Where Capital Waits Between Properties

An investor's money is rarely doing the thing the investor describes. It is between things. The building sold in April and the next one has not come to market, the insurance settlement has arrived and the roof cannot be started until spring, the partner has been bought out and the replacement deal is six months away. In all of those months the capital is somewhere, and where it waits is a decision most investors make by default and not on purpose.

This page compares the places it can wait. It compares them by what each one does and not by which one wins, because they do not compete. A savings account and a participating whole life contract are not two answers to the same question. They are answers to two different questions that happen to be asked by the same person in the same year.

What are the places capital can actually wait?

There are five, and an investor who names them all has already done most of the thinking. A savings or high interest account. A short term deposit or guaranteed investment certificate. An undrawn credit facility, which holds no money but holds the right to money. A market portfolio. And the accumulated value inside a participating whole life contract, reachable by policy loan.

Notice what that list does not contain. It does not contain the equity in the buildings themselves, because equity in a building is not capital waiting. It is capital working, and getting at it requires either a sale or a lender's agreement. An investor who counts equity as a reserve has counted the same dollar twice, once as a property and once as a cushion, and will discover the error at the moment the cushion is needed.

How fast can each one be turned into money?

Speed is the first attribute, and it separates the list immediately. An account is same day. A short term deposit is same day if it is cashable and is otherwise locked until it matures, which is a distinction people forget they agreed to. A credit facility is days, assuming the lender has not changed its mind. A market portfolio settles in a couple of business days, though selling into a bad week is a different cost entirely. A policy loan is days, on a written request, with no application.

The useful question is not which is fastest. It is which is fastest on the worst day. On an ordinary Tuesday all five are fine. On the Tuesday when values are down, when a lender has just reviewed its exposure to residential rental, and when the portfolio is worth less than it was in January, the list sorts itself differently. The account is still there. The contract is still there. The other three have all become conditional on something outside your control.

What does each one cost while it waits?

Cost while waiting is the attribute investors underweight, because nothing feels like it is happening. An account costs the difference between its rate and inflation, which in most years is a slow negative and in a bad year is a fast one. A short term deposit costs slightly less, in exchange for the lock. An undrawn facility costs nothing, which is genuinely remarkable and the strongest single argument for keeping one. A market portfolio costs nothing and may gain or lose, which is the point of it.

A participating contract costs the premium, and the premium is not a fee. Part of it buys insurance that pays whether or not the next building ever gets bought, and part of it builds the accumulated value the policy loan is measured against. But the cost of putting the contract in force lands early, which is why a contract in its third year holds less than has been paid into it, and why an investor comparing year three balances to a savings account concludes that the contract is a poor account. It is a poor account. It was never an account.

What happens to each one when you use it?

Using an account reduces the account. Using a deposit ends it, sometimes with a penalty. Using a facility creates a debt with a floating rate, secured by a property, that the lender may reprice at renewal.

A policy loan is the one that behaves differently, and the difference is worth stating precisely and not dramatically. The insurer advances money and takes the contract's value as security. The accumulated value is not withdrawn and continues to participate, which is the mechanical fact that most of the enthusiasm on this subject is built on. Interest accrues on the advance at the rate the contract sets, from the day it is advanced, and it accrues whether the building performs or not. If the loan is never repaid, the outstanding balance and its accrued interest reduce the death benefit paid to the beneficiary. Nothing about that is free, and a page that describes it as free should be closed.

Which one survives a lender changing its mind?

Two of them. The account survives because it is your money in your name. The contract survives because the loan provision is written into the contract at issue, and the insurer is obliged to honour it while the contract is in force and holds value.

The credit facility is the one that does not survive, and landlords who lived through 2008 or through the rental policy tightening that followed do not need this explained. A facility is a promise from an institution, subject to review, and it is reviewed most attentively when the institution is nervous. A promise reviewed at the moment you need it is not a reserve. It is a hope with paperwork.

This is the single attribute that gives a participating contract its place in an investor's arrangement, and it is not about rate. It has never been about rate. It is about who can say no.

How much does each one hold?

Here the contract comes off worst, and an honest comparison says so first.

A landlord with real equity across three buildings can arrange a facility that dwarfs anything a contract funded for five years will hold. A market portfolio built over fifteen years will likewise be larger. The accumulated value of a participating contract grows at a pace set by the premium and by the contract's design, and no amount of enthusiasm accelerates it.

What that means on the ground is a sequencing decision and not a choice. In the first decade the contract is the smallest reserve on the list and should be treated as the smallest. Somewhere in the second decade it becomes material, and its distinguishing attribute, which is that nobody can withdraw it, starts to matter more than its size. Investors who expect this in year three are disappointed. Investors who expect it in year fifteen are usually satisfied.

Where does the reserve for vacancies and repairs belong?

Not in the contract, and this is the misapplication that does the most damage. A vacancy reserve is money you expect to use, on short notice, several times per decade. It belongs in an account. A furnace fails in February and the tenant is entitled to heat, and the answer to that is a debit card, not a written request to an insurer.

The contract is for the money underneath the reserve. It is for the layer that exists so the reserve never has to be rebuilt from scratch after a bad year, and for the capital that sits between a sale and a purchase with no date attached to it. Two layers, two jobs. The mistake is not using a contract. The mistake is using one layer for both jobs and then being surprised that it serves neither well.

Does the waiting place change with the size of the portfolio?

It changes completely, and the investor who keeps the arrangement that suited two buildings while operating nine has usually not noticed.

With one or two properties the reserve question is simple. A few months of carrying costs in an account covers almost everything that can go wrong, because almost everything that can go wrong is one furnace, one vacancy or one insurance deductible at a time. The probability of two bad events landing in the same quarter is low enough to ignore.

With six or nine properties the arithmetic inverts. Events that are rare per building become routine per portfolio, and the reserve that covered one furnace now has to cover the month when a furnace, a roof and two vacancies arrive together, which they eventually do. At that size the reserve stops being a buffer and starts being an operating account, drawn and rebuilt continually, and the investor needs a second layer underneath it that is not touched by ordinary operations. That second layer is where the durable options belong, and it is the point in a portfolio's life at which a participating contract starts to make sense to people who correctly dismissed it earlier.

Scale changes the lender relationship too. A lender looking at a landlord with two properties is looking at an individual. A lender looking at a landlord with nine is looking at a business, applies different underwriting, and reviews the file more often. The facility that felt permanent at two buildings is visibly conditional at nine, and the value of a reserve that no institution reviews rises accordingly.

What does a sale do to this arrangement?

A sale is the moment the whole question becomes concrete, and it is also the moment most investors improvise.

Proceeds arrive in a single deposit. They are immediately the largest balance the investor has ever held in an account, and they attract three competing claims at once: the tax owing on the disposition, the deposit on whatever comes next, and the temptation to treat the whole figure as available. The tax is the part that surprises people, because the capital gain and any recaptured depreciation are calculated on a building bought years ago at a price nobody remembers fondly, and the bill does not arrive for months.

The sensible sequence is to separate the money by date before deciding where it waits. The tax portion has a known due date and belongs in an account or a deposit that matures before it. The portion earmarked for a specific purchase under negotiation has a probable date and belongs somewhere same day. What is left over is the only portion with no date on it, and it is the only portion for which a contract is even a candidate.

Investors who fund a contract with the whole proceeds of a sale and then face the tax bill have made the classic version of this mistake. The contract did not cause the problem. Funding it before the obligations were separated out did, and the correction is a sequence and not a product.

What about holding it in the corporation?

Many Canadian investors hold their buildings in a corporation, and the question of where capital waits then becomes a question of which entity holds it. That changes the answer in ways this page will not resolve, because the resolution belongs to your accountant and depends on facts a website cannot see.

What can be said plainly: a corporation holding a participating contract uses dollars taxed at the corporate rate and not personal after tax dollars, and on death the amount of the death benefit exceeding the contract's adjusted cost basis is credited to the capital dividend account under section 148 of the Income Tax Act. Against that, accumulated value appears on the balance sheet where a lender and a purchaser will both see it, and passive assets can affect whether shares qualify for the lifetime capital gains exemption on a sale. None of that is tax advice, and none of it should be settled by an insurance professional working alone.

What a partner or a spouse needs to know about the waiting place

Capital that waits somewhere only one person understands is a problem waiting for a bad week.

The account is self explanatory and the statement arrives monthly. The credit facility is visible on a credit report and in the mortgage file. A market portfolio produces its own statements. The participating contract is the one that goes unexplained, partly because it arrives as a thick document nobody reads twice, and partly because the person who arranged it enjoys being the one who understands it.

Three things should be written down somewhere a co owner, a spouse or an executor can find them. Which insurer issued the contract and the policy number. Who owns it, which is not always the same person as the insured and is the fact that causes the most confusion later. And whether there is an outstanding policy loan, because an advance that everyone has forgotten about quietly reduces what the beneficiary receives, and the discovery happens at the worst possible moment.

None of that is exotic estate planning. It is the same hour of work that goes into leaving the mortgage details where somebody can find them, and it is skipped for the same reason: the arrangement is working, so the paperwork feels optional. It stops being optional the day the person who arranged it is unavailable to explain it.

A partnership adds one more item. If two partners fund a contract as part of a buy sell arrangement, the ownership structure and the funding obligation belong in the partnership agreement rather than in a shared understanding, and the lawyer who drafts the agreement should see the contract rather than a description of it.

What this page will not tell you

It will not tell you what proportion to hold in each place. That number depends on how many buildings you own, how leveraged they are, how stable the tenancies are, whether your income comes from the portfolio or from a job, and how you sleep. A website that produces a percentage has produced it from nothing.

It will also not tell you that the contract is where capital ought to wait. It is the most durable place, and durability is one attribute among six. For an investor whose buildings already carry themselves and whose horizon runs past the next decade, durability is often the attribute in shortest supply. For an investor still assembling the portfolio, it is not, and the honest advice is to keep assembling.

Who this comparison helps, and who it does not

It helps an investor who already holds a cash reserve, who already has or could arrange a facility, and who is asking where the layer underneath those two should sit. It helps an investor who has been told a contract replaces a line of credit and wants to know why that claim is wrong. It helps an investor planning a sequence of purchases over fifteen years rather than three.

It does not help an investor who needs every available dollar for the next acquisition, because funding a contract removes dollars from that. It does not help an investor carrying expensive consumer debt, because that is settled first and the arithmetic is not close. And it does not help an investor whose question is really about return, because a participating contract compared on growth alone against a portfolio of buildings compares badly, and should.

The next question most investors ask is whether the accumulated value can actually fund a purchase, which is a separate matter with a separate answer: see a policy loan for the next down payment. The comparison against a secured facility is set out in policy loan or HELOC for a landlord, and the limits of the whole idea are collected in what a policy loan cannot do for an investor. The arrangement as a whole is described on the real estate investors page.