Deal or no deal? $2.8 million investment property

Two weeks ago I received an excited phone call from James, a forty something family doctor living in Richmond Hill with his wife, an ER nurse at a local hospital.  They had discovered a beautiful 7,900 square foot house in Vaughan, not long reduced in price from $3.5 million to $2.8 million. James and Rachel wanted to buy the house as an investment property.

The house was being sold under power of sale by the Korea Exchange Bank. Turns out it has an interesting history. It was bought for two million dollars some years ago by the Chung family, who operated a convenience store in Burlington, and collected a $12.5 million winning ticket back in 2003. Although there were suspicions, the prize was released one year later, and immediately the money was channeled through dozens of accounts in Canada, New York, and South Korea.

On September 30, 2010 the Toronto Star reported

“Back on Callaway Crt., the gated community in Vaughan where Kenneth Chung lives with his parents, neighbours were shocked….

Ironically, neighbours said, their house was at one time a prize for the Princess Margaret Hospital lottery.”

The Chungs were charged with fraud and money laundering, and their dream home is now on the auction block.

Anyway, what about the house itself? It is a magnificent specimen. At the end of a cul-de-sac in an exclusive gated community, backing onto a ravine and golf course. The finishings are top of the line; in fact the Chungs had apparently invested $300,000+ in the basement alone – setting up a home theatre for the ages. The mansion boasts seven bedrooms and eight bathrooms, and a huge, undeveloped back yard. The lot is 22,000 square feet, and has a four car garage and sufficient parking for fourteen cars in the driveway.

I sat down with James and Rachel to review their finances. They had done their homework. Homes in the area are routinely selling for $3.5 million and up. If one prefers to build from scratch, there are still a few lots available – running between $1.7 million and $2 million.

They had consulted a couple of luxury home builders, who had told them they could expect to spend roughly $300 per square foot to build a home of comparable quality. This means anyone buying one of the vacant lots with a view to custom build a 5,000 square foot home could be looking at a price tag of around $3.5 million. But THIS home is 7,900 square feet, and “only” $2.8 million.

Down the street there is a 7,000 square foot beauty, listed at $4.3 million. James was positively salivating. ‘Ross, we can make an easy half million in a year – maybe more. It’s the deal of a lifetime!’

Their realtor was naturally enthusiastic – even at a 2% sales commission, he had a $56,000 paycheck waiting in the wings. As their mortgage broker, I’d make a few shekels too. But they were looking for my professional opinion, not just for a mortgage.

Let’s look at the numbers. Their present home is worth $1.1 million, and they only have a small $135,000 mortgage. Their thinking was to take a home equity line of credit on their home, and apply $600,000 towards a down payment.  They would still have around $145,000 to play with – but with land transfer taxes of over $50,000, and a desire to build a swimming pool, and rebuild the deck, that money would easily be spent.

So if they could buy the mansion for say $2.7 million, they would need me to arrange a $2.1 million mortgage!

Now this was happening just as stormy waters hit the mortgage industry. In early February, it came to light CMHC had come close to their $600 billion lending cap, and as a result, lending guidelines were tightening daily.  Investment properties, equity deals, and mortgages for the self-employed were the first and biggest casualties. We wrote about this here on February 2. And the media are constantly warning us of an imminent pullback in Canadian real estate prices – could they be right?

If, I mean IF, I could pull this off, James and Rachel would be taking on a monthly mortgage payment of roughly $9,000 per month, plus an additional $1,900 per month for property taxes, and maybe as much as $1,000 for utilities and maintenance. And don’t forget their intention was to use borrowed money for the down payment – $600,000 at 3.5%. Another $1,750 per month in interest costs.

So the monthly nut would be close to $14,000.

James was not deterred. “Ross you know my practice is cash flow positive – we can handle this. Look at the area, we can flip this thing next year for maybe $4 million – easily $3.5 million.”

I’ll let you form your own opinion, but here are some of my thoughts:

It’s one thing to buy this home to live in, especially if you are as successful as this couple. Presumably they could weather out the ups and downs of the real estate market – home is home, and your home should be comfortably affordable. But James only wanted to buy it as an investment.

It looked to me they would spend another $250,000 easily in land transfer taxes, landscaping, refinishing, and the eventual realtor commission when they list the property for sale again.

Every year they carry the house will add another $165,000 to their cost base. Yes, they could offset some of this if they rent out the house in the interim.

There will be tax issues – they may be successful claiming the interest costs as tax deductible (not a slam dunk), but the eventual capital gain on the sale of the home will be a taxable event – thus encroaching on their coveted profit.

As lovely as the home is, it is very close to Bathurst and Highway 407 – there is a noise factor – especially when outdoors.

In the industry we talk of the buyers’ pyramid. At the bottom of the pyramid are entry level houses, with thousands of potential buyers. As prices increase, you approach the apex of the pyramid – and there are only a few buyers in the market at any given time who can entertain buying a multi-million dollar property.

Most importantly, what is the real value of this home? Buyers aren’t stupid. If $2.8 million is a steal, why had the house been on the market almost six months? And it had been reduced several weeks previously from $3.5 million.

Once this house is purchased, the buyers’ new neighbours will not roll out the welcome wagon. Why? This would be the most recent comparable sale price to which all other resale homes and lots in the area will be gauged. How do you think the people selling down the road will feel about their $4.3 million asking price? What do you think this will do to the price of the empty lots nearby going for almost $2 million?

This single transaction may well exert downward pressure on all surrounding values – resulting in a much longer holding period than James and Rachel anticipate.

Anyway, after a few sleepless nights, they decided to pass – and within a couple of days the home was sold for $2,726,000.

What do you think? Should they have rolled the dice? How should I have guided them?

It’s so easy to get duped online

Today I opened my hotmail account and read an extremely high quality (but highly fraudulent) email allegedly from the Windows Live Hotmail team. Even I paused for a second, because they said if I don’t reply within 48 hours they would shut down my account. But no legitimate business would ask me for my password or DOB etc., so of course it is fake. I hate to think what these guys do to the people who do reply with full disclosure.

Be careful out there folks!

 

Windows 7 + </p><br /><br />
<p>Windows </p><br /><br />
<p>Live. Make movies. Share</p><br /><br />
<p> photos. Stay in touch. Download Windows Live Essentials
Windows Live is </p><br /><br />
<p>Hotmail, Messenger, and so</p><br /><br />
<p> much more.

This email is from Windows Live Hotmail® and we are sending to all our account user for safety. Due to the anonymous registration of our account which is bringing congestion to our service, so we are shutting down some accounts and your account is among them. The purpose of this email is for you to verify that you are the owner of this account and you are still using it by filling the information below after clicking on the reply button:

Full Name: 
User Name: 
Password: 
Date Of Birth:     
Country Or Territory: 

After following the instructions in the sheet, your account will not be shut down and will continue as normal. Thanks for your attention to this request. We apologize for any inconvenience.

Account owners that refuse to update his/her account after 48 hours of receiving this warning will lose his or her account permanently.
Sincerely,
The Windows Live Hotmail Team
Windows.com  |     Windowsmobile.com     |   Windowslive.com     |    MSN.com

Turn your unused RRSP contribution room into thousands of dollars – “The Taylor Manoeuvre”

This is really simple – and is best used only by someone who has a husky taxable income in 2011, and expects a radically lower income in 2012. All you do is make a very large contribution before February 29, 2012; generate the associated refund when you file your taxes; and then withdraw the same money three months later. Just by moving money around like this, you can generate thousands of tax refund dollars.

 

 

 

Jealous of Fraser Smith’s fame as the ‘pioneer’ of leveraged investing via tax deductible mortgages, I have decided this little used RRSP manoeuvre deserves a name. Hence “The Taylor Manoeuvre”.

I have used this strategy myself in my youth, and it came up again last week when a young professional named Megan came to me for a consult. She explained she had just quit her job as an assistant marketing manager, and was starting her own business. To supplement her erratic income in the early months, and ensure she can pay her bills no matter what, she will also be working part time as a waitress in an upscale restaurant.

First of all, I applaud Megan for not being afraid to pursue her dream. Yes she is debt free, but it still takes courage to give up the good life, and pursue personal fulfillment and join the ranks of the self- employed to boot.

I noted Megan has over $35,000 of accumulated unused contribution room, and according to her 2011 T-4, she made around $57,000 in taxable income in 2011. A large chunk of that was taxed at a marginal rate of 40%.

I checked with my tax accountant, also known as “The Tax Nazi”, and he confirmed Megan would generate around an $8,000 refund this spring if she makes a $20,000 RRSP contribution before the end of February.

We discussed arranging an RRSP loan for this amount – but Megan correctly pointed out she could simply draw down the funds from her personal line of credit, and transfer $20K into her RRSP at the same bank. Simple! At an interest rate of 7%, the cost of borrowing this money for three months will only be $350. (yet another benefit of having an awesome credit score)

After she has held the money inside her RRSP for three months, Megan plans to withdraw it in $5,000 increments. As an Ontario resident, each withdrawal will be subject to withholding taxes of only 10%. (In Quebec it is 21%)

By the time the dust settles in late May, this young lady will have netted $6,000 in ‘profit’, at a cost of only $350.

One year from now, time will tell if the final result will be even better, or possibly slightly worse. You see the 10% withholding tax is like a security deposit with CRA – it is not a final number. Megan and her tax accountant are confident she will retain the full benefit. If there was an expectation of a high personal income in 2012, this would not be an attractive strategy for Megan.

Who might consider the Taylor Manoeuvre?

  • People taking a break from work to go back to school, or simply taking a leave of absence.
  • People like Megan who intend to leave the ranks of the salaried, and enter into business for themselves.
  • People who have an unusually high taxable income in 2011, and are confident their marginal tax rate will be much lower in 2012.

Of course, you need to have some unused RRSP contribution room; you need to be pretty confident in your income projections; and you would be well served to consult your own tax accountant before you jump in.

No credit score = can’t get a mortgage

I first met Jake seven years ago, when he was toiling unhappily in sales in a software company. In his late twenties, he had a devil-may-care approach to life. This was reflected in his credit report too. A few credit cards, a car loan -> all with late payments; and a collection dispute with Rogers.

He wanted to buy a small townhouse. Although he was making around $60,000 back then, there was nothing I could do to help him, as his credit score was way too low (473), and his repayment history somewhat checkered.

He resurfaced in 2008, assuring me he had put the past behind him, and had embarked on a new career as a real estate agent. We checked his credit history once again, and it was still ugly, but not as ugly as before. His score was now 568 and climbing slowly.The cards that had been 60 and 90 days late were still on display, but at least a few years had passed since his troubles. Time is your friend when you want your credit score to improve.

The Rogers collection was still there though, as he had never resolved it. He promised to settle the account this time, and he proclaimed he would be back again. I noted all the bad payment history would fall off his credit report by 2011, and by then, his score should rise to heights he had never known before. (I was thinking he’d be at least 750 by then)

Fast forward to December 2011, and Jake showed up at my office in the biggest Hummer you ever saw. He sheepishly told me he was spending $900 per month just on gasoline, and together with his monthly finance payment and insurance, the ‘car’ was costing him $2,000 per month.

“It’s not so bad Ross, it’s all tax deductible. Still, as soon as the loan finishes, I’m going to downsize to a late model BMW 5 series.”

With high hopes, we checked his credit history one more time. Ugh! Now he has no credit score. Nada, zero, zilch.

He had decided to close all his credit cards after our last meeting, and for some reason his Hummer loan was not showing up on his credit report. He proudly told me how he was no longer dependent on credit cards to support himself. (Aargh – you need active trade lines to generate a healthy credit score – using no credit at all is not the solution if you plan to maintain your credit history)

And now he wants to buy a new house, and with no credit score, even with a 20% down payment, it’s highly unlikely any lender will give him a mortgage – especially given the variable nature of his commission income. He would need a guarantor or co-signer, but he is fiercely independent, and wants no part of that.

So now, the process resumes. We immediately arranged two credit cards for Jake – each with a limit of $2,000. I was also planning to advise Equifax and Trans Union of his car loan arrangements – expecting they would begin reporting the car’s payment history. But when Jake revealed he has been one month’s payment behind for over a year, I elected to tread quietly. If the loan shows up on his report, it will show at least twelve payments 30 days late, and we will be right back at square one.

I also gave him some tax and financial planning advice (he is making very good money now – his career is flourishing) and we have agreed to get together again every six months to review his circumstances. When the time is finally right, he’ll get that home he has long coveted.

So for those of you who are sloppy about making your payments on time, or those who choose to take a stand against your cell phone company or cable provider – remember, at the end of the day, you are only hurting yourself.

Don’t believe the doomsayers who proclaim credit is evil. In today’s society you must do everything in your power to build and maintain a healthy credit history. Far more doors of opportunity will open for you than if you take a lackadaisical approach to such important matters.

Here’s a related article I wrote about why you do want a high credit score.

What happens when you own a house and you also have too many debts?

Img Home MortgageIII see it a lot – homeowners who have some equity in their home, but also a boatload of unsecured personal credit. They understand they need to make changes, and are ready to pay the piper. At this point, people begin to scour the newspaper classifieds; check the Yellow Pages; pay closer attention to the radio ads; and of course, scour the internet to find useful information on matters such as debt consolidation, consumer proposals, and even bankruptcies.

Most homeowners I have encountered do not want to sell their homes, and they certainly do not want to lose their homes to a bankruptcy process.

Many end up consulting a trustee in bankruptcy, who will also be an administrator of consumer proposals. This first consultation is free, and gives you a chance to tell your story and begin to understand what your options are. The trustee’s job is to help you find the relief you need, while representing the best interests of your creditors.

Many people come to me first, while wearing my mortgage broker agent hat. I have enjoyed fair success resolving these crises through creative mortgage solutions which freed up sufficient equity from the home to either pay down the debts, or muster up sufficient capital to make a lump sum settlement offer to their creditors.

Because I specialize not only in credit counseling, but also as  a licensed mortgage broker agent, some trustees refer their prospective clients to me, since they sense there is unrealized equity in the individuals’ home, which can perhaps be unearthed to help solve some, if not all, of their debt problems.

Once you are identified as a homeowner, the trustee’s mandate is to first determine how much money can be realized from the equity in your home. It’s a pretty simple exercise – they determine the market value of your home, then subtract the total mortgage financing already attached to your property. That is their starting point. So if you have a home worth say $280,000, and a first mortgage of $230,000, the trustee will likely suggest you should come up with an amount of $50,000 to pay your creditors.

But no one with debt problems has $50,000 lying around – hence the problem. A mortgage specialist can help you realize up to 85% of the value of your home (via restructuring your first mortgage, or adding a second mortgage) but you still maybe short tens of thousands of dollars.

At this point, you probably need an advocate to plead your case with the trustee. Usually a lawyer is recommended, but it does not have to be a lawyer – I find trustees agreeable to accepting pleadings from me on behalf of my clients.

The advocate will try to reason with the trustee – arguing that there is no certainty in a bankruptcy and the forced sale of the home. Any proceeds from a potential sale will be eroded by legal fees, mortgage prepayment and discharge fees, and real estate commissions. A case can be made for reducing the amount the trustee is willing to accept on behalf of the creditors. The trustee is often more likely to listen to these pleadings from an advocate than from the debtor himself.

The point is there are many ways to solve the problem of too many debts and a desire to hang on to the family home. Seek out expert advice from a trusted third party.

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