Sarah and David are 42 and live in Toronto. In 2016 they purchased a rental condo. They have been pleased with the condo’s cash flow and value growth over the last 8 years, but now they fear the housing market is headed for some turbulence and are concerned about how this might affect their cash flow and net worth in the short-term. They understand that if they can weather the storm things will eventually turn around, but they have not particularly enjoyed the unpredictable nature of owning real estate, and don’t love the idea of being landlords long-term. They know they could hire someone to manage the property for them however those extra fees would cut into their cash flow.
David and Sarah are wondering if this might be a good time for them to sell their condo. They like the idea of simplifying their investments but have some FOMO about what this will mean for their future net worth. Their original plan was to sell the property when they turn 65 to fund their retirement, and they are curious to know what they could expect to accumulate in savings if they were to sell now vs sticking with their original plan.
Here is where they stand currently:
| Purchase Price | $ 500,000.00 |
| Estimated Property Value | $ 800,000.00 |
| Mortgage Balance | $ 365,000.00 |
| Estimated Gross Equity | $ 435,000.00 |
| Annual Rental Income | $ 30,000.00 |
| Annual Mortgage Payments + Other Expenses | $ 24,000.00 |
| Net Rental Income | $ 6,000.00 |
| Net Rental Income After-Tax | $ 3,900.00 |
Option 1: Keep the Rental Property Until age 65, Invest Rental Income
If we assume an annual appreciation rate of 3%, by Sarah and David’s age 65 their condo will be worth about $1,570,000. For simplicity we’ll assume their mortgage is fully paid and they haven’t pulled any equity along the way.
Under the new capital gains rules, when they sell David and Sarah are looking at an estimated tax liability of $355,000. After taxes and roughly $65,000 in closing costs, their net proceeds will be around $1,150,000.
In addition to the property’s value growth they would also continue earning rental income which, after tax, is currently $3,900 per year.
Assuming they invest all of their rental income and earn 6% annually, they will have around $185,000 in their investments when they turn 65.
Summary
| Net Proceeds from Sale | $ 1,150,000.00 |
| Growth of Invested Rental Income | $ 185,000.00 |
| Total Retirement Savings | $ 1,335,000 |
Option 2: Sell the Condo Now and Invest the Proceeds
If Sarah and David were to sell their condo now, they estimate they would get about $800,000. After paying off their mortgage balance they would be left with about $435,000 in gross profits. They would pay about $84,000 in capital gains tax and $33,000 in closing costs, leaving them with a net profit of $318,000 to invest in the markets. Doesn’t sound like much but, they have 23 years to grow it in their investments.
If Sarah and David invest their $318,000 and earn 6% annually, by age 65 they will have $1,340,732. In other words, they would be no worse off in retirement than if they were to hang onto the property.
Where things might get a bit sticky is in the tax planning. For example, if David and Sarah invest using their RRSPs, they will be taxed on 100% of their withdrawals. In this case, holding the property might be the more financially advantageous decision. On the other hand if they max out their TFSAs first, tax becomes less of a deciding factor. Regardless of which way they’re leaning they will want to engage in some tax planning before they make any final decisions.
Option 3: Borrow Home Equity to Invest
David and Sarah thought they had made up their minds when their friend Kevin asked them if they had considered borrowing against the equity in their home and using that money to invest. He told them this strategy might make it worth holding onto the property for longer because it would allow them to benefit from both the increase in property value plus the investment growth. He said he’d heard of people doubling their equity this way.
David and Sarah met with their financial planner to find out more about borrowing to invest. Their financial planner explained that they would need to qualify to take out a Home Equity Line of Credit (HELOC), which they could then use to buy investments. In order for this strategy to be viable they would need to have enough excess cash flow to service the monthly interest payments, which would be tax deductible. The financial planner presented them with the following numbers:
| Total Equity | $ 435,000.00 |
| Max Available to Borrow (80% LTV) | $ 348,000.00 |
| Interest Rate | 5% |
| Monthly Interest Payment | $ 1,450.00 |
| Total Annual Interest Payments | $ 17,400.00 |
| Less Tax Deduction (35%) | $ 6,090.00 |
| Less After Tax Rental Income | $ 3,900.00 |
| Net Additional Yearly Cost | $ 7,410.00 |
Continuing with the same assumptions as before, David and Sarah’s financial planner estimated the following when they turn 65 and sell the condo:
| Sale Price | $ 1,570,000.00 |
| Less Taxes & Closing Costs | $ 420,000.00 |
| Less HELOC Repayment | $ 348,000.00 |
| Less HELOC Interest Paid | $ 260,130.00 |
| Net Proceeds | $ 541,870.00 |
| Plus Value of Investments | $ 1,330,000.00 |
| TOTAL GAIN | $ 1,871,870.00 |
As you can see if David and Sarah were to borrow some of the equity in their home, they might be able to increase their retirement savings by almost half a million dollars. It’s a far cry from doubling their money, but still a substantial difference. This strategy is not without its downsides though. First, they would have to come up with an extra $1,100 per month to cover the interest payments on the HELOC. Also, they’d have to continue to own and manage their rental, which is not what they had initially wanted.
Borrowing to invest is also risky. While these projections look rosy, there are plenty of things that could cause David and Sarah to realize lower than expected returns, or even lose money, such as if their investments perform worse than expected or if the interest rate on their HELOC goes up. For example, let’s say over time David and Sarah end up paying just 1% more in interest than expected, and their investments earn 1% less. Here’s how their numbers would change:
| Original Projection | 1% Increase to HELOC Rate, 1% Decrease on Investment Returns | |
| Sale Price | $ 1,570,000.00 | $ 1,570,000.00 |
| Less: Taxes & Closing Costs | $ 420,000.00 | $ 420,000.00 |
| Less: HELOC Repayment | $ 348,000.00 | $ 348,000.00 |
| Less HELOC Interest Paid over 23 years | $ 260,130.00 | $ 312,156.00 |
| Net Procceds | $ 541,870.00 | $ 489,844.00 |
| Plus Value of Investments | $ 1,330,000.00 | $ 1,040,000.00 |
| TOTAL GAIN | $ 1,871,870.00 | $ 1,529,844.00 |
With this illustration you can start to visualize how even seemingly small changes can have a big impact on your finances. Not only that, but a borrowing to invest strategy will put Sarah and David in a much more vulnerable position if they experience a financial setback such as a property vacancy or their tenant stops paying, or if one of them loses their job. They would need to decide whether this added risk is worth the possibility of increasing their future savings, or whether safer alternatives exist to grow their wealth.
Ultimately, there’s no one-size-fits-all solution when it comes to managing rental properties and achieving financial freedom. While real estate can be a valuable investment, it’s important not to assume it’s the quickest route to financial independence—sometimes, a simpler approach is more effective.
If you’re thinking about complex strategies, like borrowing against your home equity, it’s important to consult the right professionals who can help you understand the details. If you’re unsure about what to do next with your rental properties, book a call with me! Together, we can explore the best options for your financial goals and navigate this important decision with confidence.
Be The First To Comment