“A couple we’ll call Tiff (49) and Sandy (45) turned their long-time friendship into a union when they bought a house in British Columbia and combined their fortunes in 2008. The relationship came with a lot of baggage, however. Each had a house with a mortgage. Then they bought a new residence and used a line of credit to add a rental apartment to the new house. Their $1.5-million of debt is 12 times their gross employment income.
Revenue from the income properties barely covers their total costs — mortgage and line-of-credit interest, taxes, utilities, insurance and maintenance. Add in falling prices in the sliding B.C. housing market and the couple is subsidizing losing investments.
They save only $100 a month for RRSPs and $25 a month in an RESP for a Sandy’s nine-year old child from a former marriage. At mid-life, the couple, each of whom works for a large publishing company, has just $31,000 of RRSPs and almost no cash.”
They started with 25% conventional down payments, but now find themselves with about 10% equity in the rental units as a result of falling property prices and debt-financed buyouts of former partners. Their return after paying all interest costs, utilities, insurance and taxes is negligible. Unless they can raise rents drastically or realize future capital gains, the investments are flops.
A financial crisis triggered, perhaps, by unemployment, illness or accident would require them to add debt, for they have just $2,000 in cash. If interest rates rise by 1% or 2%, they would be forced to refinance, but they already have 30-year amortizations. To pay more interest, they would have to face deregistration of some or all of their $31,000 of RRSPs, heavy taxes on payouts or, in the worst case, bankruptcy.
Family Finance asked Adrian Mastracci, a portfolio manager and financial planner at KCM Wealth Management Inc. in Vancouver, to work with the couple. He is candid in describing the issues.
“The couple’s problems are far too much debt, especially for properties that are poor investments, and an excessive concentration in real estate, for each unit is within just blocks of the others,” he says.
Real estate has produced substantial gains for homeowners in parts of B.C., but the boom is waning. When interest rates rise, prices could fall further, for most people buy what they can afford and, with higher borrowing costs, they will afford less.
– from ‘Bad real estate investments leave couple with $1.5-million in debt’, Andrew Allentuck, Financial Post, 11 Jan 2013 [hat-tip JoeQ]
Summary of finances for this couple:
Assets $2M [$1.862M in RE at current market prices; $137K other]
Debt $1.542M [3 mortgages, 1 LOC, CCs, Car loan]
Net worth $456K [Assets minus Debt]
Ratio of RE holdings to Net worth: 4.1 to 1
Put another way, more than 400% of their net worth is in RE.
(I find this figure as shocking as the debt to income ratio of 12)
If/when the market price of their RE holdings drop 25% they would be wiped out.
What, me, a speculator?
Just innocent locals doing what innocent locals do, right? Building wealth with RE.
How many more out there are in similar situations?