The Retirement Crisis: Part 5: the Real Estate Gamble
It may be winter, but Vancouver's love affair with REAL ESTATE is in full bloom. After a brief pause to mark the RECESSION, the hot topic over lattes is once again square footage and million-dollar views. Which is roughly the price tag Michael Lin kept coming across last week as he and a friend sat in a Granville Street café surfing MLS, the real estate listing website, on his laptop.
Lin, a computer programmer in his late 20s, has watched the ups and downs, and then ups again, of Vancouver's housing market from his rented apartment. Now, with the economy in repair mode and MORTGAGE rates still near record lows, he's eager to take the plunge into the city's condo market. He admits prices are higher than he'd like, but believes he can easily cover the mortgage payments even if interest rates start to rise. But when asked whether he will have enough left over at the end of the month to save for retirement, he chuckles. He wasn't saving much before, either. "This way," he says, "I'll be forced to save."
Lin has plenty of company. A growing number of Canadians have come to view their homes as the ticket to a secure retirement. There's a lot to be said for that approach. Your house is the biggest investment you'll ever make, and it compels you to watch your pennies. It's also true that those Canadians who had all their money tied up in their homes instead of stock markets have come through the financial crisis with their household balance sheets largely intact.
But there are also huge risks that come with relying on your house to fund your retirement. Will house prices crash as baby boomers downsize? And is piling on debt to buy a home at record-high prices, such as we're seeing today, really the best way for younger Canadians to save up for their golden years? So far we've avoided a U.S.-style housing crash, but there's a growing view that the high-flying housing market is looking very bubbly. If you're planning to bet your nest egg on your nest, you might want to think again. "For some people who are terrible savers it can be good," says Peter Merrick, president of Merrickwealth.com in Toronto and author of The Trusted Advisor's Survival Kit. "But when people actually look at the numbers they might find it doesn't get them where they need to be. If they're banking on their homes for retirement, they might be disappointed."
Just how important are houses in the Canadian investing landscape? Benjamin Tal, an economist at CIBC World Markets, says 38.5 per cent of wealth in Canada is now tied to home ownership, up dramatically from 16.3 per cent two decades ago. Part of that has to do with rising home ownership rates. As of 2006, nearly 69 per cent of Canadian households owned their own homes, up from 63.6 per cent a decade earlier. But it's also largely due to the fact house prices have been on a tear for most of this decade. Between 1999 and 2007 home values in Canada rose 66 per cent, leaving Canadians feeling a lot wealthier. After falling around eight per cent during the recession, prices are virtually back to where they were at the peak.
Yet in the rush to get into the housing market, Canadians have spurned more traditional savings vehicles like registered retirement savings plans. In fact until recently Canada could no longer lay claim to being a nation of savers, as it once proudly did. A study last year by the Vanier Institute of the Family found average savings had fallen to just $2,000 a year, or less than three per cent of disposable income, putting Canada well behind other developed countries like France (12 per cent) and Germany (11 per cent). The savings rate has inched back up over the last year as Canadians hunkered down. And Ottawa's introduction of the tax-free savings account, which allows Canadians each year to shelter up to $5,000 from taxes, has also helped. But with go-go days returning to the housing market, few expect the savings rate to climb much higher.
Left to their houses, Canadians have several choices about how to get the most retirement bang out of their abodes, but each comes with potential risks. One increasingly popular option is a reverse mortgage, which gives homeowners access to cash while allowing them to stay in their homes. Reverse mortgage firms, which you can hear advertising heavily on radio and TV, offer loans to people aged 60 and over that are backed by the value of their houses. The loan doesn't have to be repaid until you die, sell the house, or when it ceases to be your primary residence. Nor can the loan ever exceed the value of the home. But the problem is the debt carries higher interest rates than conventional mortgages, and since you don't have to make any payments for such a long period, the loan can quickly explode in size. Over a 15-year period, all the equity in your home could easily vanish, especially if the value of the house declines. As Garth Turner, the former MP and financial author has said, a reverse mortgage "is an ideal strategy if you hate your children."
A more obvious route is to put the home on the market and downsize. Canadians certainly are sitting on a veritable gold mine with their homes. According to the Canadian Association of Accredited Mortgage Professionals, homeowners have built up an astonishing $1.93 trillion in home equity, accounting for more than 72 per cent of the value of their homes. No wonder, then, that 28 per cent of Canadian homeowners over the age of 50 plan to sell their houses to fund their retirements, according to a survey by Royal LePage in 2006, when house prices were escalating rapidly.
It can be a winning strategy for those who have built up a large amount of equity in their homes. For one thing, moving to a smaller home or condo can slash expenses like utilities, maintenance and taxes. Developers have clued in to the huge market potential by ramping up construction of bungalows, smaller townhouses and condos geared to retirees, not to mention luxury lifestyle communities all predicated on throngs of boomers selling their homes and scaling down.
Yet downsizing isn't as straightforward as it seems. "You think that you're going to have all this equity but it doesn't always work out that way," says Fred Bowie, CEO of the Canada Retirement Information Centre, an estate planning firm in Ottawa. Bowie can speak from experience. In the back of his mind, Bowie, 54, always planned to eventually sell his home and move with his wife into a smaller place, using the difference to help fund his retirement. But when the couple sold their home recently, they found they weren't ready to move into a small apartment and instead opted to build a more costly retirement lifestyle bungalow. The lesson is that when it comes to your home, circumstances can change, making it unreliable for retirement planning. "Unless you need the money to pay for long-term care, I wouldn't recommend people to rely on it for their retirements," says Bowie. "You'll still need to live somewhere."
Another serious problem is that many Canadians still won't even have finished paying off their houses by the time their retirement arrives. It used to be homeowners would scrimp and save in order to whittle down their mortgages, even throwing mortgage burning parties to mark their freedom from all that debt. Such parties are almost unheard of now. Lenders have been gradually offering longer-term mortgages, and borrowers have eagerly snapped them up. The traditional mortgage of 15 years might now stretch to more than three decades. What's more, Canadians have increasingly borrowed against the equity in their homes to finance their lifestyles well before retirement. An estimated 37 per cent of Canadians over the age of 55 still have outstanding mortgages.
Assuming you still plan to use your house as a retirement vehicle, there's something else to think about - you're not alone. Millions of Canadians are all betting on the same strategy, and that could lead to serious problems down the road. One very real fear is that the barrage of boomers expected to retire between now and 2030 will drive down the housing market. There may simply not be enough younger buyers to absorb all those condos and townhouses boomers hope to unload. For one thing, the net growth in the number of new households forming in Canada each year - a key driver of the residential real estate market - is expected to slow, from 1.4 per cent in 2007 to 0.8 per cent in 2030. By that year, when all the boomers will have turned 65, it's estimated there will be just two workers for each retiree. "If everybody comes on the market at the same time, prices are going to go lower," says Merrick. "The people at the top who are planning to use their homes for retirement are going to face major downward pressure, because if there's no one feeding the market at the bottom, there's no one who can move up and buy your house. Demographics say it all."
Not everyone agrees. Some point out boomers won't all act in unison to sell their homes, and that the effect will be spread out over nearly two decades, minimizing the impact on any one particular year. "I don't believe there is going to be a tsunami of supply that depresses home prices," says Craig Alexander, deputy chief economist at TD Bank. Others point out that Canada is a popular destination for immigrants and that its aging population can be replaced by importing even more people from abroad. Theoretically, newcomers could provide a cushion to the housing market as boomers cash out.
The challenge there is that, so far, Canada's track record of incorporating immigrants into the economy is terrible. A recent study by Statistics Canada found immigrants face a significant pay gap compared to Canadian-born workers. So while Tal, at CIBC, doesn't believe there will be a housing crash, he does think demographics will slow the growth of house prices in the years to come. "If everybody follows the same strategy, and assumes they'll sell the house and live off what they get, then you'll have too much supply and you won't be able to sell it for the amount of money that you think you can." And that could come as a shock to those banking on ever-rising prices to finance their retirements.
Whether the housing market slows, or continues to grow at its historical average of around six per cent a year, financial advisers have more immediate concerns: the rush by younger Canadians like Lin to buy high-priced homes while mortgage rates are so low. Daniel Collison, a regional director with Investors Group in Markham, Ont., and an instructor at York University's Schulich School of Business, says buyers could be setting themselves up for trouble in the near future. "When you see young professionals making $150,000 sitting there with $700,000 mortgages, they're the ones who are most at risk," he says. The problem isn't just that prices are high, but that even a modest increase in interest rates could send their monthly mortgage payments skyrocketing. For instance, someone who took out even a $300,000 mortgage when variable rates were as low as 2.5 per cent could see their monthly payments of $1,345 jump nearly $600 if rates rose to six per cent, and more than $900 if rates returned to eight per cent, where they were earlier this decade. "The shock that's going to hit some of these people is just astounding," says Collison. "There's a lot of artificial optimism about what they can afford to carry."
In the end, perhaps it's best to decide exactly where it is you plan to live - a house, or a home. They're not the same thing. If you're intent on treating your home as part of your retirement portfolio, you have to approach it the same rational way you would any other leveraged investment. But most people don't think that way. Their home is where they live, where they raise families and create memories. So if your home happens to generate some extra cash after your retirement, all the better. But don't overextend yourself. "Enjoy your home," says Merrick. "It shouldn't be a stresser." And it shouldn't be the cornerstone of your retirement.
Maclean's December 28, 2009