With the warm sun slowly creeping back into our lives, many investors will be dreaming about heading to the lakes for long weekends and equally long drinks.
Whether this year is when a client fulfils their dream of buying a cottage property or when they sell it or organise how it is to be passed down a generation, there are significant financial implications.
But it’s not all about the money. In fact, Bradley Eizenga, vice president and portfolio manager, BMO Nesbitt Burns, said the biggest mistake advisors make when dealing with a cottage is underestimating the emotional element.
Whether it’s laying down the hard reality about whether it’s a worthwhile investment for three weeks a year or dealing with the fallout between children over who gets the house, understanding people’s feelings is just as important as the technical tax discussion.
He told WP: “Don’t just make it about the money. If I could draw a line under that statement I would! When you get into the investment business, you think it’s all about the technical stuff, the money, the interest rates and taxes.
“But it’s been 40 years since I started working in finance and, I tell you, if I have an hour’s conversation with a client, 75% to 90% of the conversation will be about non-monetary, non-technical issues. It’s about how do we manage our family’s expectations? How do we set things so there is no conflict when somebody dies?
“Often advisors miss this because we get into our industry heads. But the money doesn’t matter unless we use to do all the things with our families that we really want to do.”
This emotion is heightened further, in Eizenga’s experience, when the estate transfer to the children fails to detail sufficiently who gets what. This can relate to the whole cottage or simply a painting that carries family importance.
He urged advisors not to downplay the attachment families feel when they have been going to the same cottage summer after summer for years and years.
He added: “You can equalise the playing field in terms of dollars and still create a conflict with your kids in terms of who gets the cottage because it’s been so central to the family.
“People massively underestimate with their estate the potential for their children to get into disagreements about things they think are obvious. They are just not. The more discussion [the client] has with their family about what to do with things the better. And if you can’t figure out what to do, then sell the cottage before you die and have it go through your estate.”
Speaking to other advisors is also a good way to cover all the family’s sensitivities. For example, if the tax professional, lawyer and investment expert all confer, they can make sure everything is aligned strategically.
While emotion should be at the forefront of an advisor’s mind when dealing with a client’s cottage, the front-end considerations often deal more with the cold, hard facts of whether the investment makes sense financially.
Eizenga said the cost of capital can involve some tough conversations because you are potentially pouring cold water on someone’s dream.
“So you look at it and go, okay, the cottage is going to cost you a million dollars on Lake Muskoka and you are basically going to spend three weeks a year there – that’s lost opportunity cost on that million dollars. Are you sure you want to spend three weeks a year at Lake Muskoka for the next however many years? Sometimes it makes more sense to just rent the property you want.
“That’s a tough conversation in some respects because you are basically trying to take somebody’s emotional experiences and translate it into dollars and cents – and it doesn’t always work well!”
The conversation will also include a reminder about the costs of maintaining two properties. Either the client gets their hands dirty or they pay someone else to do it for them. Eizenga added: “The second one is generally more expensive!”
And for people who think that buying a cottage is a short-cut to real estate riches, he urged caution.
“One of my clients, and their spouse, were educators and own a place in the Muskokas, the eastern part, for 30 years. When we went back and calculated the rate of return, we figured out that they had generated a return net of tax, not counting maintenance costs, of about 7% year. And that’s in a really well grown real estate market.
“Sometimes people get glazed over about hearing someone who has sold their cottage for a million bucks and they think, ‘I should participate in that’. But sometimes when you work it out it isn’t that attractive.”
Another danger is flip-flopping between which house is your principal residence, which has tax-free growth. The temptation is there if your cottage suddenly shoots up in value but many people forget that the capital gain up to that point on the other property is still in play.
Transferring a cottage that has gone up in value is another “tax event” and the gains have to be reported. Just adding children to the property can also trigger a capital gain proportionately.
Eizenga explained: “For example, you have two children, you add your kids to the property and then it’s often found to be that the CRA says you have disposed two-thirds of the property – that’s capital gain on two-thirds of it and the cost base for the future growth of the property is now split between you and your two kids.
“People do it to avoid probate fees on the estate when they die. Probate fees are 1.5% so we are going to go through a tax event in order to avoid a probate? These are things that can be done but it requires a conversation with an estate lawyer and tax advisor.”