Hey all! It’s Friday, so time for another reader case!
“I’m 39 years old and I’m on the road to FI, or perhaps I have just reached it, thanks to your and Wanderer’s great help.
I followed along on the Investment Workshop, and my Questrade account is humming along nicely, along with a recent rebalancing for the Yield Shield.
I own a condo in downtown Toronto that I am considering selling, a bachelor suite that is 480 square feet (I guess that is considered a ‘closet’ for some high-rollers). The condo market is still bonkers right now, although the housing market’s bubble is currently bursting. I’m assuming the condo market will follow suit with the housing market, so if I were to sell, I would prefer doing so very soon.
I purchased the condo in 2013, lived in it for 1 year, and have been renting it to tenants ever since, declaring that as part of my income. My real estate agent thinks I can get approx $450K+ for it now. My current tenant is month-to-month. As mentioned, I think I have reached FI (according to The Mad Fientist’s calculator, I have reached the milestone), but having the steady, dependable income that the condo rent provides may make the transition to FI easier, on an emotional level. I also like the idea of having the diversification of owning both real estate and index fund investments, but I could definitely be convinced otherwise – it just comes down to the numbers. I’m quite ignorant when it comes to understanding what kind of dividends I can consistently expect from my current portfolio and how to adapt that to my future FI lifestyle.
I feel like I have 3 options:
1. sell my condo and put the cash into further investments in my Questrade account
2. hold onto my condo and maintain that passive income from the rent it brings in
3. hold onto my condo, but take some equity out of it, and invest that equity in my Questrade account
Some more info:
1. gross/net family income:
- I’m single, with no children. My last job just ended a couple months ago, but I still generate about $10K/year from playing music gigs as a solo performer. I’m also considering doing some part-time work, to generate an additional $10-20K, if necessary.
2. monthly spending:
- Approx $1,400/month (approx $400 groceries, $150 cell phone + home internet, $200 car fuel/maintenance, $400 home property taxes + insurance + hydro, $250 other).
- I may inflate this to $1,750-2,000/month, as I have been living quite frugally and would like to do some travel/geo-arbitrage, to escape the Canadian winters.
Aside from my condo mortgage, I have no debt
Purchased for $300K in 2013
- Monthly rental income = $1,750 and the tenant pays their own hydro.
Mortgage = $67K
Monthly costs are:
- $275 maintenance fees
- $160 property tax
- $30 insurance
- I’m aggressively paying it off at $1,200 every 2 weeks. Of that $1,200, approx $1,150 goes to principal, $50 to interest. I could decrease payments significantly, but I’m not sure what the minimum payment would be.
Current mortgage rate is 2.19% fixed, and is up in May, 2019. If I sold now, it would cost me $900 to break the mortgage agreement.
Based on these numbers, I think this yields a cap rate that is just over 5%
4. fixed assets:
- car – 2009 Toyota Matrix – I purchased it in 2013 for $8,500 cash
- house – mortgage-free, approx $300K market value. It is a bit of a money pit, as it’s aging and needs some renovations, but for the sake of this analysis, I’m hoping we can exclude this from the equation. If I ended up inflating my monthly lifestyle costs to $2K, it would cover the associated costs here anyway.
- investments + cash:
- $62K TFSA, Questrade
$95K RRSP, Questrade
Of the TFSA and RRSP investments, $44K is in VSP.TO (Vanguard S&P 500 index), and the other $113K is in a 70/30 equity/fixed income split as per the Investment Workshop and Yield Shield
- $154,500 cash
Thanks again for all your wonderful help and inspiration. I have always been a good saver and lived a simple life, but like many of the people in this community, I wish I had realized this wealth of priceless knowledge much earlier in the process. I know this case study is a big step towards my foundation for FI, and with your help in this, I think I’ll finally be able to take the plunge into an exciting life of financial independence!
Hoo boy. Whenever I hear the words “Downtown Toronto Condo” a little piece of me dies inside, but let’s dive into the math of this condo and see what’s what, shall we?
Condo: Good or Shitty Investment?
So let’s start with the basics. LaidOffWithCondo’s condo is, on the surface, not bad. The purchase price of $300k isn’t too high, his tenant is paying rent of $1750 a month, and his housing expenses aren’t too crazy. He’s also been aggressively paying off his mortgage which, from a real estate investment perspective, is actually the wrong thing to do since his mortgage rate of 2.19% is so low, but whatever. He’s clearly not comfortable holding a lot of debt, so I’m not going to encourage him to do something risky just to make the numbers look better.
So if he uses all his mortgage prepayment options and kills the debt next year, he’ll pay about $1000 in additional interest, and the mortgage will be gone. He’ll also have $311,500 – $67k (mortgage) – $1000 (interest) = $243,500 left liquid assets.
So what do his numbers look like?
Well, after expenses (and no mortgage), he makes $1750 – $275 (maintenance) – $160 (property tax) – $30 (insurance) = $1285 a month, or $15,420 a year.
This gives him an ROE of $15,420 / $300,000 = 5.14%.
So is this is a good investment? It’s OK. 5.14% ain’t bad. You can get around that with a REIT index without the hassle of managing a tenant, but it’s OK.
One possibility is to use a HELOC to get that equity back out and boost the ROE using leverage, but I’m going to explain why that doesn’t actually help all that much in a bit.
Is He Financially Independent?
Now onto the other big question: Is LaidOffWithCondo Financially Independent?
In short: Yes, but with caveats.
Despite the condo being just an OK investment, he did two things here that really stand out: He kept his expenses under control despite being in a high-cost city and he built up a passion side-hustle in his music that he’s already able to monetize on. Put these two things together and things really work out.
His monthly spending (inflated to enjoy life a bit post-retirement) will be $2000 a month, or $24k a year. So that’s how much income we need to find to make that happen.
His income will come from 3 sources:
- His Condo: $15,420
- His Portfolio: $243,500 x 4% = $9740
- His Music: $10,000
Add these together for a grand total of $35,160. That’s enough to cover his living expenses, so he’s FI, right?
Here’s my concern. His condo makes up too much of that income stream (44% in a single asset). If his portfolio hits a nasty sequence-of-return period, he could make it work with just his condo and his music. Similarly, if his music career dried up, he could make it with just his condo and the portfolio.
But if the condo income stopped, he wouldn’t be able to make it. Not only that, his expenses would increase since the condo costs money to own. So he’d be hit with a double whammy of higher expenses and no income.
44% of retirement income is coming from 1 single asset. That’s not great for diversification and you’re relying on 1 tenant.
So basically, if his tenant leaves, his retirement falls apart. I don’t like them odds.
What Would I Do?
So is LaidOffWithCondo screwed? Not quite. There’s a few things we can do here to increase his odds of success to 100%.
But first, the HELOC thing. I tried to see what would happen if he took out a HELOC out on his condo and dumped it into the portfolio. This is a common thing that real estate investors do to goose the yield on their investment while freeing up capital (usually to buy more real estate).
So if he were to take out a HELOC, current B20 regulations limit the loan-to-value ratio (or LTV) of a HELOC to 65%. So he’d be able to take out a HELOC of $450k x 65% = $292,500. You can get a HELOC these days for about 3%, so this would add $292,500 x 3% = $8775 of interest back onto the condo cost, assuming he never pays that balance down and only pays the interest. How does that affect his income streams?
- Condo: $15,420 – $8,775 = $6,645
- Portfolio: ($243,500 + $292,500) x 4% = $21,440
- Music: $10,000
Even better, right? Yeah, I suppose. But there’s still a failure mode here, isn’t there? If he were to lose the condo income, his retirement wouldn’t fail, but if he were to lose the condo AND the music income, then we’d still come up a bit short.
It’s better, but I think we can get to 100% success rate.
What happens if he sells the condo?
OK, so if we sell the condo at $450k, he’d have to pay real estate commissions of 5%, $1000 in lawyer fees, another $900 to break the mortgage, as well as capital gains tax since it’s an investment property. Estimating a 30% marginal tax rate, he’d net about $450k – $22,500 (commission) – $1000 (lawyer) – $900 (mortgage fee) – $22,500 (estimated tax) = $403,100.
I’m making a BIG assumption on the tax rate, by the way, so he’ll have to run his numbers himself using his own tax situation.
But assuming that’s correct, that $403,100 would get added onto the portfolio. He’d lose the condo income, but this is what his income streams would look like:
- Portfolio: ($243,500 + $403,100) x 4% = $25,864
- Music: $10,000
NOW he can survive completely off the portfolio and his music income is completely bonus. Despite the fact that the total income is actually lower than the HELOC structure, it’s much safer. If his music career were to blow up, he’s still OK.
In fact, his annual expenses of $24k / ($243,500 + $403,100) = 3.7%. Remember that the 4% withdrawal rate rule states that there’s a 95% chance of success over 30 years. A 3.7% withdrawal rate, according to FIRECALC, gives us a 99.1% success rate! If he were to reduce his living expenses in lean years by just $1000 a year, that number crosses over to 100% success rate.
And We’re Done
And with that. we’re done for the week. What do you guys think? Is LaidOffWithCondo ready to retire? Would you do the HELOC thing for the higher income or would you sell off the condo and make your retirement safer? Let’s hear it in the comments below!
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