If you’ve been a good saver and investor when it comes to your retirement funds, the temptation can be to sit back and assume that you’ve done everything that you need to do. However, this isn’t always necessarily the case. Your retirement savings actually represent a powerful opportunity to invest in new undertakings – particularly in real estate. Learning how to use leverage when buying real estate with your retirement savings is a key lesson for Canadian real estate investors to understand.
Table of Contents - How to Use Retirement Leverage to Invest in Real Estate
Retirement funds have all sorts of rules when it comes to how these types of funds can be invested. For example, anyone with a Registered Retirement Savings Plan (RRSP) is free to withdraw from it to fund the purchase of their primary home (up to $25,000), but purchasing a rental property with these funds is a no-no.
Why leverage matters
At its most basic, “leverage” is simply borrowed capital. Leverage gives investors of all kinds the chance to pursue bigger and better opportunities that they might not have the cash for. For example, if you purchase an inexpensive property entirely with cash, the chances are much smaller than you’ll receive an appreciable payout when you sell than if you had borrowed money to afford a larger and more expensive piece of real estate.
Real estate investment is not always easy to get into for many people. This is largely because potential investors need so much capital upfront to get involved at all, which can be a tall ask of many people. Fortunately, retirement accounts represent sectors where many people have saved considerable sums of money over the years and decades, so they’re a golden opportunity to draw money.
A caveat about using leverage from retirement accounts is that you must use non-recourse funding for any purchases. This means that personal guarantees on the loan are irrelevant, you will need to provide enough collateral to secure it. This collateral is usually the property itself. This rule is in place as a necessity because providing a personal guarantee would make the account owner a disqualified person who would no longer be eligible for the loan.
These restrictions add another challenge to this type of financing. You’re going to need to find a lender who will agree to specialize in retirement plans since a lot of banks and lenders won’t handle non-recourse financing for retirement accounts. The ones who do participate and will help you tend to have specialties that they focus on (high-end homes, commercial real estate, etc.) so it’s helpful to call around and do your research. This will ensure that you find a lender who is willing to work with you on what you need specifically.
Finally, non-recourse financing tends to require a higher percentage of money down. Since the borrower has no personal guarantee to back their loan, the risk being assumed by the lender increases. It only makes sense in practice – if they believe that they have less security in the form of a personal guarantee, then requiring more money upfront can help set their minds at ease. As a result, it’s necessary to put down 30-50 percent of the total purchase price to secure this type of financing.
This can mean taking a dip into your retirement funds to secure this level of cash, but real estate always remains an interesting and viable investment option. Even though the down payment is still higher than you might’ve expected, you’re probably looking at a more advantageous purchase anyways. This is thanks to the fact that the leverage has allowed you to afford a pricier investment than you might have guessed you could buy.
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Other ways to invest in real estate via retirement savings
Holders of RRSPs can invest in real estate in more ways than one. They can put money into a real estate investment trust (REIT) that will allow them to pool together investments that are all related to real estate. These trusts typically include residential, retail, commercial, health care and other types of real estate. They make up a great way for investors to indirectly put money into real estate while relying on the advice and management of financial professionals. There are dozens of these REITs available to Canadian real estate investors, so it could represent a more attractive form of real estate investing than simply purchasing a home.
These trusts will invest in the equity portion of a piece of real estate, so this allows the REIT to be involved in many different properties at once. This diversification is always something that investors should always be on the lookout for – REITs are attractive because they aren’t necessarily limited by things like geography, sector or other variables.
Another enticing option available to real estate investors is to hold your own mortgage in your RSSP. This has the effect of basically making yourself your own lender – there are some not-insignificant fees associated with this, but it could be a great move for someone with the means to do so. This is a move more for conservative investors, or those looking for a shrewd, safe move to make. You are borrowing at a higher rate than you’d get at the bank, but you’re basically borrowing from yourself.
There’s another caveat to this – by having so much of your money tied down in this manner, you could be losing out doubly via the missed opportunity of investing that cash in higher-yield investments. These are all decisions that every investor has to make, and it all comes down to your appetite for risk and your willingness to diversify.
Final thoughts on retirement leverage
Using leverage to invest in real estate is an increasingly attractive option for Canadian retirees. While it’s not a suitable path for everyone for a variety of reasons, for the right person it could be a chance to afford a property that’s much more lucrative than what they had thought possible – paying dividends down the road.
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