Lately, I’ve had more and more clients looking for a home for future retirement, despite the fact that there is nary a wrinkle or gray hair in site. What’s going on?
These 40-somethings are planning ahead and wisely so. Buying a second home now may give them not only a hedge against future higher real estate values but perhaps more importantly, they are building an equity cushion for their retirement years.
Here’s how it works. The buyer purchases a property now that can be rented out for an amount that will cover the mortgage principal and interest, property taxes, insurance and any other assumed costs of owning the property. To finance the down payment, the buyer might utilize existing and available investment funds or, finance the down payment by drawing equity out of their principal residence.
Let’s look at an example. The Smith’s now own a home in Toronto but love their frequent visits to South Georgian Bay . They already expect that they will retire to the area one day. The Smith’s decide to buy a second home now for $250,000 with a down payment of $75,000 (30%) from savings they currently have invested elsewhere. The remaining amount of the purchase price is placed into a mortgage which, together with taxes, insurance and maintenance is expected to cost them about $15,000.00 per year to carry. They secure an excellent tenant (or decide to rent their property out on a seasonal basis for shorter periods but with generally higher revenue) who cover these costs.
Although the Smiths initially took out a mortgage that was amortized over a 25 year period, they were able to pay the mortgage off in 15 years through accelerated bi-weekly payments and by increasing their monthly payments as rents increased. They can now retire to their fully paid for South Georgian Bay home and invest the proceeds of their principal home sale upon which to live. Alternatively, the Smiths could decide that the second property no longer meets their needs and decide to sell.
Here’s the best news. Even if the value of their second home didn’t increase by a single dollar over 15 years (have you ever heard of that?), they will still have gained a return of over 300% which is over 20% a year before taxes on their original $75,000 investment. This is the value of leverage!
Some things to consider:
- Don’t focus totally on finding what you think will be your ideal retirement home. Needs and tastes change over time. The key goal is securing a property that will give you the equity you’ll need in order to retire.
- As property values differ from one area to another, it would be wise to choose a second home property in the area where you think you are most likely to retire. This way, your investment in that marketplace will keep pace with your future real estate investment needs.
- Ideally, find a property in a location that is likely to be desirable in future years. For example, waterfront is a limited commodity and is therefore always desirable. In-town properties in mature neighbourhoods follow the same rule. Always try to buy the least house in the best neighbourhood or at very least, in the most desirable community. Look at appreciation potential and be careful of unproven areas.
- Look for areas where rents have been established so you can accurately project your potential income.
- Look into mortgage deals being offered by lenders. Variable rate mortgages with built-in cap rates can be found at less than prime allowing you to pay your mortgage off faster.