We are currently in the midst of the greatest generational wealth transfer in the history of the world. Economists and financial observers estimate that the Baby Boomer generation has a collective net worth of US$30 trillion – more than any previous generation. And much of that money will be transferred to children and grandchildren. Economists are calling this shift of financial assets the “great wealth transfer.” And it will likely impact people younger people who are now entering the workforce, getting married and settling down.
Many Baby Boomers may look for creative ways to transfer their wealth to their children and grandchildren. They may consider factors such as return on investment, interest rates and time horizons when figuring out the best way to enrich their heirs. And one of the best investments continues to be real estate.
Few assets build equity and appreciate as well as real estate – particularly in the Greater Toronto Area (GTA). Even in slow times, house prices in the GTA continue to appreciate by more than 3 per cent a year, according to the Toronto Real Estate Board. A 2018 report by one of the largest brokerages in Canada (RE/MAX) found that Toronto-area home prices increased 119% between 2007 and 2017. The average price of a home in the GTA in 2007 was $376,236. Today, the average home price in the GTA is $822,681, according to the report.
Add to this more stringent requirements for securing a mortgage from a bank, and, for many people, getting money from their parents or grandparents for a downpayment on a house is the best chance they have for entering today’s residential real estate market. New federal guidelines require all federally regulated financial institutions, including Canada’s big six banks, to vet borrowers’ applications using a minimum qualifying rate equal to the greater of the Bank of Canada’s five-year benchmark rate (currently 5.34%) or their contractual rate, plus two additional percentage points.
“Young people today are finding it extremely difficult to become homeowners,” says Jim Burtnick, Senior Vice President of Sales at Sotheby’s Realty in Toronto:
Not only are prices out of reach for many young adults, but the stress tests today are more difficult than ever before. Help from parents can go a long way.
But while helping your kids get into the real estate market with a financial gift is a wonderful gesture, withdrawing money from the bank of mom and dad is not without risks. There are many things to consider before placing a bet on your children and the housing market. Here are five important tips for purchasing real estate through the bank of mom and dad.
1. Make a long-term investment
For any real estate transaction to yield a solid financial return, it needs to be a long-term investment. It is therefore important that your children not place the money you give them on a short-term residence. Buying a property and then selling it in two or three years is not a smart move. Make sure that if you give your children money to buy a house or condominium that they plan to live there for a minimum of five to 10 years. That will be sufficient time for equity to build up as they pay down a mortgage, and for the value of the property to appreciate substantially.
2. Consider the location
It is a cliché, but location continues to be one of the most important factors when purchasing real estate. In many cases, it remains the most important factor. Not only does the location of a property dictate how much it will appreciate, but it can also determine how long it will take to sell in the event that your children decide to move. As a rule, properties in Toronto proper, or within the 416 area code, tend to sell easier and quicker than real estate in the 905 suburban regions. Give consideration to the location of a house or condo that your children are considering buying and that you may be helping to pay for, and, if needed, steer them towards a more established and desirable neighbourhood.
3. Buy a condo in an established building
If your children or grandchildren are considering purchasing a condo, it is best to choose one that is located in an established building rather than buying a condo “on spec” that has yet to be built. Condos in established buildings already have a track record and have settled many of the issues that tend to arise with brand new condos, such as repairs and finishes that often need to be completed with the builder; creating a condo board; setting condo fees and so on.
These headaches are often out of the way in condo buildings that have been around for three to five years. Also, purchasing a condo that’s a few years old means you can be sure it has been built and is move-in ready. With condos that have not been built yet, you run the risk of the builder going belly-up before the building is completed. This unfortunate situation continues to happen more often than it should.
4. Treat the financial gift as a business transaction
Many parents worry about the complications that can arise when family and business become entangled. Parents may also worry about what could happen if they help a child purchase a property with their spouse and they later divorce. One way to alleviate such concerns is to treat any financial gift given for the purchase of a house or condo as a business transaction between yourself and your child. For example, you could give money for a house down payment as a loan rather than a gift. You could make arrangements for that loan to be paid back within a certain time frame and with interest.
You could also jointly purchase a property with your child and their spouse, placing your name on the mortgage documents as well. Or, you and your child could purchase a house together as a rental property – with your child living in the house while renting out part of it and sharing the rental income with you. There are many ways to structure a house purchase as a business transaction, and some favourable tax implications for doing so. Eligible home buyers in Canada may receive a tax credit of up to $750, and may also qualify for a rebate for some of the taxes paid on a home purchase.
5. Take out a second mortgage
In the right situation, it might be advisable to use a second mortgage to secure the money to give a child or grandchild for a house down payment. A second mortgage is when you borrow against the equity in your house to fund other projects or expenditures. The advantage of a second mortgage is that you would be on the title and have control over the property purchased by your child.
Home equity loans also tend to have more favourable interest rates and more flexible repayment plans that loans taken out on credit cards or with unsecured lines of credits. Keep in mind that there are costs associated with second mortgages, including appraisal fees, costs to run a credit check and origination fees. Taken together, these fees can cost as much as $1,000 or more. However, you can negotiate with a bank and may be able to have some, or all, of these fees waived.
Samuel Chinniah, Senior Vice President of Family Office Services, at T.E. Wealth in Toronto says:
A second mortgage is a simple and easy way to give money to a child while retaining some oversight of the transaction.
Using your wealth to help your children and grandchildren is one of the best things you can do. And real estate remains one of the very best investments. Giving your heirs a down payment to purchase a house, condo or property can be a solid financial decision. But be sure to give consideration to the risks involved and think of the best way to structure such a wealth transfer.