans of mice and men are just about equal. So give yourself some flexibility. Don’t put yourself in a position to be paying a $6,000 interest penalty on something, because you didn’t know what the hell you were doing when you made this plan. So keep that in mind as well, that’s why we refer to lines of credit. Even if they’re going to offer you a half a percent lower for locking it in for five years, that’s probably not in your best interest. Most of the time, talk to your advisor, this isn’t advice. Sure.

Josh Sheluk:
So let’s, Colin, say that I’m somebody that doesn’t have a line of credit available to buy that second property but I do have some investment, I do have some other assets. What options do I have at that point? Do I cash in my investments? Do I go to the bank, try to get a new mortgage? What should I do?

Colin White:
And again, you’re going down through the list of, let’s tackle them one at a time. So if you have investments, it depends on what sort, all of your money’s invested and RSPs are taxable when you withdraw them. So cashing money out of an RSP has got huge tax consequences and that’s really not likely to be smart, financially. Now, if this is your absolute dream property and it overlooks the lake that you and your grandfather used to fish in and you are absolutely hell bent to get it regardless of anything, then okay, cash out your RSP.

Colin White:
Financially, it’s probably a really stupid move, but spiritually, maybe it’s the thing you need to do. And exaggerating to make a point, it really depends how motivated you are as to whether cashing out any money out of an RSP makes any sense. And especially in pre retirement, once you’re into retirement, then while cashing an RSP, it makes a little bit more sense, maybe. But again, any lump sum you take out of there is going to have tax consequences. Then you go from there to the next likely account to have is a TFSA. So Josh, would you recommend pulling out of a TFSA for something like this?

Josh Sheluk:
TFSA is nice because we talked about flexibility before. TFSA does give you a lot of flexibility and the beauty of the TFSA is the TF. The tax free. You can pull money out tax free. So, if you’re looking for funds and tax is important to you, as it should be, TFSA might be a really good option for that. Now, so just to bring it full circle, you really have three options in terms of your investment accounts, you have your RSP, which is going to be fully taxable when you pull it out, you have your TFSA, which is going to be tax free if you pull money out. And then, you potentially have a non-registered investment also known as a cash count or a margin account. Whereas if you withdraw money from that, maybe tax full, maybe not, depends on how much growth and unrealized capital gains that you may have in that account. So you have three buckets, depending, and each one’s going to have slightly different tax consequences of making that decision. TFSA potentially is the most tax efficient or lowest tax, I’ll call it, way to do that.

Colin White:
And the other advantage to TFSA is when you pull money out, you gain that contribution room back. So you can put the money back in. So typically if you’ve got the three accounts, you’ve got a regular investment account and a TFSA, and if you’re fortunate and have a whole bunch of unrealized gains, and I’m going to take a moment here to reinforce that people, that’s what I hope your problem is because if you’re invested with us, I hope you have a lot of unrealized gains. You can get angry at me for paying tax and that’s fine. I’ll just giggle because you’re either going to get angry at me for losing you money or you’re going to get angry at me for taxes, get angry at me for taxes. But in that situation it may be, hey, I don’t want to trigger all these gains right now so I’ll pull some out of my TFSA.

Colin White:
And then, over the next couple years I’ll use my non-registered funds or my regular investment account to gradually top up my TFSA and kind of control that tax bill over a couple of years. So you can actually get the money back into the TFSA. Typically, what we would advise people is to spend money that’s invested outside of a TFSA first because you’re going to pay tax on that money as it grows. The money inside your TFSA, you get to pull out tax free so typically that’s, from a long term investment perspective, that’d be the last place that we’d want you to pull from. So again, this is part of what it is balancing the immediacy of, okay, what’s the tax situation this year? And then taking a look at whatever your investment time horizon is, over the next five to seven, 20, 30, 40 years to say, what’s best over that time period? And sometimes it’s a combination of the two. What can we do this year? Versus what can we do going forward?

Josh Sheluk:
Yeah. Just to be clear, you can re-contribute any amounts that you withdraw from your TFSA, the following calendar year. You can’t withdraw from your TFSA 50 grand and say, I’m going to put that 50 grand right back in next week. Can’t do that. You got to wait until the next calendar year.

Colin White:
You can, you just get fined.

Josh Sheluk:
Right.

Colin White:
You shouldn’t

Josh Sheluk:
So Colin, you did a good job, I think, covering the financial aspects of how you make the decision, how you make the decision to come up with that money. Before you even get there, are there any [inaudible 00:13:55] financial reminders that you usually provide to clients like, hey, have you thought about this before you buy a second property?

Colin White:
There’s a couple of these come to mind. One of the existential risks and what we’re talking about here is, client calls up and says, I need $200,000 out of my investments and I’ll put it back in six months time. Now, you’re now incurring some market risk, there’s a risk to that. Now again, it’s not horrible. It’s not necessarily a show stopper, but that’s way different than borrowing $200,000 for six months and paying it back. Having 200,000 to 300,000 out of the market for six months, yeah you can see, that can make a material difference. So given the two choices, typically if it’s a short term need, borrow money for the short term. And if it’s a longer term need, then cashing on investments can make more sense. But I think Josh, what you’re trying… That the path you’re trying to get me on is the whole, can I really afford it? And is this really accomplishing my goal?

Colin White:
So I can get into start telling stories about people who are trying to buy a property that their grandkids can enjoy when there’s a 3% chance their grandkids will ever go there because they don’t live in the side of the country, and you’re going to spend all that money for this property and I walk really gently when I see those kinds of things happening, because I’m going, I’m here to do math. Yeah, this isn’t going to get you where you want spiritually, but I’m not your spiritual advisor, I’m just going to do math for you.

Colin White:
Buying a property, expecting that there’s going to be utility in that property for other members of the family, I’ve seen to be a fraught decision. And from a lifestyle perspective, maintaining multiple properties over the long term does tend to bother people, eventually. That I’ve seen creep into the equation. And you did a good job really Josh, of explaining some of the carrying costs that can actually be material and impact your financial situation. And not always, they’re not always apparent because people always forget about maintenance and oops, the Creek flooded and oh, the basement flooded. And if you have one property that you’ve got one set of risk, you have two properties, you’ve probably at least doubled your risk.

Josh Sheluk:
Mm-hmm (affirmative). Yeah. I just… For me, the lifestyle thing is material and I think it’s just something, again, we’re not spiritual advisors as that, it’s glad that you put it that way, but you need to consider what the impact is of having two properties in your life. If you’re going to spend every weekend at the cottage in the summer then yeah, buying a second property could make a whole lot of sense for you. If it’s summer where you want to spend four weeks a year and you may have other options that are going to be a lot more cost effective for you. I’m not saying it’s going to accomplish what you want necessarily from, oh yes, I have this place that I own. Some place that I live in, I can go there whenever I want.

Josh Sheluk:
But if you can, for example, rent a place for four weeks a year, and that’s giving you what you want, from that second property, I’ll call it that, then that might be a lot more effective way to do it than to actually spend money on a down payment, spend money on legal costs, spend money on property tax, spend money on utilities, spend money, fixing the basement, et cetera.

Colin White:
I sat down with a friend one time and we did the math because he had hit that point in life where he was still working towards the end of his career and they had nailed it. They had the properties that they thought they should have, and they were very super proud and excited. They were very property proud people and were playing cards one night and [inaudible 00:17:26] exhausted. So we sat there, we helped him do the math. He spent 21 and a half hours per week mowing grass. Either driving somewhere to mow the grass or actually mowing grass. And this is while he’s working full time. I said, so how much time are you spending enjoying all of this property? Then it was a bit of a moment for him that he maybe said, hey, look at the cost of upkeep in these things is maybe more than intended. But one thing we’ve glazed over Josh, that I think deserves a little bit of a comment is, the other kind of additional property purchase for somebody that says, hey, this is a great investment.

Josh Sheluk:
Sure.

Colin White:
Yeah, we didn’t really spend a lot of time on that. And you can go back through previous podcast and we’ve done different podcasts of investing in real estate or commented on such, but this is the time to bring it up to reinforce the whole, how much of your net worth are you going to tie up in one asset class? And it’s an asset class with a certain set of attributes, not being very liquid is a big one. Having risks with regards to valuations are interest rate sensitive might be a way of framing that. But also, with very significant, specific risks involving the immediate surroundings of where you buy a property and the economic conditions there that may turn it one way or the other.

Colin White:
So, we always talk about how much of your net worth is tied up in real estate and just understanding that there are risks with that. So if 30% of your net worth is in real estate, that’s one conversation. If 95% of your net worth is tied up in real estate, that’s a different conversation. And sometimes people choose investing in real estate because they can see it, they can feel it, they can touch it, they can walk around it if they understand it, and the stories and the press on it is largely positive. But that does gloss over a lot of the real risks that they’re taking on in doing something like that.

Josh Sheluk:
If you listen to our predictions podcasts, I’m quite sure that some [inaudible 00:19:26] this here, somebody’s going to tell you that real estate is the best investment you can possibly make. We’re a little bit more [inaudible 00:19:31] that.

Colin White:
Yeah, absolutely. And again, for me, one of the things that’s recurred over and over in my career working with clients is, life doesn’t go a straight line. Cash is king, and if you’ve got liquidity, you can deal with a lot. If your money is tied up in an asset that’s not available to you then it’s not uncommon that at some point in your life, you have a regret over that. You’re wishing that you didn’t have the money necessarily tied up the way it is so it’s a balancing act. And well, absolutely, we do walk our clients through advising them as to what reasonable numbers are for expectations and what a reasonable allocation, and some of them even listen to us, Josh.

Josh Sheluk:
Some don’t.

Colin White:
But it’s to be cautious. And again, we’re not predicting the future, but it is possible we could see an interest rate move and if you are financing to do this, you could see a mortgage renewal that comes in with significantly higher payments, which is a risk. I’m not saying it’s a probability, it’s a risk. And these things all should be factored into any conversation about picking up the second property. But for me, if it’s a temporary need, and I guess this is my [inaudible 00:20:39], if it’s a temporary need, like next six months next year, maybe in two years that the moneys needed, that leads me to say cashing money out of the market to do this. It introduces an additional level of market risk that maybe doesn’t need to be there. The low cost of borrowing may make that the better way to do it. If you’re getting into a longer term, and again, I’m not going to give you an exact number because it really depends on the situation on the day you ask me. Well, you start talking about five years out going on, maybe if it’s a five year thing, then yeah, we’re making it an allocation of capital here that isn’t, this is more of a systemic change. And maybe then that leads us back more to yeah, cashing an investment that might make more sense. But it’ll also come back to, what percentage of your net worth are we talking about? What other goals do you have? How close to the line are you with accomplishing other goals? And all the other things that go with it.

Colin White:
Did I cover everything Josh?

Josh Sheluk:
Well, I think the last thing that I would add is, when you have second properties, and this is going back to the tax impacts of this. Your second property is going to be taxed on any capital gains that you have on that property. So, we’ve talked about tax a lot. It’s a lovely thing. We all have to deal with it. But one of the mechanisms you have at your disposal when selling a property, is the principal residence exemption, and the principle residence exemption exempts your quote-on-quote principle residence from capital gains tax when you sell it, as of today. And the lines of what is your principal residence are a little bit murky, so the tax guidance is really just stating that any home or any property that you own, where you spend a substantial amount of time each year can be considered your principal residence.

Josh Sheluk:
So this is, again, where I’m going to go say, talk to your accountant, talk to the professional in your life that can guide you to do these things well. But if disposing of a second property would, likely you will be doing at some point during your life, or not, at the end of your life, you will have some flexibility, potentially around what you consider your principal residence and how you optimize that consideration for tax purposes.

Colin White:
All right, let me smack everybody down a little bit here so nobody goes and tries to think they’re smarter than the system. You get one, you don’t get two. You and your wife don’t get two separate ones. You can’t have one principle, two principle residence at the same point in time. So you get one, not two. It’s not two per family. Your cat doesn’t get one. Your kids don’t get one. If you give it to somebody else after you’ve had it for 20 years, that means you had it for 20 years and the whole 20 years worth of gains doesn’t go to the other person who’s just gave it to them. There’s no way around it. Sorry, there’s all kinds of way around it, but if you get caught, the people who catch you aren’t going to be happy and then they’re going to make you not happy.

Colin White:
So, don’t rock the boat too far. Don’t push. Ask questions of your accountant. They will walk you through exactly what you can and cannot do. And don’t think you’re smarter than the system and you’re going to game the system and end up having three principal residences. In fact, the current writing that’s going on with the whole even flipping houses thing. The government is pretty pissed off with that because they can gain a lot of political capital by coming down on evil people flipping houses, making houses too expensive. They’re paying more attention to this than they have in the past. And they’re crankier about this. And they’re allowed to be cranky about this because the general opinion of the population is, those people who they’re cranky with are doing things in the system. They should be cranky with them. So you get one, you don’t get two. Your wife doesn’t get one. Your cat doesn’t get one. Your dog doesn’t get one. You get one, be careful. Don’t push the envelope.

Josh Sheluk:
We’ve had, I think, three disclaimers in this podcast Colin. That’s great.

Colin White:
And I think they’re still going to tag one at the end, but we’ll be fully disclaimed. [inaudible 00:24:33] wrap up. We’ve given you some of what you need to consider in purchasing an additional piece of real estate during this podcast. We’ve not given you nearly enough to draw a specific conclusion in your situation. That’s why there’s room for people like us in the world. We have given you some stuff to think about and talk through before you come talk to us or whoever you’re speaking to, so use it as such. And we look forward to having a chat with anybody if they ever want to give us a ring and have this conversation.

Announcer:
This information has been prepared by White LeBlanc Wealth Planners, who is a portfolio manager for iA Private Wealth. Opinions expressed in this podcast are those of the portfolio manager only and do not necessarily reflect those iA Private Wealth Inc. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.

Speaker 4:
We’ve noticed something. It seems there are a lot of people who would rather try to figure out their lives with an online calculator than area finances [inaudible 00:25:50]. Stop doing that. You need to talk to someone who can help direct you, tell you where to start with what you’ve got to make the biggest impact on your future. You can’t figure that out at doihaveenoughcash.com, but you can figure it out by chatting with us. Call us. It’ll be okay. You’ll see.

Announcer:
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