Monday, June 13th, 2011
If you or your loved ones are approaching retirement and have been investigating different housing options, chances are that you have come across the term Life Lease.
What are Life Leases?
In basic terms, a life lease is a form of prepaid rental housing. The owner of a life lease purchases the right to occupy a unit and use the common facilities for as long as the lease remains in place. The length of the lease term could be for life or for a fixed number of years. Depending on the contract structure and jurisdiction, as we will learn later in the article, a life lease is a legal agreement that usually lies somewhere between renting and owning a residential premises.
Depending on the legislative environment, the occupant of a life lease unit may be referred to as the purchaser, lessee or tenant. The developer or owner of the life lease units may be referred to as the sponsor, lessor or landlord. A life lease is not equivalent to the ownership of a condominium or strata unit even if the life lease project has been registered with a condominium or strata plan.
Typically, life lease projects are targeted at those over 55 and may also be targeted at specific ethnic or religious groups.
A life lease may, depending on the terms of the lease (see below) be sold, either to a third party or to the lessor. Construction of new life lease projects may be undertaken by for-profit or not-for-profit entities. Where a for-profit entity develops a life lease project, ownership of the project is generally transferred to a not-for profit entity after completion.
Few jurisdictions have legislation covering life lease projects. In most jurisdictions, the life lease is simply a contractual arrangement between the lessor (generally a not for profit entity) and the lessee.
Advantages of Life Leases
- Most commonly provides accommodation for seniors in a community of seniors. Amenities are generally geared to this target market.
- May allow lessees to obtain “ownership” of a property at below market levels. This can occur because land may be donated or sold to the sponsor at below market rates or the sponsor may not earn the usual developer’s profit on the project. New construction may not always provide this opportunity as sponsors are often inexperienced and profits given up by a not for profit developer may be partially or wholly offset by increased consultant costs.
- Can allow individuals on fixed incomes to tailor level of rents to their incomes.
- Generally not subject to the will of a condominium or strata council.
- Life leases may avoid land transfer tax in some jurisdictions where this applies.
- Redemptions by, or sales back to, the lessor (which may have a waiting list) may reduce market risk.
Disadvantages of Life Leases
- Units may not be freely marketable (e.g. lease may require units to be sold back to the lessor at predetermined prices).
- Lease transfer restrictions (such as a requirement for new lessees to be “approved”) may depress resale prices.
- Title is held by the lessor and registration of a lease on title may or may not be possible (in jurisdictions with land transfer tax, lease registration generally triggers tax payment).
- New construction is generally not covered by the usual new home warranty program. As such, deposits are often used to fund development costs and are uninsured (i.e. the lessee risks losing the deposit if the development is unsuccessful).
- Lessee does not have input into operations through a condominium or strata council.
- Lessee generally does not have registered title to his/her unit.
- It may be difficult to obtain residential mortgage financing of a life lease unit.
- Lessor may not have liquid assets to fund redemptions.
- Lessees who wish to vacate may need to find their own substitute tenant.
The Life Lease Ownership Process
- Applicable terms and conditions of life leases vary widely but the general features are similar. Life leases should not be confused with ownership of a dwelling unit on leased land.
- The lessee of a life lease unit pays a sum of money to the lessor. The amount of money paid may be the full cost of the unit leased or it may be a lesser amount. If the lessee pays the full cost of the unit, then (subject to the terms of the lease), the lessee will generally only pay a monthly maintenance fee (roughly equivalent to condominium or strata fees). If the amount paid by the lessee is less than the full cost of the unit, the lessee will also pay a prorated rent (e.g. if the cost of a unit is $200,000 and the lessee pays $100,000 up front, his/her rental payment will be approximately equivalent to a payment on a $100,000 mortgage plus the monthly maintenance fee)
- Most not for profit lessors of new life lease projects expect full payment in order to cover construction costs.
- The lessee does not generally obtain title to the unit. Some leases do not permit the registration of the lease but, where this is permitted, registration of the lease generally triggers the payment of land transfer tax.
Types of Life Leases
- Zero balance lease/life estate: the purchaser pays in advance for the right to occupy a unit for the duration of his/her lifetime. No redemption value exists (i.e. the lessee or the lessee’s estate cannot sell the leasehold interest).
- Declining balance redemption value: the redemption value of the unit is fixed and reduces on a pro-rata basis over a fixed term until a redemption value of Zero Dollars is reached. Generally, if the lessee moves or dies while there is a redemption value, the unit is returned to the lessor and the lessee (or estate) has a claim for the redemption value.
- Fixed value: the redemption value is constant for the life of the lease.
- Indexed redemption value: the redemption value is based on an initial fixed value with periodic indexing to an inflation-sensitive index.
- Future value: probably the most common type of life lease. The lease may be sold at market value with the lessor usually taking an administration fee to facilitate transfer of the unit. The tenant may bear the market risk if the value of the life lease unit has fallen.
Who Develops Life Lease Properties?
- Life lease project sponsors are often religious or charitable foundations. While these may have been successful in raising the initial funds for the project, they may have limited development experience and they may lack the ability to fund cost overruns.
- A full review of the history, resources and capacity of the developer should be undertaken by the buyer.
- Life lease projects are often targeted at the constituencies of the charitable or religious foundation developers. It is essential, therefore, to ensure that the life lease agreements are non-discriminatory.
As we can see, the concept of the life lease is very complex. Because each development may have a different set of lease parameters, and many jurisdictions have no legislation governing the parameters of life lease developments, it is essential to get an informed legal opinion on the specific development to type of life lease contract that you are considering.
Posted in Real Estate | No Comments »
Monday, February 22nd, 2010
When we apply for a mortgage we should always have some idea as to how much we can afford to borrow, and our capacity to repay the mortgage. Knowing how much we can afford is vitally important because nobody would like to lose their house or investment property to foreclosure. When we ask ourselves the question of ‘how much can I borrow for a mortgage’ it will be highly dependant on two major factors:
1.) The interest rate charged on the mortgage
2.) The amortization, or length, of the mortgage.
When it comes to lenders or banks deciding upon the amount and rate of the mortgage loan, they will certainly look into the financial background of the borrower.
Lenders are typically looking to satisfy themselves of the Three C’s of credit – Including the capacity to repay the loan, along with the credit history and the character of the individual. These factors can be determined initially by looking at the credit score, and secondly by calculating several ratios before the determination of how much credit they can grant to the borrower.
The Real Cost of A Mortgage
When one decides to buy a house, there are several payments that must be paid on time in addition to the actual mortgage payment. These other payments should always be included when we ask ourselves the question ‘How much can I borrow for a mortgage’?
Such additional payments consist of home owners insurance, property tax and home owners association fees. When these are all added to the mortgage payment, they comprise a more realistic cost of home ownership. In addition, add this to your other anticipated monthly expenses and this is one of the ways to estimate how much you can really afford when you apply for a mortgage.
Private Mortgage Insurance – PMI
This might be another expense that could alter how much mortgage we can afford. Private mortgage insurance, also known as PMI; is an additional cost that must be added if you are not able to afford 20% of the homes price paid as a down payment. In such a case, you will need to purchase private mortgage insurance in order to protect the bank’s investment in your high ratio mortgage.
Front-End Ratio
The front and ratio is the comparison between the monthly mortgage cost-which includes insurance, real estate taxes, private monthly insurance with your total monthly income. Generally mortgage costs are given to make up between 26% to 29% of your monthly income, in this case your monthly maximum repayment amount would be $840. This is another analysis you can use in answering the How much I can borrow for a mortgage question.
Back-end Ratio
When your total income is compared with your total debt payments, this is called back end ratio. This, more comprehensive, ratio includes credit card debt and college loans, and any other debt you have. It can make a total of up to 33 to 40% of your income.
For example, if your bank sets 35% as the limit, and you have a monthly income of $3000. In this case your total debt paid in a month would be $1,050. If you pay $400 as a monthly student loan, you would then have a maximum of $650 left from your income which can be used to repay the mortgage loan.
Credit Score
If you have a good credit score, the banks may increase the limit of the above ratio calculations because your history of repayment cements the bank’s faith in your credibility. Once the ration is determined, all the aforementioned characteristics and calculations help both the borrower and lender in deciding how much credit is really affordable for the borrow.
As you can see, answering the question ‘How much can I borrow for a mortgage’ is not as easy as we might think. There are many variables that lenders take into consideration and we must fully understand those variables in order to determine how much mortgage we can really afford. It’s just not as easy as some online mortgage calculators would have you believe!
For more information on Mortgages, check out my Mortgage Survival Guide For the First Time Homebuyer!
Posted in Investor Education | 2 Comments »
Friday, September 5th, 2008
How about doing both at the same time
Many financial writers will claim that everyone needs to build and emergency fund of some kind that is kept in a liquid vehicle such as a high interest savings account ( I prefer ING DIRECT ) a money-market fund, or some other readily accessible investment like a cashable certificate of deposit.
While I am a fan of financial leverage and will swear up and down for as long as I live that leverage is the ONLY way to build exponential wealth, I still believe in making extra payments on my mortgage versus having excessive funds in a savings account.
First off, I do have a savings account but it is hardly at the level of 6-12 months of living expenses. In fact, it consists of about 3 months of living expenses and possibly less from time to time. What I do have is a mortgage with an attached revolving interest-only line of credit.
The reason that I make extra payments on my mortgage (after funding all of my tax advantaged investment accounts) is that I reduce the amount of interest that I pay on the principal of the mortgage amount. My mortgage interest rate is currently at 4.25%, while my savings account interest rate is just over 3.0%.
Therefore, because all payments made against my mortgage simply increase the amount available to me through the line of credit, it is financially smarter to pay down the mortgage and borrow the money back for investing (When and if I find an appropriate investment) rather than pay the 4.25% interest on the mortgage and collect 3+% interest on my savings.
P.S – In Canada Interest paid on loans for investment purposes is tax deductible, while mortgage interest on a principal residence is not. Check with your personal tax advisor for an explanation of the advantages.
Psychology of Money
Of course there is the psychological factor of knowing you have cash in the bank in case of an emergency. However, there is also a psychological advantage to reducing your mortgage (or other debt – I only have mortgage debt left).
For most folks it is a good idea to have a “rainy day fund”. However, if you can mange credit wisely it may be in your best interest to set up an appropriate line of credit for emergencies. In addition, you will then also have the ability to pounce on investment opportunities that might come out of the blue.
Remember, strike a balance that is right for you and always due your due diligence!
Posted in Investment News, Investor Education | 1 Comment »
Thursday, August 21st, 2008
There’s really nothing like a poor economy and a tumbling stock market to send people’s financial plans into a tizzy! So, where can we look for guidance and assistance in these troubled financial times?
Some “experts” are now saying that this is the time to buckle down on spending with rising energy and food prices. Wow, I guess that “late breaking news” really caught us off guard – good thing there are financial experts out there to save us from this financial apocalypse.
Let’s see what the experts have to say:
The Canadian Government
Statistics Canada says gas and food prices are eating up a larger portion of our spending money, while CIBC reports household debt in Canada is rising faster than personal disposable income.
You don’t say? I guess nobody saw that one coming!
A “Smart” Canadian – The Usual Suspects
“It takes a rough patch in the economy like this for people to take a look and see where they can save money,” says Pat Foran, author of the Smart Canadian’s Guide to Building Wealth.
I’m pretty sure that this is what everyone should constantly be doing to build wealth. Always look for ways to cut spending and use that extra cash to increase your asset base.
- Foran recommends reviewing everything from your cable and cell phone bills to seeing where you can trim costs, going to the library instead of buying books, and renting movies instead of going to the theatre.
- Bringing your lunch to work a few times a week also saves money, as does cutting back on daily trips to the coffee shop for a java jolt.
- An economic slowdown is also a good excuse to cut expensive bad habits, such as smoking or overdrinking, Foran says.
- On big ticket items, he says consumers should consider used cars instead of new and putting off that vacation to Mexico when a trip closer to home might suffice.
For many families, Foran says budgets don’t work and instead recommends “forced savings,” which means setting aside a certain amount of money from each paycheque for investment.
Could Foran be any more vague? I guess we have to buy the book – good marketing strategy!
Go On A Money Diet
Patricia Lovett-Reid, author and senior vice-president at TD Waterhouse, recommends cutting back spending as if you were cutting back on calories for a diet.
Because we all know how easy it is to stick to a diet!
“There is some mindless spending going on,” she says.
“Look for ways to cut back so you don’t feel like you are on a budget.”
Hmmm…any ideas?
Another tip she has is to avoid shopping in bulk because the mass quantities that are purchased are sometimes not used and are discarded or wasted.
“If you look at what you throw out, you aren’t really further ahead … it might be better to purchase in smaller quantities.”
She also says that being an early adopter of technology is very expensive. I can concur with this as many folks purchase more computer than they need (you don’t need a $3000.00 computer to surf th enet and write e-mails) and don’t even know about half of the features of the new iPhone, for instance.
Review Your Debt
Many experts recommend refinancing your mortgage and consolidating high-interest debt through a line of credit where possible.
This makes sense if you have credit card or other high interest consumer debt.
“If you refinance and get a new mortgage you pay principle and interest on the entire amount from day one … . However, if the purpose of your refinance is to consolidate but not use all of the money at once, then set up a line of credit. You only pay interest on the amount you borrow at the time you use it,” says mortgage expert Peter Kinch.
However, he says be wary of how you used that line of credit.
“We want to make sure people don’t get into the habit of using their house as an ATM machine,” Kinch says.
Very thoughtful for a guy who just “sold” you a line of credit. Too bad this advice comes a little too late for some. For the sake of disclosure, I have a home equity line of credit that I use for investment opportunities.
What I Don’t Get
There are two major things that stick out to me in all of these expert articles and financial media mumbo jumbo.
Nobody suggests paying down debt. Everyone talks about consolidating debt and lowering interest rates, but nobody actually says (or writes) that you should pay that debt down. This is absolute craziness. In an economy like we are facing today, it should make absolute sense that people should be reducing their total debt. I recently outlined how reducing debt provides a guaranteed return on investment that is virtually unmatched.
What about the stock market? When the stock market is high all of the experts are telling us to buy stocks and that stocks are a great investment, but when the stock prices of those “great companies” are 20% lower, all of a sudden investing in the stock market is “risky” and not at all a good idea. This is absolutely counterintuitive to the basic investing tenet of buy low – sell high! In fact, one could argue that investing in the stock market now is less risky because prices are lower.
I am not claiming to be a financial expert, but the more I read the news media, the more disappointed I become. Basic financial advice changes from day to day and even the simple tenets of investing and finance are twisted or even discarded for the sake of selling a few magazines or newspapers.
At the risk of making it too simple, here are some ideas for building wealth:
- Live within your means
- Reduce personal debt
- Buy assets (Stocks, Bonds, Real Estate, Precious Metals)
Of course each of these points can be fleshed out and much more detail can be added to each point. However, I find that when the articles from the “experts” start getting in my head and causing doubt, I look back to these guiding principles for direction.
Do you ever get distracted by the media? If so, what are your strategies for dealing with the constant barrage of information?
Posted in Investment News | 4 Comments »
