Today’s post comes courtesy of a question from The Personal Finance Clinic held by the moneygardener, Canadian Capitalist and Triaging My Way To Financial Success.
“I am a recently retired 72 year old living on income from a commercial mortgage that has paid 6% for four years. It is up for renewal this September and I am wondering if I should agree to renew or ask for payout and find an investment advisor or broker to try to at least match this income. I am only moderately experienced with investing so would not try to do it myself. I assume the mortgage could be renewed for at least 6%.”
This is a situation I think many retirees find themselves in when searching for income from any investment and the answer to your question depends on a few important decisions. The two most important questions you want to ask yourself are “What amount of risk am I willing to take for the income I need?” and “What alternatives do I have to maintain my income?”
A commercial property that is worth $1,000,000 and pays out 6% through a lease or mortgage could provide you with a pre-tax income of $60,000 per year. If the property is paid off (you own it), you have little in the way of maintenance or management and the property is of very high quality than continuing with leasing the property for 6% could be very desirable for your lifestyle. If you’re lending the mortgage to an individual or company than determining the financial strength of the individual paying the mortgage is very important in this economic climate and I would consider looking at their operations very seriously.
The difficulty I’ll convey to you is choosing between a single investment (your current commercial property/mortgage) and a diversified mix of investments through a financial advisor. A diversified portfolio of income paying stocks, income trusts and bonds would reduce your non-systemic risk (the risk of any single investment) versus what you currently have for income. If you were to hold onto your real estate property as your single investment than your portfolio would be directly exposed to the real estate market; whether it went up, down or sideways or directly exposed to the person you’ve lent the mortgage to. Your potential for capital appreciation is limited to that single investment and the property may require maintenance to maintain it in the future reducing your net gains or the lender may fail to pay and be foreclosed upon bringing legal fees with it.
In contrast a diversified portfolio through an advisor may expose you to higher fees and achieving a balanced 6% may be more difficult depending on your asset allocation. In an environment where safe government bonds and GIC’s pay very little interest corporate bonds do pay in excess of 5-6% but you’re taking on more risk than you may want for your age. At a 70/30 split between bonds and equity you’re still very exposed to the stock market which while showing strength recently isn’t a sure bet for significant future gains or safe income payments via dividends.
The other dilemma you want to consider is the potential for the mortgage to be renewed at a significantly lower interest rate. If the mortgage was renewed at 4% how would that impact your current income and decision to invest in a diversified portfolio since you mentioned in your question that you are living on the income from this property?
This is a situation where I think you would benefit from sitting down on your own (or with family) and discussing the pros and cons to each option. I would still recommend you seek financial advice from a reputable professional, but keep in mind what fits best for you for your risk tolerance, time and peace of mind.