In a recent conversation the topic of renting versus buying came up for a retired couple. This said couple decided to sell their home and rent rather than downsizing or continuing to live in their own home. You can imagine the blasphemy that erupted from the table. “Why are they renting? Why would they sell their home just to pay someone else’s mortgage?” “Why would they throw money away when they already have a house? It would have been smarter to downsize rather than throwing money away!” “Owning the house would have been better, they can build up equity rather than throwing money away”.
All of these are common themes that occur when a conversation about renting starts. It’s a Canadian thing. In fact, it makes it worse when the conversation has Chinese participants, because real estate is the end all and above all in wealth accumulation. It’s no wonder that this retired couple in the conversation, who were of Chinese descent, were getting chastised with their decision. Thankfully they weren’t present, but who are we to judge? Do we even know if what they are doing is really wrong?
Cash Flow, Cash Flow, Cash Flow
I keep drilling it into everyone’s head, but cash flow is what makes someone financially independent. It’s not about the things that you own or the house that you live in. It’s all about the generation of cash flow that supports one’s lifestyle.
What I keep reminding people on a day to day basis is that a house, particularly a primary residence, does not generate any cash flow. If we try to model what a house will do for you financially, you’ll soon realize that it’s an asset, but it’s an asset that is an expense. A home owner ends up buying something that will drain her monthly cash flow.
If we were to model a home as a leaky bucket the house would not generate any inflows of income; however, since there are so many costs associated with upkeeping a home, it would spring many leaks in our bucket. The only way to pay for these costs is to obtain some kind of income or eventually our bucket would run empty.
Having a house itself doesn’t accomplish being financially independent. It doesn’t pay the bills, it doesn’t put food on the table, and it certainly doesn’t let you retire unless you find some other form of income to fill that leaky bucket. That’s why for retired people, the home is still the single most expensive thing on a monthly basis. Not food. Not the car, but the home.
Freeing Up Cash
For a retired couple where most of their wealth is tied up in the home, it comes down to very few choices. Live miserly on the small stipend provided by the Canadian government called the Canadian Pension Plan, do a reverse mortgage to pull money out, or sell and invest.
The maximum benefit for CPP is only about $1,130. That’s barely enough to scrape by in expensive cities like Vancouver and Toronto. Doing a reverse mortgage seems like a great idea because the house is still owned, but why would anyone who has paid a lifetime of interest to the bank, want to pay the bank even more money to take out equity from the house?
This makes selling and investing a perfectly viable option. Even at the most conservative estimates, a house sold at $1.2M dollars, in an expensive city like Toronto, could potentially yield an annual income of $48k a year with a 4% return. That would give the homeowners an extra $4,000 a month on top of the CPP amount. With $4,000 that would allow the homeowners enough to rent a condo for $2,500 and still be left over with $1,500 and plus the CPP benefit.
The strategy of renting actually increases cash flow despite the fact that the retired couple needs to rent. Yes, they are “throwing” their money away, but now they have financial flexibility. They can actually move closer to the amenities they need to be. They can also live worry free and not have to worry about paying maintenance or taxes for the dwelling they live in. All the repairs can now be done by the landlord free of charge.
For a lot of people it might seem smarter to hold the house and hope for more appreciation, but by selling and investing over $1M in liquid portfolio, it will generate much more cash flow on a monthly basis than any of the other alternatives.
You Need To Invest
Just because selling the house can generate more cash flow doesn’t mean you should go find your real estate agent and list right away. In fact, this kind of strategy takes careful planning and the willing to invest the principal in a safe and balanced portfolio.
The approach of selling and using the money to invest is to generate a passive income that will sustain a suitable lifestyle. The example above shows how selling a home and investing the $1.2M can generate $48k or $4,000 a month if invested properly.
What does this mean? This means no weed stock. Don’t buy Bitcoin. Avoid holding Amazon stock. Why? Because holding individual stocks is volatile. Imagine holding Amazon this week and seeing 6% of your wealth go down the drain ($1900 to $1790).
In retirement years, it’s more important and vital to aim for capital preservation rather than appreciation. This means a balanced and safe portfolio. It’s not wrong to use a larger fix income allocation like 60% fixed income to 40% stocks to maintain capital. Why risk so much when only an annual 4% average in growth is required to maintain the same level of principal?
For those that are unwilling to invest, then draining the principal over the retirement years would be no different than doing a reverse mortgage, or living in the same house while only spending the government CPP benefit. Without investments of some sorts it’s impossible to become financially independent.
This approach of freeing up capital appreciation seems like the most obvious choice for many home owners. As home prices in Canada approaches stratospheric valuation, it leaves very little money left to save for retirement. Future retirees in Canada will need to reflect and realize that selling and renting while investing the principal is a valid retirement strategy. Holding on to the house for life, though sentimental, may not always be the most financially prudent decision.