To me, the idea of becoming a landlord and owning a real estate empire sounds better in theory than practice. I can barely look after my own home maintenance, let alone having to manage another property. There’s also a major lack of diversification when you put all your eggs in the real estate basket – an asset class that’s awfully expensive in Canada.
Related: Borrowing to invest – how it works
That’s why I was intrigued when I read about a different type of landlord strategy. In his book, The Smart Debt Coach, financial author Talbot Stevens explains why a dividend landlord approach could make sense for those who’d rather avoid having to manage and maintain a rental property.
Here’s how it works:
With the dividend landlord strategy, the investor borrows an amount he or she is comfortable with, say $50,000, and uses that money to buy dividend paying stocks. The interest expense is tax deductible when you borrow to purchase an investment that has the potential to produce taxable income. Not only can the dividend income pay for most or all of the tax-deductible interest, dividends from Canadian companies are taxed less due to the dividend tax credit.
The lowest cost of borrowing is likely through a home equity line of credit, or HELOC, which can be obtained today at a rate between 3 and 4 percent. The investments would need to be held in a non-registered account in order to make the loan tax deductible, and to be eligible for the dividend tax credit. That means you can’t use this strategy in your RRSP or TFSA.
The dividend landlord opportunity was born after the financial crisis hit in 2008, when interest rates dropped so much that the average dividend payout of companies listed in the TSX became higher than the prime rate of borrowing.
Related: Is your investment loan tax deductible?
It’s now possible to be the owner and landlord of dividend paying stocks and have the dividend “rental income” cover the cost of borrowing to invest in them. One example shared in the book is that you could go to any of the banks, borrow the bank’s own money to buy its own stock, and have the dividend income more than cover the interest cost.
Benefits of becoming a dividend landlord
When you consider that the interest cost of borrowing is fully deductible and the dividend income is taxed less, many investors can be cash-flow positive even when their dividend income is less than their cost of borrowing.
By purchasing quality blue-chip stocks that you’d want to hold for the long term anyway, being a dividend landlord can be an effective no- or low-cash-flow strategy that is much less work than a rental property.
Related: Is it time to say goodbye to dividend investing?
The other benefit to this approach is that if you choose stocks in stable industries that have a history of increasing their dividends over time, your “rents” should go up automatically each year.
Downside to becoming a dividend landlord
Borrowing to invest comes with certain risks. Just as your gains can be magnified, so can your losses. The author also cautions investors that they’re almost guaranteed not to be cash-flow positive indefinitely. That’s because interest rates go up and down over time.
The strategy is designed to have the borrowing costs mostly or completely paid by the dividend income. Still, you should be able to comfortably handle the loan payments on your own, even with higher interest rates.
And just like you might have vacancies or tenants skipping out on rent, there may be times when a company might reduce or suspend its dividend. You have to be able to deal with those times.
There are also behavioral risks to consider. If you want to eventually be debt free and own the stocks outright, as with a rental property approach, you need to be careful with what happens with the additional cash flow generated by this strategy.
Related: How the behavior gap affects investor returns
For example, the tax savings from the interest expense deduction and the dividend tax credit should be used to cover the interest costs and pay down the amount you borrowed.
“If this cash flow disappears out the back door and is used for something else, it’s going to be tougher to retire the debt before you do.”
One last thing the author mentions with the dividend landlord strategy – and with any investment debt strategy – is that when you start can make a big difference. Starting your dividend landlord business when the stock market is down can significantly increase your profitability.
Final thoughts
I enjoyed reading The Smart Debt Coach – it explained strategies on how to use debt to increase your investment portfolio, and how to think in terms of before-tax and after-tax dollars in order to maximize your returns.
I’ve already used one of the strategies in the book when I used a top-up loan to boost my RRSP contributions. I like the concept of the dividend landlord approach – certainly better than being a traditional landlord – but I’m not too excited about starting while the stock market is at its current high level.
What are your thoughts on the dividend landlord approach?
Canada is widely considered to have one of the safest banking systems in the world. The “Big 5” banks have proven to be safe and stable companies, both for depositors and stockholders, and neither have any worries about their money.
Related: How Baby Boomers Changed The Banking Industry
However, the 1980’s saw one of the biggest collapses in Canadian financial history.
Financial difficulties
Two Alberta financial institutions – the Northland Bank and Principal Group Ltd. – defaulted. Through bad management and lending policies, together with somewhat shady practices, plus a recession, they ultimately left the savings of thousands of Canadians in jeopardy.
Both institutions invested heavily in oil, gas and real estate loans. Following the collapse of the Alberta real estate market in the early 1980’s due in part to the drop in world oil prices, almost three quarters of the entire mortgage portfolio held by the Principal Group was in arrears, with 42% in foreclosure.
Related: How Technology Has Impacted Banking And Investing
Neither one could payout their term deposit and GIC maturities.
Depositors in jeopardy
Investors originally flocked to these financial institutions with their deposit money because they paid 1 – 2 percent higher interest than the major banks on term deposits and GICs.
It took 14 years before investors in Principal received their final payments. Most of them were elderly people who had entrusted their entire retirement savings to them. In the end they received about 90 cents for every dollar invested. They received no compensation for any accrued or accumulated interest.
Related: Senior Discounts Vanishing From Our Banks
Buyers – and investors – beware
Bank depositors are (or should be) aware that their financial institutions are (or should be) members of depositor insurance plans.
Banks are members of CDIC (Canada Deposit Insurance Corporation). Currently up to $100,000 in accounts such as savings, chequing, and GICs up to a 5-year maturity are covered. Not covered are deposits such as foreign currency accounts and mutual funds.
Click here for more details on what’s covered and what’s not.
Credit Unions and Caisses Populaires are backed by their own provincial insurance plans that generally are the same as the federal plan, with some exceptions. For example, there are no dollar limits on accounts in Alberta, Saskatchewan and Manitoba; and US Dollar accounts and GICs with longer than 5-year terms are covered in Saskatchewan.
Be informed – know what’s covered and what’s not.
Bottom Line
Could this happen today? Maybe. It’s more likely that an underperforming financial institution would be swallowed up by another bank. The ailing Bank of British Columbia was bought by HSBC in the late 80’s, increasing its holdings considerably in Western Canada. Most trust companies were absorbed into the major banks in the 1990’s.
Related: What’s Next For ING Direct? My Interview With Peter Aceto
Many investors can’t stand the thought of losing money. They look for safe investments with high returns. But there is some element, or probability, of risk in everything, especially over the long term.
We tend to become complacent, or just plain ignore risks to chase better returns.
How many of us could stand to wait for 14 years to regain our lost life savings?
Tired of shovelling snow, thousands of Canadians have decided to live in a warmer climate. We’re familiar with snowbirds, but there are many who are choosing to move permanently to somewhere nice and sunny – a place where the pace of life is slower and the quality of life higher.
Why move?
There can be the temptation to retire to a county where your money stretches further, especially if you haven’t saved enough for retirement.
Visit your proposed new country several times, especially during the off-season. You need to look at the place differently when you’re planning to potentially live there. Instead of the obvious tourist attractions, check out possible residential areas, shopping, services and amenities.
Do you want to live in a predominantly ex-pat, English speaking area, or live among the locals? Take advantage of any opportunities to meet with people in the community of your choice.
Related: How this couple spends their retirement travelling
For valuable information, check out ex-pat websites and blogs such as The Real Costa Rica and Blogs from Expats in Guatemala.
Choosing a place to retire is more than finding an area with inexpensive living costs, low taxes, great weather and fun things to do. Think of how you want to live. Assess services and the livability of various areas.
Separate the romance from the realities.
A Permanent Retirement Overseas
Some popular retirement destinations
In the U.S. popular destinations are still Arizona – cheap real estate, sunny days, endless golf – and Florida. Canadians are the number one purchasers of real estate in some Florida communities.
Here are some spots where your retirement dollars will go far:
- Costa Rica – affordable health care; politically stable; well established ex-pat communities.
- Mexico – Canadians love Mexico so much they’ve taken over entire towns. Favorites include Puerto Vallarta and Cabo San Lucas.
- Panama – retirees easily qualify for residence status; top quality health care is affordable; and, bonus, everyone speaks English.
- Ecuador – affordable cost of living. According to Forbes magazine, a couple could easily get by on as little as $1,200 a month.
- Portugal – ex-pat communities where retirees can golf, roam the castles, or relax on the beach.
Giving up Canadian Residency
When moving permanently to another country, you must sever your ties with Canada in order to avoid being deemed a resident of Canada for tax purposes. The most important factor is whether or not you maintain residential ties with Canada.
Among other things, you must:
- Sell your principal residence.
- Take all valuable personal possessions out of Canada.
- Terminate Canadian bank accounts, investment accounts, credit cards and safe deposit boxes.
- Give up your provincial driver’s license and health care card.
- File a Canadian exit return and pay departure taxes. This includes deemed disposition of certain assets.
- Plan to not return to Canada for at least two years after leaving.
- Establish residential ties in the new country.
Government benefits
CPP/QPP benefits will continue to be paid without any residency requirements. People who are eligible to receive OAS benefits will continue to receive payments.
Depending on the tax treaty in effect, withholding tax may apply to these payments, as well as any employer pension or annuity payments. The normal rate is 25%.
Buying property
Check local property laws. Not all countries allow expatriates to buy property, and some impose restrictions. Inheritance taxes might apply to real estate in a foreign country. Consult with a local real estate lawyer rather than relying on the assurances of real estate agents.
Related: 16 habits that helped me retire wealthy
It may make more sense to rent than to own.
Some things to consider
When choosing a location, here are some factors to consider:
- Safety and political stability of the country and the overall culture.
- Being able to speak the local language may be important in dealing with local people.
- Is there a comprehensive health care plan and access to medical services that provide coverage after a certain waiting period? Are private health care facilities available, and at what cost? What about pre-existing medical conditions?
- Some countries are more tax friendly than others. Does the country have a tax treaty with Canada?
- Citizenship regulations. Some countries require immigrants to take out citizenship in order to live full-time and/or own property. While many people are prepared to give up Canadian residency status, few want to relinquish their Canadian citizenship
Final thoughts
Leaving Canada permanently in retirement is a major decision not to be undertaken lightly. Whatever your reasons, detailed research and planning is required. You need to know the implications on your personal taxes, and your assets and investments.
You would do well to consult with an experienced advisor who specializes in permanent moves, not only to become familiar with the requirements, but also to develop investment, tax planning and estate strategies.