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.

The argument for either side of the equation usually heats up over the topic of investment return. While some argue that investing can yield a higher after tax return based on historical figures, others posit that those historical figures are likely not going to be accurate going forward and that finding a ‘guaranteed’ rate of return in the current environment as high as your mortgage rate is improbable.

While both can make good arguments, I am not going to approach the mathematical side of this subject with this article.

The truth of the matter is that everyone’s situation is different and everyone has their own personal views on risk and debt. Truth be told, I firmly believe that we can’t reasonably compare an investment portfolio with one’s personal residence. Therefore, I view this argument as much more emotional than mathematical. It is for that reason that I want to bring to light some of the emotional trigger points that evoke the polar responses often associated with the pay down debt vs. investing debates.

Let’s start with a few basic questions that may help you decide whether it is better for you to invest or to pay down your mortgage.

1.) How many years are remaining on the current amortization of your mortgage?

If you have fewer than 10 years remaining on your mortgage amortization and your rate is fixed until maturity, you may be better off taking the guaranteed return associated with retiring your mortgage early. The reasoning behind this is that, while investments in the stock market may yield a higher return on average, ten years is a relatively short period of time to invest in the stock market. This is especially  true when we consider the necessity to achieve after-tax returns greater than your mortgage interest rate.

2.) Do you have the financial discipline to invest 100% of the amount of your mortgage payment once it is paid off?

If you choose to pay off your mortgage prior to retirement, you will have some catching up to do with respect to your investing goals for retirement. While there is peace of mind involved in being ‘mortgage free’, diverting that former mortgage payment to an investing/savings account is the perfect way to beef up your retirement portfolio.  the opponents to the pay off the mortgage early plan often cite the tempation for the new found cashflow to lure you in to a lifestyle that you won’t be able to afford once your working days are through.

3.) How confident are you in your investing abilities?

While I like to think that by investing in dividend growth stocks and dividend paying ETFs, I don’t always make the perfect investment. Yes, I even lose money sometimes

According to the statistics, most of us do not have the ability to consistently out perform the stock market indexes. What’s more, none of us have the ability to move the market which puts us at a further disadvantage. So, I must agree with Five Cent Nickel on one benefit of paying off the mortgage early:

Another advantage of paying off your mortgage early is that doing so protects you from yourself. While paying the minimum on your mortgage and investing the difference might sound like a great idea, there are no guarantees that you’ll actually follow through on the second part of the equation.

4.) What is your current state of job security and liquidity?

This is where we have to take a long, hard look at our personal situations and assess those things that could derail even our best laid plans. If you are confident in your job security and are comfortable with lower liquidity as you aggressively reduce your mortgage, then mortgage reduction may be the decision that is best for you. However, if job security is a question or if you are the sole breadwinner in the household, you may be more inclined to carry a higher level of liquidity (ie. larger emergency fund).

So, what am I doing?

I took a similar approach to this question that The Financial Highway suggests. Look at both the mathematical and emotional aspects of the equation and answer honestly to the above four questions.

Well, I am somewhat confident in my investing abilities, but the emotional side of me would like to eliminate my mortgage. However, the real benefit for me in eliminating the mortgage is in the increased cashflow provided from the complete elimination of the debt.

You see, my mortgage rate is variable and currently at 2.25% 2.50%, so the idea of paying extra payments instead of investing has little merit in reducing the overall interest paid on my mortgage.

Comparatively, saving/investing until I can eliminate the debt entirely will have the effect of keeping my funds liquid as a hedge against job loss or another financial tragedy until such time as I can mitigate the risk of job loss etc. by removing the entire mortgage payment from my liabilities.

What are your thoughts on the invest vs. pay down mortgage debate?

Resources:

Mortgage Pay Down vs. Investing Calculator

The following are three high-level economic data points that we can use, along with our other tools, to further assist us determining our views on equity market investments.

1.) U.S. Housing

As the root of the credit crisis, healing in the U.S. housing market is a precondition for sustainable recovery. Recent data has confirmed that the worst is behind us and the residential real estate market is stabilizing.

The inventory of unsold houses while still high is heading in the right direction towards clearing and sales of existing homes have recently turned positive on a year-over-year basis. And an index which measures year-over-year price changes of houses in 20 major U.S. cities (the S&P/Case-Shiller Home Price Index) plunged 33.6% from its June 2006 peak to the April 2009 trough, but has now climbed 1.9% over the past two months.

2.) The U.S. Consumer

The resurgence of the U.S. consumer will be key to watch as recovery unfolds since consumption is 70% of the American economy. Despite the ‘hit’ that the housing crisis has exacted on their net worth, American household balance sheets are still in relatively better shape than they’ve been in the past due to the tremendous growth net worth over the last decade.

However, the process of deleveraging (winding down debt) has begun and this will impact spending patterns in the near-term.

3.) The U.S. Manufacturing

The level of manufacturing has historically followed an inverse path to the Fed funds rate but on a 6-month lagged basis – as the fed funds rate drops, six months later, manufacturing activity picks up.

However, in fall 2008, although rates declined to historically low rates, the credit crunch intensified and that typical relationship between low interest rates and increased manufacturing activity did not materialize. More recently, credit channels have opened up and the ISM (gauge of manufacturing activity) has improved, indicating the economy is finally responding to massive stimulus after a long lag.

And further improvement just yesterday with the latest ISM level better than expected at 52.9 – the first reading above 50 since January 2008 and hit the highest level since June 2007. This is further indication that while not yet normal, the economic environment is normalizing.

These are three key areas of the market to watch when assessing the high-level economic situation and it’s relationship to the stock market trends and valuations.

Of course this isn’t the be all and end all of data you should include in your due diligence, but it certainly plays a role as you calculate your risk tolerance moving forward.

Whether we like to think about it or not, we cannot escape the reality that we will never be completely free from the day to day management of our finances. The increasing stack of bills piling up in the mailbox and the all-too-automatic withdrawals from the checking account are a relentless reminder of our consumption.

There are people, like me, that are intensely concerned about their finances. I am certain there are others who are more concerned and more diligent with there finances than I am; this article is not for them.

What motivates you to manage your finances?

Of course we could sit here and debate the semantics of motivation and personal finance. However, for this exercise, we will let Wikipedia define those terms for us:

Motivation:

“The reason or reasons for engaging in a particular behavior, especially human behavior as studied in psychology and neuropsychology. These reasons may include basic needs such as food or a desired object, hobbies, goal, state of being, or ideal. The motivation for a behavior may also be attributed to less-apparent reasons such as altruism or morality.”

Personal Finance:

“The application of the principles of finance to the monetary decisions of an individual or family unit. It addresses the ways in which individuals or families obtain, budget, save and spend monetary resources over time, taking into account various financial risks and future life events.

Components of personal finance might include checking and savings accounts, credit cards and consumer loans, investments in the stock market, retirement plans, social security benefits, insurance policies, and income tax management.”

There, now that the definitions are out of the way we can get down to business!

What Motivates You?

Many people have been turned on to managing their personal finances more diligently because of a financial meltdown of sorts. It seems to be a common theme among financial writers and I think it is one that carries the most weight with the average reader.

Lets face it…we all want to make more money. It’s not a bad thing and it’s not evil. Wanting to excel is a basic human function. The need for constant improvement is what separates us from animals and the reason for our progression as a species.

My motivation comes from the fear of being poor. I grew up poor; not as poor as some…but poor.

Just to give you an idea (without too much detail):

• I did live in a trailer park
• My family did receive the charity hamper of food at Christmas for several years.

My family’s financial situation was hampered by the bankruptcy of the family business caused by my father’s health. In case you need further clarification about bankruptcy – it’s horrible. My parents are still recovering from that devastating financial blow and I vowed that it would never happen to me.

Even though I swore I wouldn’t be in debt up to my ears, I ended up with over $40,000 in student loan debt. I managed to pay that off and, within 3 years, my net worth has reach over $250,000.

How did I do it?

I Started To Learn About Money

I learned from the mistakes of my parents and began to research (formally and informally) the ways that the wealthy made money. I also learned about the importance of education and building the power to earn money.

Your ability to generate an income is the most important asset that you have. This is why Life Insurance and Long-Term Disability insurance are critical components of your financial plan in your younger years.

I also studied how mortgages work and the ways that financial leverage can accelerate your wealth exponentially. The concept of leverage is instrumental in learning how to carefully and methodically speed up the wealth accumulation process.

The ability to earn an income is the greatest asset that you have.

Think about that.

This is exactly why I am a huge fan of dividend paying stocks and income producing real estate. These assets generate cash flow. Increasing cash flow is the basic building block for generating wealth.

Cash Flow is the ticket to play the game.

Personal finance is a game. A very serious game, but a game nonetheless. As long as you have enough cash flow coming in to pay the bills, you can continue playing the game. Evaluate the cash flow that you generate and be sure to begin with a solid budget that does not exceed the cash flow.

Plug The Holes, Then Turn on the Hose!

I also started to learn about budgeting. Many of the people that I have talked to about growing wealth continue to harp on the fact that a budget is a budget, no matter the size. What they mean is that before you go looking to earn more money, you need to learn to master what you have.

This lack of control and poor foundation of the concept of financial planning is the reason why many lottery winners go broke within just a few years. Regardless of the amount of money you earn, if you have no idea how to manage it, you will end up in the same position.

It is essential to learn basic finance and budgeting skills. Don’t fall into the “I need to earn more money trap” before you learn to manage what you have.

• Work first to decrease your expenses; then look for additional sources of income.

Remember, it’s not how much you earn, it’s how much you keep!

Make keeping more of your money automatic. Learn how to save more money every month by reading this previous article of mine:

http://dividendmoney.com/automatic-savings-is-essential

Golden Rule of Finance

This leads us back to the golden rule of finance which is:

Spend Less than you Earn!

*Note: Another dividend investor has also pointed out that in addition to spending less than we earn,  we must simultaneously find ways to both increase our income and decrease our expenses.

I’d love to hear your motivation for mastering your personal financial situation! Feel free to contact me with your story or drop a note in the comments.

I’ve recently had a discussion with my 9-month pregnant wife about the idea of moving. Now, I should have known better than to approach that subject when my wife is in her “nesting” mode – needless to say she was not happy.

The reason that I brought up the subject is that we can literally choose to live wherever we like. There is nothing holding us back from moving anywhere that the respective laws allow. I began thinking about this subject as I have watched home values in my city double over the last two years.

My Thoughts

We have made a couple of really savvy real estate deals that have made us more money over the past two years than our respective salaries. This, along with minimizing our expenses has put us in a comfortable position with no consumer debt and an increasing net worth.

Because our only debt is our mortgage, I have been toying with the idea of selling our house and moving to a less expensive location whereby we can purchase a similar home and be completely debt free.

In my mind this makes a lot of sense, here’s why:

• We would not be enslaved at jobs that we may not enjoy because we need to make a mortgage payment.
• We could plow a lot of money into other investments at the age of 29, with a long time horizon to watch it compound.
• We could spend money on travel and experiences that produce life-long memories, which is more valuable to me than “stuff”.
• We could choose to take extended “vacations” from our jobs to spend with our new child and extended family.

Rationale

• We both have Master’s degrees and are highly employable in any location. Even in a remote location, we could easily make ends meet by telecommuting or freelancing.
• Our city is freakin’ cold in the winter – what is the advantage to that?
• We would be further from extended family, but with the added freedom of not having a mortgage, visiting would be less taxing on the pocketbook.
  (To be honest, we see our extended family only slightly more than when we previously lived much further away)
• Real Estate values are bound to cool at least slightly as evidenced by the “trendy” markets in the United States and Canada. I’m not calling a top to the housing market in my city, but I’m not greedy either – freedom is very tempting.

Making a move to a slightly smaller city less than three hours rive from our current location, with good job prospects for the both of us could set us completely debt free under 30 years of age.  Most importantly, it would do so while living the same lifestyle that we are accustomed to. This is something that I find very tempting. (The winter would be just as cold though)

Of course it was seriously bad timing on my part to bring this up due to the pending birth of our first child. However, it has been eating at me ever since we did our annual budget in January and I realized the possibility.

Complete freedom from debt is a huge goal of mine; but is this the right way to achieve it?

I’d love to hear your stories or thoughts on this matter. Feel free to share in the comments!