With my being a Realtor and my wife being a financial planner, we frequently have investment discussions about the best place to invest our after-tax dollars. My wife recently put forward a pretty compelling argument about why a Universal Life policy could be a better long term investment than a downtown condo bringing in $1,500 per month in rent. So, we decided to each make our case and ‘square off’ on the topic.
Here were the rules of the game:
- A 30 year time horizon
- Similar net amount invested
- Ignore inflation in order to compare the relative merits of each investment more easily
The case for Investing in Real Estate
For my side of the comparison, I chose a condo in the popular and well-priced Spectrum Development, located right on top of the downtown Costco. Optimistically, a one bedroom unit there will rent for $1,500 per month, and there are units on the market under $450,000 with strata fees of nearly $300 and property taxes at 1,600 annually.
- Sales price of $438,000
- A 20% down payment ($87,600) to avoid CMHC mortgage insurance costs
- A mortgage amortized over 25 years at a constant 5% for the life of the mortgage
- NO increase in strata fees, property taxes or homeowner’s insurance
- NO special assessments • Occupied with a rent paying tenant 100% of the time
- A small annual investment in maintenance (new carpets, paint, etc) of $1,000 per year.
In Vancouver, we generally accept that making money in real estate means relying on market appreciation, as opposed to cash flowing on the rent. The silver lining to this is that you may write off the loss as an investment loss on your taxes, as opposed to increasing your income (who wants that anyway?).
So, the first big question is: What is a reasonable capital appreciation value to assume over the 30 year time horizon? I looked at Real Estate Board of Greater Vancouver statistics for the 20 years between 1992 and 2012, as I couldn’t go back any farther. During that time, the median price of a condo in the same price bracket more than tripled in value. If I extrapolate that over another 10 years, it would be a five-fold increase in value. However, I recognize that the transformation from post-Expo 86 to 2012 has been remarkable, and that next 20 or 30 years are not going to see as dramatic a change because the downtown core is that much more “built out”. So, I assumed a 400% increase in value. With that assumption, my condo would sell for $1,752,000 in 30 years’ time. Not bad, right?
However, the costs of owning a condo are also significant. First, there are property taxes, homeowners insurance, strata fees and regular maintenance that add up to $540/month on top of the mortgage costs of $2,038 (equating to a lifetime interest cost of $260,984). Then upon selling the unit, I would incur a capital gains tax of $328,000 and transaction costs of about $50,000, not to mention my initial cash investment of $87,600. After all is said and done, I calculated a net profit of $712,709.
The case for Insurance
Many people view life insurance as a black hole in which money goes, only to come out when they die. This is no longer the case! Savvy investors, and indeed wealthy individuals and families, have been using life insurance as an investment for generations and recognize it as a powerful means of doubling net worth with each generation.
For those not interested in improving their children’s’ standard of living, Universal Life Insurance is a means of building a nest egg that may be accessed for retirement income, vacations or their children’s’ or grandchildren’s education. Better yet, it is a tax preferred investment vehicle with no minimum withdrawal amount.
Let’s say I was 39 and I took out a $800,000 policy on my own life combined with a $750,000 on the life of my child, aged 4. Insurance on children is cheaper, because they are younger, and it will allow me to build wealth in a portfolio that I can either keep for myself or transfer to my child when she is an adult.
The beauty and unique feature of Universal Life, as opposed to Whole Life insurance is that it is totally flexible. I can increase or decrease premiums as my cash flow allows, within parameters established when the policy is set up, and depending on how and when I want to use the cash value of the account.
I looked at what I could do with a policy using a similar cash outlay to the condo above. David paid $87,600 at the start, followed by 25 years of $12,995 per year. His total net cash investment was about $354,000. I spread the condo down payment over the first 5 years of my policy, and added in the $12,995 for a total of $30,515 for five years, followed by 21 years of premium payments of $12,995 and a final payment of $6,500, equating to the same $354,000.
At a 5% long term investment growth (I am allowed to pick from a variety of funds within the insurance company’s portfolio) I will have $1,411,898 cash surrender value in my account. I can withdraw this as a lump sum, incurring taxes at a preferred rate to net me $831,350. I’m ahead by about $120,000. Alternatively, I can borrow against this and retain the account value, and pay the tab from the death benefit which is over $3.6 million by the time I am 80 years old. Not to mention, if the market does better than the very conservative 5% growth I assumed, then so do I!
People love, and will continue to love, property as an investment. It is perceived as a safe long term bet. It is tangible, which is a huge psychological plus. We live in a city where property values seem to continualy rise over a five to ten year time horrizon. A property in the downtown core may be a great growth opportunity, with no ‘sweat equity.’ There are other ways of leveraging an investment in property that could work to your advantage. For example, renting out a basement suite until you are ready to grow into it.
However, with a Universal Life policy, everything is simple. You do not need to take ads on Craigslist to rent out your unit, you do not need to respond to emergencies, ensure access for maintenance, renovate, or worry about the housing market when it is time to cash in on your investment. Moreover, you leave a legacy for your family.
If you would like to play with the assumptions on the property investment, or see more details about the insurance illustration, you may download our spreadsheet by clicking here or give one of us a call.