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Financial Post / Rechtshaffen: Hang on a minute: Inflation is actually good for some people

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Don’t fear inflation if you have low or no debt, higher assets and are receiving some form of indexed income

There are few words in the financial world scarier than inflation.

Many remember the early 1980s and mortgages of 20-plus per cent, but if you are a student of history, or even lived in certain countries during periods of hyperinflation, you might recall these unbelievable cases: in Venezuela, consumer prices grew at 65,000 per cent from 2017 to 2018; in Zimbabwe, the daily inflation rate was 98 per cent from March 2007 to mid-November 2008; in Hungary, the daily inflation rate was 207 per cent between August 1945 and July 1946. Now that is an inflation problem.

In North America, our inflation rates have never really topped 20 per cent annually. I am not suggesting 20 per cent is nothing to be afraid of, but for many of you, inflation may actually be your friend.

One of the fundamental components when we do a financial plan for clients is a fair estimate of annual spending. If the client doesn’t have any debt, then this annual spending number is the only part of the plan that is negatively affected by higher inflation. For example, if someone spends $100,000 a year and inflation is 10 per cent, then the same level of spending would be $110,000. They now have an extra $10,000 of costs to worry about.

Now let’s look at parts of the plan that will be helped by higher inflation.

Let’s say this same client, a couple both aged 70, does not have a defined-benefit pension to fall back on, but they receive full Canada Pension Plan (CPP) and partial Old Age Security (OAS) benefits that total $50,000 a year. This income is fully indexed to inflation and, based on the 10-per-cent inflation rate, it will now go up to $55,000 a year. This couple would have $5,000 of that extra $10,000 covered by index increases in their government pensions.

Next, the couple has $2 million in investment assets and likes to keep $150,000 in high-interest savings accounts and money market funds. These were earning one per cent in a low inflation environment, but in a 10-per-cent inflation world, they are now perhaps paying six per cent. The extra five percentage points on $150,000 is $7,500, which puts them in a positive cash flow position.

Next, they have another $1.85 million of investments. In a high inflationary world, you want to invest differently than in a low inflationary one. It isn’t as easy to mathematically show a net benefit or negative in this part of the portfolio, but there are some ways that we would manage investments differently (we are doing so to some extent now) that can add net dollars.

Let’s start with bonds. For most clients, we have already been holding significantly lower weights in bonds than usual. The reason was that yields on bonds were so low, and there was a heightened risk that rising interest rates would hurt bond returns. This has been the case.

However, there will be a time when holding bonds goes back to traditional weights or even higher. If inflation is 10 per cent, yields on bonds will be much closer to 10 per cent than they are today. Simply owning bonds and collecting the coupon payments will generate much higher income. In addition, at 10-per-cent inflation, the odds of interest rates going back down to more normal levels from there would be much greater, and this would also add to bond returns.

We aren’t there yet, and may not get there, but the point is that when inflation and interest rates reach a high enough level, bonds once again become a good investment option for almost all clients and that hasn’t been the case for a few years.

As a quick example, the Fidelity Canadian Bond Fund in its first five years from 1988 to 1993 returned an annualized 8.7 per cent. The same fund is negative over the past five years, with a five-year annualized return of -0.31 per cent. If $200,000 was invested in this fund during higher inflationary times than we’ve had during the past five years, the difference at the end of five years is more than $106,000, or over $21,000 on an annual basis. That would certainly have a big impact on the extra $10,000 in costs that high inflation brought to bear.

In terms of other investments, you traditionally want to be more in value than growth stocks during high inflation periods. The main reason is that growth investments rely on a high value of their future potential. If interest rates are high, a dollar in five years will be worth much less than if interest rates were low. As a result, many growth stocks (good and bad ones) are getting hit hard this year.

Value stocks generally include sectors such as utilities, consumer staples, some real estate and commodities. These hard assets have traditionally been less reliant on high future growth, and more reliant on quarter-to-quarter profits and stable-to-growing dividend payments. As a firm that leans towards value investing, we certainly don’t mind a little inflation.As a quick aside on value vs. growth, a 2016 study by BofA Securities Inc. found that the average annual price return of value stocks since 1926 was 17 per cent versus 12.8 per cent for growth stocks. It found that value outperformed growth in roughly three out of every five years during this period. Since 2016, there is no question that growth has meaningfully outperformed value, but that has turned in the past year. We believe, based on this history, there might be a long period of value outperformance ahead.Getting back to real estate, this is one hard asset that people sometimes say will benefit from inflation, while others say it will decline due to higher interest rates. Both are right, which means you need to be careful in terms of how you invest. For example, a real estate investment trust with a larger ratio of debt would be in for a rougher ride than one with lower debt.

One private REIT we currently invest in is Rise Properties Trust, which is focused on residential rental properties in suburban Seattle and Portland. Its rental income is tied much more to inflation than Canadian residential properties, because of the relative lack of rent control in those markets and a culture that moves more frequently, thereby allowing average rental income to be more closely tied to current (inflationary) rates.

Of course, many people do suffer from rising inflation. If you have high debt and low assets, as many younger people do, rising inflation is a real risk and concern. However, don’t fear inflation if you have low or no debt, higher assets and are receiving some form of indexed income (including CPP and OAS). It is actually your friend.

Reproduced from Financial Post, June 14, 2022 .

Ted Rechtshaffen
Provided By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

Tips for helping your kids buy a house

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TriDelta President Ted Rechtshaffen joins House Money on BNN with advice for parents possibly looking to help their kids buy a home.

Ted Rechtshaffen
Posted By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

If you’re retired, is now the time to sell your house?

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ted_bnn_15sep16cTriDelta President Ted Rechtshaffen appeared on BNN TV as a guest speaker to discuss retirement income from selling a house in Toronto.

Ted Rechtshaffen
Posted By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

Our housing market – is this the top?

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The explosive growth of the Canadian housing market in the last decade may finally be coming to an end.

Interestingly there is good logic on both sides of the debate and it is anyone’s guess where markets go in the short term:

The reasons for it to continue growing:

  • Foreign buyers remain very active despite a slowdown in Vancouver due to the new 15% BC foreign buyers tax. This has however likely boosted Toronto sales.
  • Three decades of low interest rates.
  • Job growth in the major centres outpaces the national average, particularly Toronto and Vancouver, which collectively accounted for all of Canada’s increases in 2016
  • Demographics reflect that there are more people aged 25 to 40 in these two cities and they have grown faster relative to other age groups. This segment is also in their prime home buying and child producing years, further stimulating home sales.
  • The number of single detached homes built in Toronto in 2015 was the lowest since 1979 according to a BMO report. This imbalance in supply and demand is a big reason prices for single-family houses are experiencing double-digit price jumps. In May 2016 the average detached home price jumped 18.9%, while condos only saw a 5.9% increase.
  • Housing market speculators flipping properties are very much part of this process although hard data on this activity is sparse.
  • A continued weak Canadian dollar is stimulative to the housing market. Since 2011, the Loonie has lost 27% of its value against the greenback, while Canadian homes appreciated by 26%.
  • If houses were priced in U.S. dollars, a very different perspective emerges. Canadian home prices aren’t appreciating, but show a decline of about 9% against the average benchmark price. The same trend is evident when pricing Canadian homes in Chinese yuan. This is worrisome because Canadians are actually being devalued on a global scale.

Among reasons for the long boom to end:

  • Steven Poloz, head of the Bank of Canada says the Canadian housing boom is unsustainable for a number of reasons including overall household financial stresses and climbing debt.
  • The anticipated interest rate trend, changing from the past three decade decline to a rising rate environment, appears to have already started in the U.S.
  • Continued weakness in the price of oil as is anticipated by many given slow global growth and excess oil supply.
  • Asset prices inevitably revert to their historical mean, which is overdue in Canadian housing prices.
  • Buyers believing the real estate market is different this time.  Canada’s housing market dropped about 15% in 1957 over six years and a whopping 25% in the early ‘90’s so maybe this market needs to digest some of the recent gains, which are more than double our long-term averages.

The correction may already have begun. Consider that the Teranet-National Bank index of house prices in Canada’s 11 largest metropolitan regions rose 6.1% in November, yet only four cities—Toronto, Hamilton, Vancouver and Victoria actually posted gains. Values in the other seven cities contracted, suggesting that a correction is well underway.

Here are two recent articles that provide more food for thought on our real estate market:

The first article from Maclean’s suggests that population growth isn’t driving Toronto house prices as many have claimed.

The second article from MoneySense magazine, takes a broader approach and provides the Canadian Real Estate Associations (CREA) perspective.

Anton Tucker
Compiled by:
Anton Tucker, CFP, FMA, CIM, FCSI
Executive VP and Portfolio Manager
anton@tridelta.ca
(905) 330-7448

What you need to know about the new mortgage rules

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mortgage

On October 3rd , the federal government announced new mortgage requirements, which are designed to dampen the housing price euphoria.

Getting a mortgage approved at a great rate or maximizing the value of your real estate could both be impacted by these changes.  At TriDelta, we are able to help you or your children with getting the best mortgage, and also help those with their planning around whether to buy, hold or sell real estate.  Feel free to ask us for help in either of these areas.

These new requirements follow four rounds of changes made previously to tighten eligibility rules.  For new insurable loans between 2008 and 2012, the changes included:

  • the minimum down payment was increased to five per cent from zero
  • the maximum amortization period was reduced in stages to 25 years from 40 years and the maximum insurable house price was limited to below $1 million.
  • Buyers with a down payment of at least 5% of the purchase price, but less than 20% must be backed by mortgage insurance. This protects the lender in the event that the home buyer defaults. These loans are known as “high loan-to-value” or “high ratio” mortgages.

New rules include:

Applying a Mortgage Rate Stress Test to All Insured Mortgages.

Effective October 17, 2016, a stress test used for approving high-ratio mortgages will be applied to all new insured mortgages. This includes those where the buyer has more than 20 per cent for a down payment. This new stress test is designed to build in some wiggle room so new buyers can manage an interest rate rise. The home buyer would need to qualify for a loan at both their contract mortgage rate (currently +-2.5%) and the Bank of Canada’s conventional five-year fixed posted rate, which is currently 4.64%.

The stress test also requires that the home buyer spends no more than 39% (previously 32%) of income on home-carrying costs like mortgage payments, heat and taxes. The buyers also have to ensure their Total Debt Service (TDS) ratio, which includes all other debt payments does not exceed 44% (previously 40%). This shows the government easing up on previous limits as they allow home owners to allocate more of their income for housing and debt payments.

This new provision ensuring home owners have an ability-to-repay will put pressure on self-employed borrowers who will have to make sure they can document at least two years’ worth of sufficient income to get a mortgage.

Down payment requirements have also been boosted:

Under the changes Canadians can still put down five per cent on the first $500,000 of a home purchase, at least 10 per cent down on the portion of a home that costs more than $500,000 and for homes that cost more than $1 million will still require a 20 per cent down payment.

For those purchasing with less than 20% down, the affordability table below illustrates the impact of the new mortgage rules, indicating  the maximum house price before and after the October 17th changes.

Changes to Low-Ratio Mortgage Insurance Eligibility Requirements  –  Effective November 30, 2016, mortgage loans that lenders insure using portfolio insurance and other discretionary low loan-to-value mortgage insurance must meet the eligibility criteria that previously only applied to high-ratio insured mortgages.

Impact of Changes: Based on year-to-date 2016 data, it is estimated that a little over one third of insured mortgages, mainly for first time home buyers, would have difficulty meeting the required debt service ratios and home buyers would need to consider buying a lower priced property or increase the size of their down payment. Additionally, approximately 50% to 55% of new insurance requests, would no longer be eligible for mortgage insurance under the new Low Ratio mortgage insurance requirements.

This will affect all home buyers who are seeking a mortgage that may stretch them too thin if interest rates were to rise.The government is responding to concerns that sharp rises in house prices in cities like Toronto and Vancouver could increase the risk of defaults in the future should mortgage rates rise.

An additional change that may come as a surprise to many, is the new reporting rule for the primary residence capital gains exemption. As you know, any financial gain from selling your primary residence is tax-free and does not have to be reported as income. As of this tax year, the capital gains tax is still waived, however the sale of the primary residence must be reported at tax time to the Canada Revenue Agency. Everyone who sells their primary residence will have a new obligation to report the sale to the CRA. The change is aimed at preventing foreign buyers who buy and sell homes from claiming a primary residence tax exemption for which they are not entitled. However this will catch many off guard.

These new rules will definitely have an impact on new and upgrading homebuyers, but also come into effect at a time when many who are thinking of retiring, may not be able to sell their homes as quickly or for as much as they originally hoped to fund their retirement plans.

To review how these changes may impact your home purchase or retirement plans, please contact us for a no obligation review of your situation.

Lorne Zeiler
Written By:
Heather Holjevac
Senior Wealth Advisor
heather@tridelta.ca
416-527-2553

Record debt levels only bad if you’re using the money wrong

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ted_bnn_15sep16cTriDelta President Ted Rechtshaffen appeared on BNN TV as a guest speaker to discuss the implications of Canadian household debt levels at new highs.

Ted Rechtshaffen
Posted By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221
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