Real Estate Investing - "I am so confused!"
Investing in real estate has become very popular over the past several decades and involves more than just finding the ‘family home’. Time has shown that investing in real estate can have a low correlation to the stock and bond markets, thus providing investors further diversification to their portfolios. Although the real estate market can provide many opportunities and increased returns, it can also be very confusing for the average Canadian.
There are many ways to participate in real estate, one such being, rental properties. In this scenario, a person will buy a property and then rent it out to a tenant. The objective here is for the landlord to charge enough rent to cover his or her costs of the property including mortgage costs, taxes, utilities and costs of maintaining the property. Sometimes landlords will charge a slight premium, over and above these costs, in order to make a monthly profit but in most cases, charge only enough to cover the aforementioned costs and then hope to make a profit off the increased value of the property at a later date. The potential downside to this sort of investment can manifest in the form of a bad tenant who does damage to the property and leaves the landlord with the bill. In addition, the rental market can be quite saturated on occasion and finding good tenants, or any tenants at all, can be quite difficult. Lastly, one of the greatest challenges to investments of this type can be the required effort to maintain the property and the associated costs. If the investor does not employ a property management company to oversee this aspect (which comes with a price), it can be quite laborious for the landlord.
Another option for investors is to be part of a ‘real estate investment group’ which is very much like a mutual fund for rental properties. Unlike directly buying property and being a landlord, this approach allows the investor to be part of a group that invests in a company that buys or builds a variety of rental properties like condos and then takes ownership of a single or multiple units in that property. The company manages all aspects of the property and is responsible for everything from the maintenance of the property to ensuring that the units are always leased out; for this the company takes a piece of the monthly rent. There are several versions of investment groups, but in the standard version, the lease is in the investor's name and all of the units pool a portion of the rent to guard against occasional vacancies, meaning that you will receive enough to pay the mortgage even if your unit is empty.
A popular way to participate in the real estate market, without having the hassle of directly owing a property, can be through a Real Estate Investment Trust or REIT. This investment product allows people to invest in a company that, in-turn’ purchases and operates income properties which could include apartment buildings, condos, student housing properties, corporate developments like strip plazas etc. REIT’s come in the form of public companies if they are traded on a major stock exchange or private companies that do not trade in a secondary market. Companies must pay out 90% of its taxable profits in the form of dividends in order to keep its status as a REIT. In doing this they are exempt from paying corporate income tax. For investors looking for diversification within a single investment and regular income, REITs can be a viable option.
There are many other variations of real estate investment opportunities such as investment funds (a pooled fund that primarily invests in one form of real estate such as farmland or student housing) or Mortgage Investment Corporations (MIC) that are companies that are specifically designed for mortgage lending primarily in the residential market. Investors in a MIC own shares in a company that manages a diversified portfolio of mortgages that are secured by the properties that the MIC is lending on. Much like a MIC, syndicated mortgages are another option for investors. Like a MIC, these investments are mortgages held by more than one person but unlike MIC’s, syndicated mortgages are investments in a single project like a condominium or office building.
Investing in real estate can be a confusing proposition for some people and therefore consulting with a financial advisor is paramount to determining what type of investment best suits an individual’s needs and objectives. Unlike stocks and bonds, one beneficial aspect that real estate investing provides is leverage. Even when you buy a stock on margin (which is not always allowed depending on what financial institution you deal with), the percentage amount you can borrow for real estate investing is much higher. A conventional mortgage can require as little as 10% down, depending on your situation and if you are a first time buyer etc. This allows a person to invest with a fraction of what is typically required to buy a property and increase your equity as the property value increases.
Investing in real estate allows Canadians to buy into an asset class that is not tied to the ebbs and flows of the stock and bond markets and provides diversification and typically increased returns; but as the old saying goes....’caveat emptor’ (buyer beware) as it is recommended you work through a financial advisor like DIAM Capital Markets Inc and speak to a professional.