- How The Hell Are We Going To Pay For All This Stimulus? - July 13, 2020
- Investment Workshop 59: Are Robo-Advisors Compatible With FIRE? - June 22, 2020
- Reader Case: Grounded in Vancouver and Dreaming of FIRE - June 19, 2020
It’s Friday, and you know what that means: Reader Case time!
Today’s reader case comes from a familiar place: A Canadian wanting to buy a house because they want to use it as a “passive investment.” Hoo boy.
Now I know that it may seem like we have a bit of an anti-housing bias on this site, but we’re not actually anti-housing as much as we are pro-math. We will go where the math takes us, and if it tells us that it’s OK to buy, we will say so.
So with that in mind, let’s dive in, shall we?
Just discovered your blog a few weeks ago and I have been perusing through the investment workshop – It’s awesome.
So here’s my situation. I live in Northern Alberta Canada and this is just for me. My boyfriend and I keep our finances separate for now and don’t live together yet. Thinking of getting married next year and have 1 or 2 kids but this has only my info as I haven’t convinced him yet. He earns $120,000/yearly, he is 29 and I am 30.
I also made an Excel sheet of everything, I just want to know if I should buy a property solely for the purposes of earning passive income. I recently switched jobs and moved up North so I transferred my RRSP from previous employer to wealthsimple. The right hand contains my current employer contributions to RRSP and Savings.
The home prices is based on Edmonton but i could also purchase a home in Saskatchewan, Montreal, Ottawa as I have family who will help me with the house.
I recently got a car loan which I intend to pay off with this years (and next year) tax refunds. Purchased it for $16,500 at 6.36% for 5 years and I have paid off $1500.
Also, note that when i retire, i intend of moving out of this expensive city to somewhere like GTA where I don’t need a car and traveling out isn’t as expensive.
So should I invest in property as a source of passive income or not? And how am I doing financially?
Housing is NOT a Passive Investment
First of all, let me dispel one big assumption that our reader seems to have: that housing is a passive investment. A passive investment means that once you buy it, you don’t have to do anything with it.
Housing is NOT one of those things.
A house takes work. When a storm damages the roof, you have to fix it. When the refrigerator starts making weird noises in the middle of the night, you have to deal with it. When your tenant decides to set up a meth lab in the basement and the Feds have to bust in the door with a battering ram, you have to deal with the aftermath.
Hopefully that last one doesn’t happen very often, but my point is that real estate is a very, very actively managed endeavor, and those hoping to just hire a property manager and make all the work go away are grossly overestimating how much a property manager will do for you.
Bottom line: If you want to passively own real estate, buy a REIT and collect your 5% dividend every month. That’s what I do.
Does Buying This House Make Sense
OK so onto the reader’s question: Does buying this house she’s looking at make sense? The reader attached a spreadsheet showing all her calculations, but to be honest I couldn’t make heads or tails of it. She appears to be making some VERY sketchy assumptions (at one point, she assumes the house will appreciate at 2% PER MONTH, so yeah…) As a result, we are just going to take her inputs and re-do all the math ourselves.
Here’s the financials of the house we’re looking at…
|Mortgage Type||Fixed 25 year amortization|
|Expected Rent||$1800 per month|
OK so right away alarm bells are ringing. Real estate investor Paula Pant uses the 1% rule as part of her housing calculations, which states that the house should not cost more than 1% of the monthly rent. At a monthly rent of $1800, the house should cost at most $180,000. This one costs nearly double that. So things aren’t looking too positive so far, but for the sake of thoroughness let’s continue MATHING SHIT UP.
Plugging our reader’s information into a mortgage calculator (I used Ratehub.ca) gave me a monthly mortgage payment of $1683.
But as we know, the mortgage is just the start of the cost of home ownership. There’s property taxes, land transfer taxes, lawyer fees, maintenance, real estate agent commissions. The list goes on and on and on, but for the purposes of this analysis, I’m just going to focus on just a few of these costs.
TravelJunkie provided us an insurance cost of $300 a month in her spreadsheet. And as for maintenance, you’re supposed to set aside between 1% and 3% of your home’s value for maintenance, so let’s be aggressive and go with 1%. That’s $3500 a year, or $291.67 a month. Property taxes vary widely by location, but she provided a property tax rate of 0.85%, so that’s an additional $3000 per year, or $250 a month. And she also provided an estimate of $180 a month for her magical property manager that would theoretically make this entire investment passive.
So that’s an additional $300 + $291.67 + $250 + $180 = $1021.67 added onto the monthly mortgage cost. This house now costs $1683 + $1021.67 a month to own, for a total of $2704.67.
That’s way more than the monthly rent she’s estimating she’d get of $1800. That means this “investment” would have you losing money to the tune of almost $1000 a month!
And again, we’ve only included like half the additional costs of home ownership. The rest like real estate commissions, land transfer taxes and other per-transaction costs I can’t turn into a monthly cost because I don’t know how long the ownership period is. But suffice it to say, these additional costs will make that math worse, not better.
So unfortunately, MATHING SHIT UP has returned a verdict on this house, and it’s a big fat NO. DO NOT BUY THIS HOUSE.
How About Retirement?
OK so now we have an answer on the housing question. What about retirement?
TravelJunkie sent me her numbers in that crazy spreadsheet, so I’ll copy and paste the relevant parts below. Her gross income is $88,000 (ooh, lucky!). And as for her spending…
|Rent + Cable||$1,385.00|
So that’s $3916.72 per month, or $47,000 per year. That puts her FI target at $47,000 x 25 = $1,175,000.
We also have to figure out how much she’s saving.
By plugging her info into an Alberta tax calculator and, assuming she’s maxing out her RRSP, that puts her after-tax salary at about $70k. That puts her savings rate at $70,000 – $47,000 = $23,000. On a side note, she also indicated that there’s also some kind of employer-contributed savings in her spreadsheets as well, but I’m assuming this is reported as part of her gross income so this simpler calculation should work out just fine.
Finally, she has a combined total of $93,621 in her RRSP and TFSA. So now we have enough to do our projection. How long until she can retire?
That sounds pretty long, and it’s mostly caused by her surprisingly high spending. Specifically, the car. Yikes. When you add up all the car related costs in her budget, we get $149.79 + $152.94 + $100 + $50 = $452.73 a month. Car costs like this can really eat into your budget, but when you’re living in Northern Alberta you don’t really have much of a choice.
She also spends $700 a month on travel, but I can’t exactly fault her on that. Travel IS pretty awesome 🙂
Also, charitable giving. She donates $500 a month, and that’s great that she’s doing that, but that does add up to $6000 a year. Many people who write in with such a high recurring charitable giving item are doing it for religious reasons, so we’re going to leave this one alone.
That being said, this might be a good time to point out that being nomadic eliminates many of these costs. If she were willing to retire and live in lower-cost cities with good public transportation networks, many of these costs drop away. The car, for example, would be eliminated. As would the travel budget since, travel is just part of your every day base cost rather than a seperate thing you have to purchase. And life insurance would no longer be needed either.
Taking these costs out post-retirement would bring her budget down to $2709 per month, or $32,508 per year, which in turn brings her FI target down to $812,700. According to our above table, she’d be able to get there in 17 years, or 4 years earlier.
Life Changes Coming Up
So right now, TravelJunkie’s finances look OK. Not great, but not bad either. All this will change, of course, if she decides to marry her boyfriend and combine their finances. This, unfortunately, I can’t anlayze because I have zero information on his budget. Depending on what his expenses look like, you may find that you’ll be able to streamline your spending because you, for example, move in together which will speed up your journey. Or maybe he’s bringing a lot of debt into the marriage which will slow you down.
The point is, what she decides to do with her relationship in the next year or so could profoundly change her financial situation. I’ve shown you how to do the math, so when the time comes to make that call, make sure you MATH SHIT UP first.
Comments? Questions? What do you think of TravelJunkie’s situation? Let’s hear it in the comments below!
Update: Anyone in the London area? Join us, Emmy award winning producer Shakespeare, TheEscapeArtist, theMadFientist, and Mr.1500, at the UK premiere of Playing With Fire on June 12! The first 100 ticket sold out in record time and more have been added due to popular demand. Get your tickets here before they’re gone! (If you’re not in the London area, check out these screenings in a theatre near you).
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