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financial facelift

-Fred Lum/The Globe and Mail

Julia is one of a growing number of Canadians who plan to downsize their homes when they retire mainly because they will have to. She is 55, self-employed in the arts earning about $40,000 a year before tax, and plans to quit working at age 65.

Thanks to soaring Toronto real estate prices, Julia's house is now valued at $900,000. She has only $50,000 left to pay on the mortgage. Three years ago, she borrowed to buy a condo to rent out. So far, it is breaking even, with the rental income just covering the carrying costs, including the line of credit. She does not want to live in the condo herself.

As Julia sees it, she could sell her house now, pay off her loans and rent or buy a smaller, less expensive home, possibly a condo, to live in. She would hang onto the rental condo for retirement income.

Or she could sell her house, invest the money and rent an apartment.

"Should I hang onto my investment condominium for income?" Julia asks in an e-mail. "Currently I only pay the interest, not principal, on the loan." She figures the condo has increased substantially in value over the past three years. Her goal: "A comfortable place to live in retirement."

We asked Calgary-based Morgan Ulmer of MeVest, a financial literacy and counselling firm, to look at Julia's situation.

What the expert says

Julia's rental property has done well for her so far, rising by $100,000 in three years, Ms. Ulmer says. "Of note is that 89 per cent of the value of Julia's assets is in Toronto real estate." Excluding her primary residence, 72 per cent of her assets are concentrated in one rental property.

"As well as being underdiversified, she faces additional risk," Ms. Ulmer says. The condo is at break-even (annual rent equals annual expenses), it is leveraged, and Julia is paying interest only on the line of credit used to buy the property, so the principal on the loan is not being repaid.

Julia could face challenges if interest rates were to rise (a two percentage point rise would cost more than $5,500 a year), or if she had a disruption in rental income, an increase in condo fees or a special assessment by the condo board. "It's possible that more than one of these problems could arise at the same time."

Whether Julia should cash in now or keep her rental condo for the long term depends on her answers to some important questions, Ms. Ulmer says. What is her risk tolerance? Is she comfortable with a major part of her retirement portfolio being in one specific asset? Would a drop in the Toronto condo market cause her stress? Is she willing to pay out of pocket if the condo no longer breaks even? Is she interested in being a landlord long term?

"Having the rental income in retirement is enticing and could contribute to a comfortable financial life," Ms. Ulmer says. But she could sell the rental property now and still meet her retirement goals. Selling the condo now would capture the capital gain on the property, lower Julia's risk and allow her to pay off the $50,000 line of credit left on her primary residence, "positioning her to be completely debt-free come retirement," the planner says.

After fees, taxes and debt repayment, Julia would have about $10,000 left from the sale after paying capital gains tax, which she could use for an emergency fund.

Holding on to her home until she retires at age 65 is a good idea for Julia because her home carries much less risk than the rental property. It is about 95 per cent paid off and could therefore withstand a dip in real estate prices or a rise in interest rates, the planner says. "If Toronto real estate decreases or flattens, 10 years should be enough time to ride out a market cycle." As well, prices of semi-detached houses like Julia's likely will be more stable than the condo market. She will not be subject to rent or condo fee increases. Finally, capital gains on a primary residence are tax-free. "In 10 years, the gains on a $900,000 home could provide that much more retirement security for Julia."

If and when she finally does sell her house, she can decide then whether to buy a smaller place or rent and invest the proceeds, Ms. Ulmer says.

Ms. Ulmer assumes a 4-per-cent return on Julia's registered savings. Julia will get Canada Pension Plan benefits of $875 a month when she retires and Old Age Security of $570 a month. Given her target retirement spending of $3,750 a month, Julia would have a few more years after she retires before she would have to sell the house, the planner says.



The person: Julia, 55

The problem: Should she sell her house now or later? Should she sell her rental condo or keep it for retirement income?

The plan: Sell the condo and pay off the real estate loans. Live comfortably in her house until she is ready to sell. If she sells in 10 years, she will have that much more money to invest for retirement.

The payoff: A comfortable place to live, now and later.

Monthly net income: $3,400

Assets: RRSPs (stocks, mutual funds) $157,740; TFSA $10,000; residence $900,000; rental condo $400,000.

Total: $1,467,740

Monthly disbursements: Property tax $413; water, sewer $26; home insurance $84; hydro, heating $188; maintenance $150; car lease $470; car insurance $145; other auto $108; groceries, clothing $250; line of credit (house) $135; gifts $50; vacation, travel $60; entertainment, drinks, dining out $200; grooming, clubs $20; hobbies $40; pets $40; health insurance $95; dentist $5; telecom, TV, Internet $244. Total: $2,723 Surplus: $677

Liabilities: Lines of credit $355,000

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