...But You Have To Pay Tax

Just a short post today and a slight rant about tax...

I was recently reading another blog post about the pros and cons of real estate investment.  There were several comments below....and one really stuck out.

Here is the comment:

"There is no money in landlording. I bought one condo after prices went down by 50% paid cash for it.  Still only make 6% return on it and that if I have tenant renting all the time. Any maintenance or repair or unoccupied take profit off 6%. so if I include that then the return is more like 4%.  Plus you have to pay income tax on it. You tax go up every year. Your maintenance fee go up every year. And you can’t raise rent much or not at all."

I can appreciate his comments, but what really ticks me off is the comment about tax...."Plus you have to pay income tax on it".

....Really?

Tell me a way to make money without paying tax....other than winning the lottery.

It's funny because this is not the first time I have heard this comment.

"Oh yeah, he made $50K on that property, but he has to pay tax.".....no kidding

"That guy makes over $100K.  Think of the tax that he pays!"....yep, probably true.

In Canada, if you make money, you have to pay tax, or you go to jail. 

Being tax efficient is another story.  Deferring tax or starting a corporation to reduce tax is smart.  Avoiding tax all together is another story.

So please, if someone makes money, don't complain about the tax to be paid.   Someone has to pay for the road repairs in our great country!

HELOC vs PLOC

The basic principle of a line of credit is fairly straight forward…the bank thinks your credit rating is good enough to justify borrowing you more money than they already have.  

As I mentioned in my last post, I think it is a good idea to gain access (but not necessarily use) a line of credit as soon as you can.  The reason for this being that it is a good safety net to have in case of any unforeseen events.  Used PROPERLY, it can also be used for investment purposes, although I would not necessarily recommend this route….investing with borrowed cash can often turn ugly if you do not know what you are doing.

So you have decided to gain access to a line of credit?  Good stuff.  DON’T use it as your piggy bank and DO pay off the balance as quickly as possible.

Next question: Personal line of credit (PLOC) or Home equity line of credit (HELOC)?

Well if you don’t own a home, the answer is fairly obvious.  For those that do own a home, I would argue that the HELOC is the better option due to the flexibility of payment options and the lower overall interest rates, but I will go over the differences.

The PLOC is fairly easy to obtain.  At your local bank, you will fill out an application, giving them your basic info.  They run a credit check, calculate how much debt you are servicing otherwise (car payments, mortgage, credit card, etc) and come back with a “yes” or “no”.  If yes, they attached a dollar value to the approval and you are all set.  

The interest rate is also dependant on your credit history.  The better your credit, the better your interest rate, although this rate will never be lower than a HELOC.  The reason it is always higher is that it is “unsecured”, meaning you are not putting up anything as collateral in case you take the money run.   

The payment terms are slightly different at each bank, but at TD the ‘repayment term’ is 3 years, meaning that if you max out your credit, say $15,000, you need to repay $416.66 per month, plus interest.  This is automatically taken out of your account each month.

HELOC is slightly different.  The premise behind it is that the banks will lend you cash up to 80% of the value of your home, less any mortgages outstanding. 

If you have a $250,000 home and have a mortgage on the property of  $215,000….sorry, no HELOC for you.   The Loan to Value ratio is above 80%....(215/250 = 86%)

But if you had a mortgage of $170,000, you would be eligible to borrow $30,000, provided the credit check comes back relatively clean and your house has been accurately valued at $250,000

80% of $250,000 = $200,000 minus your mortgage of $170,000 = $30,000

Sign me up right!?

Well, here is where the downfalls come into play.

For one, there is an initial set-up cost.   To get the application process started, you have to put your estimated home value through a computer valuation system at a cost of $99.  The tough part is that you have to estimate the value of your home by yourself!

If you estimate incorrectly….your application is denied and you need to have a ‘human’ appraise your home at a cost of $300….so make sure your  valuation is correct the first time! J

Registering your HELOC on title comes with a cost of another $495, so worst case scenario, you are looking at $795.

Yikes you say!...well yes and no.

Let’s look at an interest comparison.  The interest rate on my PLOC was 5.25%.  The rate on my HELOC is 3.7%.  If I have a drastic emergency and need $25,000 fast, the interest for 1 year on that money at 5.25% is $1312.50.  At 3.7%, the interest is only $925….a savings of $387.50

And remember, you may have this HELOC for a long time, so you will make up the up-front cost through interest savings.

Payment terms are also an advantage for the HELOC.  The minimum payment is interest-only, meaning if you borrowed $25,000 at 3.7%, your cost is only $77 per month….but don’t forget you have to re-pay the principal eventually…and the sooner the better.

So what option is best for you?

Emergency Fund VS Line of Credit

Countless personal finance" gurus" try to drive home the fact that everyone needs an “emergency fund” to cover any unseen costs that might arise in the future.  The amount of money that they recommend to have stashed away, however, seems to be different.  It can vary greatly…. 1 month, 3 months, 6 months and even 9 months of earnings is not out of the question.

For many people, I do agree, that having a ‘rain-day’ fund is a good idea, but in my opinion, this is unnecessary if you can obtain a line of credit.

Let me explain….

A lot has been said in the media recently about the personal debt of Canadians and the “danger” we are in if interest rates move too quickly.  This may be true for certain people who adopt a “buy now, pay later” philosophy for all consumer goods and use a line of credit as their piggy bank….but my philosophy is that you should gain ‘access’ to all available credit BEFORE you need it because chances are you can’t predict the future….but if you can, please contact me asap.

There may be unexpected home repair (especially if you own a few investment properties on top of your existing home), you might have a large auto repair bill, medical bills, etc, etc.

Why not have an ‘emergency fund’ for these types of occurrences??

In my opinion, having an emergency fund just sitting in a bank account is not the best use of money.  Each day, this money will lose value due to inflation and I would much rather have that same amount of money invested in a liquid asset MAKING money.  In addition, having 3 months of earnings stashed away for example may not be enough to cover a large repair bill…and then where do you get the extra cash that you need?

For these reasons, my emergency fund is a line of credit.

Here is a quick comparison:

$5000 in a “high interest” (laugh) savings account at 1.5% will be worth $4925 in 1 year adjusted for 3% inflation.  $5000 invested in Skyline REIT (currently yielding 9% on their commercial properties) will be worth $5300 in 1 year adjusted for 3% inflation.  This is a swing of $375.

If you need money fast and you have access to a line of credit, you can use the line of credit for the short term fix and either pay off the balance according to the payment terms or use the $5300 from your investment account to pay off the balance….(assuming you didn’t need more than this during your ‘emergency’)

Adding to this flexibility is the fact that a home equity line of credit (HELOC) can offer even more flexible payment terms.

More on lines of credit in my next post!

REAL Cost of Owning a Car

For those of you that read my blog, I typically write about real-estate-related matters, however I am going to deviate slightly to some personal finance – the true cost of car ownership.

I overheard one of my colleagues mention last week that she ‘really would love to buy a car’.  She hates walking, waiting for the bus to around is a pain, and her hair is always messed up by her hat in cold weather.

Ho-hum.  I still hate my car…and I told her that.

Why? Because it takes money out of my pocket.  Some people list their vehicles as an ‘asset’, but if you are a follower of Robert Kiyosaki (author of Rich Dad, Poor Dad), you might be inclined to think of it as a liability.  Let me explain….

I have a very accurate picture of how much a vehicle costs as I save every receipt for business purposes so here is my breakdown in expenses for 2012: (note, this is based on driving almost 40,000KM last year, which I realize is above average)

Car Payment:  $0…..(it is a 13 year-old car….no payment here!)

Insurance: $1390…(this is actually low as I qualify for a good discount based on my rental properties being with the same company)

Routine Maintenance: $2020…(oil changes, coolant flushes, tire changes, general issues)

Non-routine Maintenance: $1600…($1200 for a brake-job and ABS sensor, $400 to repair a bumper from a hit and run event in a parking lot)

Miscellaneous: $400..(CAA membership, registration fees, safety + emissions test)

Gas: $3800…(again, I drove 40,000KM)

GRAND TOTAL:  $9210

Remember, this is WITHOUT a car payment.  I also did not include any depreciation, of which I have very little due to my car being 13 years old, but everyone knows that cars depreciate at blinding speed.  Throw in a $300 per-month car payment (which is low) and this number jumps to $12,810.

Don’t get me wrong, I hope to never sell my car.  I need it for work and business  purposes….and like my colleague, I don’t know if I could stand waiting in the cold at a bus stop!  OK, so maybe I don’t ‘hate’ my car like I mentioned above…I just hate that it takes money out of my pocket.

So what I do hope to accomplish with this post?  At least get people thinking about the TRUE cost of car ownership…don’t just look at that advertisement for a nice car at only “$149 bi-weekly”…..what they don’t tell you is that it is bi-weekly payments for the better part of a decade..

And who knows, maybe  you can live without a car for 4 years and have $40,000 in your pocket to invest in some cash flowing real estate!

Numbers Don't Lie??

According to the Jan 14^th issue of “Maclean’s Magazine”, the average debt-to-income ratio of a Canadian household is now 164 per cent, higher than the pre-crash levels in the USA.

So what’s in a number? 

This calculation of this ratio is simple.  Take your current debt load (car payments, lines of credit, credit cards, mortgage, etc) and divide this by your income.  YES – your mortgage is included in this.

Let’s take one scenario about Joe. 

Joe is 30 years old and makes a $50,000 salary.  He has paid all of his student loans, owns his car outright and has no consumer debt – in fact he has saved up $25,000 for a down payment on a $150,000 condo in Kitchener, Ontario.  This leaves him with a mortgage of $125,000 that he has locked in for 10 years at 3.5%.   His mortgage payment is only $625….add a condo fee of $150 and his total payment is $775.

Sounds pretty good doesn’t it?.......except one thing…..Joe’s debt-to-income ratio is 250%  ($125,000 / $50,000) - almost 100 points higher than the (already outrageous!) national average. 

Joe must be crazy.

Here is a more detailed breakdown of Joe’s monthly income and expenses. 

Income	(after tax)	3000
Expenses
mortgage		625
condo fee		125
utilities		150
property tax		100
house insurance		70
house up-keep		100
cell phone / cable / internet		165
car insure		125
car gas		200
car maintenance		100
food		300
entertainment		300
misc		200
clothing		100
Total		2660
Monthly Savings		340

 Yes, there are some fairly large assumptions and generalities, but if Joe keeps this up and invests his $340 per month at 8% interest, he will have a mortgage free condo and $322,000 in financial assets…all this with a debt-to-income ratio that started at 250%!

Yep, Joe is nuts.

Take Pictures While you Can!!

If you have a long term buy and hold property, chances are you will have turnover….actually you can guarantee that you will have turnover.

For this reason, it is a good idea to take pictures while you can (ie. Right after you complete any renovations, painting, etc). 

There are several benefits to doing this:

-          You can continue to use those pictures over and over again whenever you have vacancy! 

-          No more tidying up to take pictures or asking your tenants to clean up after themselves prior to picture taking!

-          Gives you a chance to ‘stage’ the unit slightly to give your pictures that extra “wow” factor!

 Here are some pictures that I have taken of my basement apartment when I renovated last summer. It turned out very nicely and the pictures look quite nice!

Another tip is to save your Kijiji ads on your computer.  Either the “screen shot” of the ad, or just a word document that has the written information. This is a huge time saver, especially if your ads are as detailed as mine, as they can be used again and again.  And each time you make an improvement or think of something else you can just update the ad.

To everyone, the proof is in the pudding.  I recycled my Kijiji ad and used these pictures for this year’s student turnover and had a dozen hits on my ad in the first day, resulting in 5 showings for this week!  I don’t think I’ll have much trouble renting it this year J

Anyone else use this technique?

Please Look Past the Headlines

A couple of days ago, the Globe and Mail published an article entitled "Home Sales Plunge, Market 'clearly' in Correction Mode"

For the average Joe, looking at this headline without reading the details would likely result in misinterpretation, drawing incorrect assumptions and generally cause panic among homeowners.  

Again, this article focuses on “National” numbers.  As I have always said, the “Canadian” real estate market is non-existant….it is made up of tens of thousands of markets and submarkets.   Yes, other markets may feel a slight ‘domino effect’ resulting from neighbouring markets dropping in value, but the market in Yorkton, Saskatchewan, for example, will generally not be affected by a slump in the Vancouver or Toronto markets – an entirely different set of factors are at play in Yorkton namely oil, potash and other commodities that are the backbone of the economy.

For real estate investors and even the average home owner, this article should all be ignored – even if you live in Vancouver and Toronto (the 2 markets that are feeling the worst effects of the ‘correction’).   Again, focus on your own sub-market.

If you read further into the article, you find that, not only have prices not dropped….they have actually increased by 1.6% from December 2011!  But you won’t see that in any article headings – it’s not what they want you to see.  They want you to see the shocking numbers – the double digit declines – that will sell newspapers and cause panic among regular folk. 

While I don’t disagree that the market will go through some sort of correction over the next year or two, I understand that this will likely be restricted to the markets that are at the highest risk and have the highest inventory of high priced homes (Toronto and Vancouver).  For all other homeowners, please ignore this article and focus on your own market and submarket because I can guarantee that if prices are dropping in one area, they are going up in another.