Qualicum Beach November 2011 ============================================================

Real Estate and Rising Debt

Canada’s personal debt continues to rise which is no surprise. What is surprising is the demographic that is raising their debt. The age group of 65+ has increased their debt three times more than the average pace. The Ipsos Reid Canadian Financial Monitor Survey confirms there has been a dramatic rise in debt across the 65+ age spectrum over the past ten years.

A closer look shows that a large part of the growing debt burden among older Canadians reflects investment in real estate. Indeed, the trend toward real estate has been more prominent than average among the 65+ group, where average holdings have doubled since 2002. Like others, older Canadians have been lured by the attractive combination of low interest rates and home price appreciation. And for those in or close to retirement, low returns on interest bearing securities and sharp equity losses in recent years have provided an added incentive to diversify portfolios into real estate. That said, those aged 44-64 and 65+ years are the only age groups where debt growth has outstripped asset growth over the last decade. So is buying real estate a good idea given how equity markets have faired? The short answer is there is nothing wrong with buying real estate if it is in proportion with your other asset classes – in other words do not overweigh real estate, which is easy to do given your largest asset is likely your personal residence. I often hear people speaking favorable about buying real estate for rental or investment purposes – with the view that real estate can only go up. I have also heard people making assumptions about how real estate will likely fair better than equity markets going forward. So let’s test some of these assumptions. Over the past 50 years, real estate as an asset class has crashed periodically just like the equity markets. The most recent example is homes in the various Sunbelt regions of the U.S. as I’m sure you’re all aware of. In Canada I have personally lived through two significant real estate crashes in the 1980’s and early 1990’s where you could barely give property away let alone sell it.

If you own your personal home during a real estate crash its likely not an issue. If it is a rental or investment property it could be a significant problem – and here’s why;

1) Liquidity – rental and investment property in stronger real estate markets can still take months to sell. In weak real estate markets it could take years to sell. Equity markets by contrast (either weak or strong) can always be liquidated if there is an immediate cash need.

2) Income stream – the taxation on rental income is like interest income (or employment income)

meaning it is fully taxed. Income on equity investments such as dividends has more favorable tax treatment – meaning you keep more of the dividend income yourself with less going to the government.

3) Property tax – rental property yes – investment portfolio no 4) Maintenance cost – rental property yes – the investment portfolio will have some management or

trading fees attached but will never need a new roof. 5) Vacancy rate – old tenant moves out, and new tenant not ready to move in equals interruption in

rental income. Unfortunately there is not an interruption in the mortgage and tax bill. 6) Credit and collection of rental income – rental income is typically due on the first of the month to

the landlord. Late payments and NSF cheques become something a landlord needs to manage. Dividends by contrast tend to be more consistent.

7) Rising interest rates – this is likely the biggest factor affecting real estate appreciation going

forward. Higher interest rates means high carrying costs of property – and raising the rent may drive your tenant way

8) Too much mortgage debt already – as interest rates rise, mortgage defaults may rise with it – and

we end up with a flood of properties coming on the market as we saw in the U.S. which will drive down real estate prices. So do we load up on real estate given the state of the equity markets? Answer: you never load up on anything – diversification is always the key – and real estate has its own set of risks just like any other investment.

So the next time your friend or neighbor is looking for some additional income, please direct them toward our Qualicum Beach website so we can introduce ourselves.

David Nellist, CFP Frank Colonna, CFP

Navigating Your Way to Financial Balance

www.raymondjames.ca/qualicum

Raymond James Ltd. Independent Financial Services

103-193 Second Avenue West • Qualicum Beach, BC • V9K 2N5 Tel: 250-752-8184 • Toll Free: 1-888-752-8184 • Fax: 250-752-8154 •

www.raymondjames.ca/qualicum

This newsletter has been prepared by David Nellist and Frank Colonna and expresses the opinions of the authors and not necessarily those of Raymond James Ltd. (RJL). Statistics and factual data and other information in this newsletter are from sources RJL believes to be reliable but their accuracy cannot be guaranteed. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. This newsletter is intended for distribution only in those jurisdictions where RJL and the authors are registered. Securities-related products and services are offered through Raymond James Ltd., member CIPF. Financial planning and insurance products and services are offered through Raymond James Financial Planning Ltd., which is not a member CIPF.