Real Estate to Fund Retirement

CREDIT: Glenn Baglo, Vancouver Sun
Chartered accountant Melanie Frers (left) gives the good news to Debbie and Dennis Nisbet: They will be financially comfortable in retirement.

Dennis and Debbie Nisbet are the classic millionaires next door. They've made a pile of money by investing in real estate while living modestly and making sacrifices. Now they find it hard to start spending.

The two realtors sought a free Vancouver Sun money makeover, courtesy of the Chartered Accountants of B.C., to get a handle on their retirement options.

With a $1.4-million waterfront home in Port Moody and eight rental properties, it is no surprise that Debbie, 48, and Dennis, 49, can afford to retire when they are 55.

Their big challenge is letting go of one or two of the golden hens that have built their fortune.

"I am passionate about investing in real estate to build wealth," said Dennis. "I look at the income it could create and wonder why not just keep the properties? It is hard to transition from 'don't sell' to 'sell.' "

However, chartered accountant Melanie Frers tells the pair they must make that transition because most of their wealth comes from the growth in the value of their real estate, rather than the rental income, which is primarily used to fund about $1.3 million in mortgages.

"You don't want to be 90 years old and living in a basement suite with no heat and have all this property," Frers said. "The properties are supposed to work for you. This is your retirement money."

Although they also have about $150,000 in registered retirement savings plans and $60,000 in non-registered investments, the Nisbets have no pensions other than Canada Pension Plan.

They estimate their personal retirement expenses will total $4,650 monthly ($55,800 per year), but their net rental income before tax in 2010 is estimated at $22,316, a shortfall of $33,484 plus tax.

Frers started the makeover by projecting the value of their real estate portfolio, which consists of mostly single-family homes in the Tri-Cities area and Maple Ridge.

Using a growth estimate of 7.4 per cent a year on average -- based on the Nisbets' example of a house going from $100,000 in 1980 to $600,000 in 2005 -- they would net $4.45 million after tax if they sold everything, including their personal home, in 2010.

If they could invest that money at five per cent, they would earn $222,505 before tax without touching the principal. "But they would sell the home with a view which they love," said Frers, of Port Coquitlam's Meyer Frers Chartered Accountants.

The real estate forecast could be derailed by a major correction in the market, and Dennis acknowledges that a 50-per-cent price appreciation is typically followed by a 25-per-cent decline. "The market tends to go two steps forward, then one step back," he said.

If their assumptions pan out, Frers said they will need to sell one property in the year after they finish working, subject to the state of the market.

If the market is flat or down, they can use their RRSPs to fill the income gap until it bounces back, although Frers notes that their financial assets give them a more balanced investment portfolio if property values decline. As well, the tax on RRSP withdrawals will likely be higher than the tax on capital gains from real estate.

She suggests they sell their recreational property in Birch Bay, since it is the only one that does not provide any income. The property was originally acquired for $19,000 in the 1980s because it was cheaper than paying for moorage for their boat in the Lower Mainland. They now have a floating dock off their home in Port Moody.

The Birch Bay sale could be expected to generate about $200,000 in cash, which Frers suggests they invest very conservatively -- earning only two per cent interest -- while they draw it down to supplement their rental income.

By 2013, they will need to sell a second property, and Frers picked one expected to net $515,103 after tax and paying out the mortgage. Again, they would invest the money very conservatively and use it to supplement their rental income.

When they are 60, they can apply for reduced Canada Pension Plan, which will boost their income by an estimated $10,560 per year, and by age 67, one of their mortgages will be paid off, adding another $12,264 to their annual cash flow.

By the time they are 75, Frers anticipates that all of their mortgages will be gone and they will be more than meeting their budget without selling any more homes. They will still have seven of their nine properties and will be able to leave a large inheritance for their four adult children from previous marriages.

Frers assumes the couple will work for the next five years, and suggests they resist the temptation to purchase another rental property. They don't need to boost their RRSPs, but if they choose to save more, she suggests they contribute to a spousal RRSP for Debbie, giving Dennis the up-front tax break while equalizing their retirement nest eggs to minimize taxes when the money is withdrawn as income.

Both Nisbets describe themselves as frugal, although they have built an enviable lifestyle based on previous sacrifices and what Dennis describes as a "nose-down, tail-up" approach whenever the real estate market turned against them.

In addition to "an older" eight-metre boat, Dennis owns a '92 Harley motorcycle, a pre-owned car, and has built his own kit car for road racing. He raced for three years with the Honda Michelin professional series, and would love to race again when he is 60, although he says it costs a fortune.

Debbie, meanwhile, wants to do some renovations on their home, and Frers suggests she begin, using their non-registered savings to pay the bills.

Frers' concluding advice to both of them: "Relax and enjoy your retirement."

(prepared by Michael Kane/Vancouver Sun)