Not a Real Estate Investor….

This is a guest post by Dave, who is also looking to retire no later than 45, but unlike Tim has no kids and doesn’t want any.  Dave is from Ontario and is working towards his CGA certification.

…Or any kind of investing that would require me to take on debt.  I have read many articles and books on real estate investing and utilizing the Smith Maneuver to increase investing potential.  Personally, I just don’t find it very appealing.  I have no interest in taking on debt as part of an investment, no matter what the possible upside of the investment may entail.

I have spent most of my adult life paying off or keeping myself from getting into debt.  I am currently using almost 75% of each of my paycheques in an attempt to rid of my mortgage as quickly as possible.  Perhaps my mind is too closed off in taking on “good” debt in order to profit, but the idea of taking on substantial personal debt in an attempt to increase wealth just goes against everything I have spent the last decade or so doing.

One factor that may impact my perception is my investing window – my mortgage (if my current cash-flow remains unchanged) will be paid off in a period of five and half years (I currently have three and a half left).  I am hoping to retire at age 45, which will mean I will have ten years to save and invest:

  • At retirement, if I invested in real estate, I would still have an enormous mortgage on my personal balance sheet.  Also, much of my retirement savings would be locked up on one asset, which to me is not really ideal.
  • In the same manner, if I chose the Smith Maneuver (at current dividend yields) I can’t see being all that much further ahead than my current plan of paying off my mortgage in as short of period as possible and then investing afterward.

In the end though, it comes down to my comfort level – I would much rather make what could be a risky stock investment with my own money, knowing that I could lose 100% than be on the hook with a bank’s money.  I am not comfortable with debt and probably never will be, the upside potential of leveraging investments just doesn’t seem to balance with the downside.  At some point I will invest in a REIT to get exposure to real estate, I just can’t see myself being a landlord.

I’m wondering if anyone out there is doing the Smith Maneuver?  Am I looking at this the wrong way – is this a goldmine that I’m missing out on due to my aversion to debt?  What about real estate – are you making money renting a house (or something bigger) for cashflow?

13 thoughts on “Not a Real Estate Investor….”

  1. I agree, taking on debt to finance an investment is always risky. Rental properties are seen as a more ‘secure’ investment by some due to the fact that the debt is secured by an asset. If you take recent events in the US into account you realize that such an investment is just as insecure as stocks or bonds. The risk is still there as house prices can go down or you can run into huge expenses such as evicting bad tenants or replacing a roof, etc. In my mind you would just as far ahead to get a LOC for $100,000 and put it in the stock market. At least by going this route you wouldn’t have to spend the time on rental property maintenance and collecting rent.

    If you aren’t adverse to risk and think you can turn a profit then go for it. Just be sure to claim the tax deduction on the interest you pay:

  2. I have a rental property. It has worked out extremely well for me so far. I actually bought a house 2 years ago, with the intention of living in it for a while and then renting it out when I moved. A move opportunity came up sooner than I thought. Including down payment I’ve only put about 6k into the house. I’m making about $150/mo in profit (after taxes, ins, mngt fee) and another $250/mo in equity. It’s a family house so my renter’s will typically be longer term. Obviously more risk than putting my money in bonds, but I can’t get that sort of a return anywhere else right now.

  3. Take all the rental property you can get your hands on provided that a) the rent more than covers cash costs and b) its in a location that you can easily rent out in any type of economy i.e. walking distance to the university.
    That is as sure of an investment as you can get, even if as your comments imply real estate prices implode in Canada, as long as you can rent out that property and get paid to do so every month the tenants will ulitmately pay off the mortgage and your cash inlay is limited to the downpayment.

    “I would much rather make what could be a risky stock investment with my own money, knowing that I could lose 100% than be on the hook with a bank’s money.”

    I would suggest that being that debt adverse will reduce the overall growth of your capital.

  4. Like Dave, I also really dislike debt. I am 27yrs old and have just recently paid off my mortgage. I have also invested along the way only using my own money, but now that I am debt free am wondering if I should be looking into rental properties or an investment LOC to put some amount of the equity in my home to work elsewhere. I don’t quite see myself being a landlord either….is it common for people to borrow on LOC’s to invest?

  5. Yes, you are looking at it totally the wrong way (you asked). Just my opinion. Money is money, whether it’s yours or the banks. By using only your own money you are almost insulting yourself. Bank money is almost free right now, so what you are saying is that your investment ideas are so poor that they won’t even work with free money. Yet you are willing to put in your own money, which costs you years of sweat and saving and denial.

    By not considering debt for investing you are keeping yourself small. Your money will grow many times faster with debt. You should have no personal debt, but I recommend that you are leveraged to the hilt for investment (as long as you are competent, if you’re not competent then you shouldn’t even have your own money invested, just save).

    The Smith Manouver is of no consequence if you already have investments. Whether you do it or not will make hardly any difference to your wealth because you only save the taxes on interest payments, which are typically higher for a HELOC. At todays interest rates you are talking tens or maybe hundreds of dollars per year gain, more money than it would cost to set up. It also doesn’t result in more leverage, you are simply making your existing loan tax deductible. You should get your head around the idea of using leverage in the first place, then do more than just use the smith manouvre.

  6. I shopped around for the best USA margin rate I could find (Interactive Brokers) and it was substantially lower than a HELOC or mortgage. I’m dipping my toes into using that low rate and buying high yield dividend stocks to create a consistent stream of monthly income. Resulting yield is over 10% and will rise to about 13% as I add less consistent dividend payers & borrow more money.

    Ironically, in a margin account, the more one borrows, the better the interest rate becomes. Borrowing $10k, the rate is about 3%… borrow $100k and the rate is only 1.6%.

    I can understand your skittishness in borrowing for real estate investments. I’ve not heard of a reasonable escape plan if the property turns out to be a mistake. Stocks, on the other hand, can be liquidated quickly/automatically and it’s easier to expand the number of holdings across industries.

  7. With real estate, the trick is in doing your homework to make sure that the property is not a mistake. The wind can blow a stock quickly, but real-estate is valued on the income stream. As long as the income is stable, so is the value. I just turned down a “great” real estate opportunity where the rents were far above average for the area, but since the leasor was unwilling to sign up for 10 years I turned it down. For five years it would have been a stable return on equity of about 27%, but it was not good enough.

  8. I started the Smith Maneuver last year, and so far so good. Starting small as I too have a general aversion to debt. My dividends are covering my interest payments (for now, in theory) and I am using the dividends to pay down the mortgage faster (I am swapping mortgage debt for HELOC/deductible debt) – but my total debt does not change.

    Benefits come from stock price appreciation (up about 4% since I started, plus dividends); deductibility of the interest and favourable tax treatment of the dividends …

    I have only very conservative investments (banks and such) so I am not too concerned about the dividends being cut. But it is a long term (10++ years) strategy.

    But so far so good.

  9. We had no intent of buying rental real estate beyond our primary residence, but a good friend across the street was divorcing and just wanted to get out quick. We thought we might just buy it, fix it up and flip it for a capital gain. The next week the neighbor next to us came over and begged us to buy his also because he had a job transfer. We decided to rent them both and we qualify our tenants like you would a new employee. We take our time, find the right tenants and were prepared to let the rentals sit cold and dark if we had to. That was 10 years ago, and with the capital gains as well as favorable tax consideration, the real return has been close to a compounded 45% return on our initial down payments. Don’t forget that you also get to claim upkeep from your before tax rental income. Tough to beat that.

  10. You are missing out on a key point- leverage! This is not the risky type of leverage that you see in stock markets or futures etc- and does not promise the payoff that those do either. Is there risk – yes. There is also risk when you go to bed at night that you might not wake the next morning, or when you get in your car etc, yet you take those risks. Real estate is similar. As a landlord you have to be ready to be a landlord or ready to pay someone to do it for you. I do both as I have one property that is too far away for me to manage, but I found a great person with a great fee structure. The other is close enough that I take care of it myself. It is best to build a network of craftsmen that you can trust to assist you whenever you need as well. I have a couple that actually have keys to my places and can go whenever I need them to without me being there.

  11. I got a bit lucky there. About 8 years ago I switched to Scotiabank (via a broker, they had the best rate for what I wanted) and at the time setup their Total Equity Plan (STEP). I don’t recall what the fees were, if any. I suspect not much as I wouldn’t have paid them!

    When I setup a separate LOC within STEP to track just the investment portion (easy accounting)Scotia wanted to “increase” the plan to 75% of the current 2010 value of my house – rather than 2004 where it still is. I declined. I don’t want to risk the house! But even if I borrowed all I could, it would still be less than half of what the houses in the neighbourhood are selling for. So even if stocks collapse, dividends disappear, and I panic, I will still have a chunk of equity (or not – things would be very serious if that happened!).

    Until late 2010, I had never ever used my LOC – it was safety blanket for emergency furnace or roof replacements, etc. Still is. But I managed to get some dividends stocks cheaper than normal but not as cheap as after the crash. The fortune goes to the brave!

    Have friends who use the ManuLife One account, but the higher rate generally is not offset by the cash management (IMHO).

  12. I intend to use the Ed Rempel version of the Smith Manoeuvre in a year or so when I have the equity to do it (I’m only 23). Basically he does the Smith Manoeuvre, but increases the leverage to as much as you can get/are comfortable with. He also offers some other services which I won’t get into since he doesn’t pay me anything haha. Long story short, I think the numbers pretty definitely add up over a long time horizon in favour of using the SM. I intend to die with a 200,000 HELOC and never pay much tax my entire life, just as Smith recommends.

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