Many homeowners strive to pay down their mortgage as the first step to financial freedom but what if that was absolutely wrong? Forgot the warm & fuzzy feeling that freedom from mortgage debt promises and think logical paths to true financial freedom. Robinson Smith and Kyle Green sit down with Adam and Matt to discuss ways to unlock the potential in homeownership – the potential to grow your investment portfolio, invest efficiently from a tax perspective over time, and genuinely grow wealthy! Your home equity is the first step for so many aspiring investors and this discussion is guaranteed to inspire everyone from the first-time buyers to the seasoned investor. Listen Up!
Vancouver Real Estate News, Market Updates, Insider Tips, Stats, & Analysis
Kyle Green, Owner of the Green Mortgage Team
Robinson Smith, President of Smith Consulting Group Ltd
Tell us a bit about yourselves.
R: I live in Victoria but grew up in West Vancouver. I moved to Victoria to attend UVic, double majoring in Chinese Studies and Economics. I then spent some time in China, most recently as an investment banker in Beijing. I grew tired of a big city and pollution, so moved back to BC in 2006.
K: I’m a mortgage broker and have been in the business for 13 years. I focused on building a niche around working with real estate investors.
Tell us about the Smith Manoeuvre, created by your dad
R: My dad always said he got his best ideas in the shower. One day it came to him how to convert a mortgage from non-deductible to deductible. He didn’t think it was fair that Americans could write off their mortgages while Canadians could not. So he came up with a method to make your mortgage tax-deductible. All the big banks in Vancouver turned him down so he went to the head of the bank, Larry Bell. The banks started cooperating and eventually my dad shared his ideas with the public in his book in 2002. The strategy is still not as well known as I’d like it to be so I started writing a book. I sold my business a year and a half ago to work on this book and it will be coming out soon.
What is the difference between a mortgage broker who specializes vs a broker works on everything?
K: I always stress that it’s important to plan from your first property.Do you want one or two or do you want to buy 10 rental properties? You need to know how to build it right from the beginning. Utilizing that Smith Manoeuvre, I can help clients save money on taxes and plan for their future.
So what exactly is the Smith Manoeuvre?
R: Americans can deduct the interest on their mortgages, which gives them a huge advantage over Canadians. But Canadians have the capital gains exemption that Amerians don’t get. With the Smith Manoeuvre, we get the best of both worlds. We can deduct the interest on our mortgage and we still get the capital gains exemption.
The Smith Manoeuvre is a re-advanceable mortgage which is an agreement by your lender saying they will always agree to let you re-borrow the same initial amount. So we re-borrow to invest, with a reasonable expectation of generating income, so we can deduct that borrowing from our income, which then gives us a tax refund. We then can use that tax refund to make a mortgage prepayment. We can then borrow that prepayment amount back and re-invest that.
So every month we are re-borrowing with the expectation of generating income, so we can therefore deduct interest, and the subsequent tax refunds allow us to pre-pay the mortgage. The mortgage is paid off a lot quicker as we’re pre-paying.
Usually, Canadians have to decide between paying off their mortgage and saving for retirement. We focus on the mortgage payments because that’s what’s owed, at the expense of saving for retirement. So we see senior citizens signing up for reverse mortgages, which are great if you need them. But ideally, we don’t want to be in a position where we need a reverse mortgage.
With the Smith Manoeuvre, you improve cash flow, take advantage of compound growth by investing now, and pay off your mortgage faster.
What are the restrictions with the Smith Manoeuvre?
R: There’s not a lot of restrictions. All there needs to be is a reasonable expectation for generating income. You can invest in stocks, bonds, mutual funds, investment real estate, your business, someone else’s business, etc. There are a few things, like gold bars, that you can’t invest in as they don’t generate income. This is you saving for your family’s future, so you shouldn’t go too crazy. It should be something solid that is going to grow and be there when you need it.
Even funds that don’t typically send out dividends, but have the ability to, can work with this manoeuvre.
Do you see pushback from people about the Smith Manoeuvre?
R: A lot of people feel that your home is not an investment, it’s where you live. And I get that; it’s not for everyone.
Another pushback is that we’re holding our debt constant. The older generations have this fear of debt. But we know there’s good and bad debt. Good debt is tax deductible. But there’s this belief that borrowing to buy material items (like a car) that will depreciate and that aren’t tax deductible is okay – but borrowing to invest, which is deductible, isn’t okay. So there’s a re-education that’s needed. The younger people understand that. They believe they’ll be in debt the rest of their lives so it might as well be good debt.
I never want to be mortgage free and I think a lot of Canadians should feel that way too. But if you’re someone who will just sleep better if you are mortgage-free, then that’s okay. But if we don’t start saving for our future, we’re going to be in trouble. There is a way to improve your financial condition and it doesn’t cost you anything extra each month.
Thoughts on real estate as an investment
K: There are three ways to make money with real estate: cash flow, mortgage paydown, and appreciation (and forced appreciation). Most people focus on cash flow and appreciation.
Let’s say you buy a million dollar condo and put 20% down. If the value goes up 10%, your return is actually 50% because you made $100,000 on your $200,000 investment. I usually model with an annual appreciation of 3% (but it’s been closer to 6% in recent years), so right there you’re getting a 15% return on investment.
Mortgage paydown is one area I really want to focus on. You can get a 7.5-9% per year return on investment if your tenant is covering your mortgage payments, regardless of appreciation. That’s a solid return that you don’t always get in the stock market. It’s a stable investment but it is less liquid than stocks. So you need to maintain liquidity as you build your real estate portfolio.
How does the interest rate environment impact this strategy?
R: We’re paying down a mortgage and a line of credit with the Smith Manoeuvre. Generally, we think a low interest rate is better but with the Smith Manoeuvre, it’s actually the reverse. The rate of interest on your line of credit is tax-deductible.
When this method was developed by my dad in the 80s, interest rates were in the double digits. And the manoeuvre worked then. The higher your interest rate, the higher your tax deduction. So this strategy works with low rates, like we have now, and high interest rates too. Even with low return rates, this method works.
The key is you have to maintain discipline and not freak out when rates change or the market changes.
How does this affect your credit rating and ability to borrow?
K: The credit bureau looks at your available limit and the balance you’re borrowing on that limit. So it won’t hurt your credit unless you’re borrowing the maximum. But even if you are borrowing at your max limit, the impact of that hit is very minimal if the rest of your credit rating is good. It’s important to look at the full picture and think about what you’re trying to do. If you’re going to be investing, you have to have that money available.
R: With the Smith Manoeuvre, there are still ways to protect your credit and access what you need when you need it. It comes down to being reasonable, responsible and knowing what you want. It’s about education and finding the limit between not over-extending and not being too conservative.
K: I ask my clients if they’re using their line of credit to invest or for material goods. Answering that question can determine whether or not you should take out a line of credit. If you’re going to use it for the wrong, non tax-deductible reasons, then just get a normal mortgage.
Robinson, what investments are you excited about and which ones lend themselves to the Smith Manoeuvre?
R: With a regular investment, you can have $700-1200 extra per month in your pocket to invest. It might not be enough for real estate investments but there’s still a lot you can do. And if you want to get into real estate, it doesn’t take long to save up, sell off the stocks you invested in, etc.
Personally, I’m getting into alternative lending. But it all depends on who you are, what risks you want to take, when you need to pull from your investments, etc. Another thing I’m very excited about is trees. You can buy acreage in trees and share in the profits when the trees mature. It also offsets your carbon footprint so it’s feel-good investing. The trees are a ten year hold and returns are looking pretty good.
Kyle, what are the opportunities you’re interested in and working in?
K: A lot of people still want their money in real estate but they are shifting into debt. There’s less risk of lending on current market values these days. So if someone doesn’t qualify with their bank, they can turn to alternative private lending, at a 6-9% interest rate for a first mortgage and 9-12% for a second.
The difference with private lending is a private lender will assume you will default while a bank does everything they can to ensure you don’t default on your mortgage. The sweet spot with most private lenders is 65% of the property value or less. It provides a solution for buyers who don’t have options and investors looking for opportunities.
Here’s a recent example: an investor lent to a buyer at 12% interest. But he borrowed that money from his line of credit, that only charged him 4% interest. So he was making money without spending any.
Can you be more conservative in private lending?
K: Yes, you can do a one-off deal where you lend to just an individual. Or you can lend into a MIC – mortgage investment corporation – where you’re a shareholder with funds spread over a group of properties. There’s lower risk and policies in place for the type of lending your MIC will do. You can also specify the type of client, type of home and your risk tolerance when looking at deals.
What advice do you have for millennials and what advice should they ignore?
K: It’s important to not buy a depreciating asset too early. It’s almost always a car loan that someone gets saddled with; they can’t save because they’re stuck with this debt. Save up your money, buy the appreciating asset (stocks, real estate, trees) first and then by the time you’re 40, you can go out and buy the Porsche. Don’t get stuck with depreciating assets.
R: I agree with Kyle 100%. My advice would be to start putting something away each and every month. Start now! Put money away now and you’ll be thankful that you did.
What is some bad advice in the world of investing that you hear all of the time?
R: As a former advisor, I was told if you are not someone’s advisor, you are not allowed to advise. I’m weary of the question around bad advice because if I hear a tip on investing that makes me cringe, it might mean it’s not for me but it is for someone else. Those are individual decisions.
What new belief/behaviour/habit has changed your life in the last 5 years?
K: I’ve started to take fitness a bit more seriously. I’m only 30 but my metabolism has really slowed. But the fitness mindset has been really important. It’s changed my life and is something I now invest in. We hear about people prioritizing wealth in their younger years and health when they’re older but health is important now. Why not do both?
R: I now operate from a place where helping others without expecting anything in return does come back to you. It’s not a competition – it’s a rising tide. Competition is just stressful. So I try to operate with the goal of helping wherever I can.
Favourite Neighbourhood: K: Cambie Village, R: Yaletown
Favourite Bar or Restaurant: K: Home cooking, R: Mahoney & Sons Modern Irish Pub
A book you would recommend: K: Rock Start Real Estate Investing by Kyle Green, R: Manage Your Mortgage for Financial Freedom by Robinson Smith or Trillion Dollar Coach by Bill Campbell
Something that you have purchased for under $500 that changed your life: K: Standing Desk at the office, R: Blender for a smoothie or a ping pong table