Investing in Real Estate - There's more than 1 way!

In today’s investment world, people often look for different ways to diversify their investment portfolio. Since the market crash in 2008 (which somehow seems a short time ago), a lot of investors have been unsure or scared to get (back) in to the markets, and have been looking at alternatives. Real Estate investing has become more and more popular, especially over the last 2 decades, but with the big spike in interest rates, slowing economy and high inflation, many are unsure whether it still makes sense.

What most people don’t know is that there are several different ways that they can get involved with, or invest in, Real Estate, and they can vary drastically. Each will differ in regards to the amount of capital required up front, the control you have, responsibilities, the costs and also the overall intended result.

With all the different options, it's easy for investors to get a little confused or even intimidated when considering where to allocate their money. To simplify, below are 4 of the main ways that people can get involved in Real Estate Investing in Canada, with some of their pros and cons:

1. Rental Properties

Rental Properties are one of the most common ways people use Real Estate in their investment portfolio. Using this strategy, someone would purchase a home, with the intention of keeping it for a period of time (can be short or long), while renting it out to a tenant. This creates an immediate stream of income, but also creates additional assets and debt to their name.

Generally, to purchase a rental property, the buyer would be required to put a minimum down payment of 20% of the property’s value (which, especially in big cities, can be $200,000 - $300,000+), and then would have the responsibility of qualifying for and paying the mortgage on the property (if borrowing is involved). Additional responsibilities include finding tenants, maintenance/repairs, paying property taxes, as well as covering any costs associated with having this investment. Costs usually are made up of: Real Estate Broker Commission, Closing/Legal Costs, Property Taxes, Home Insurance, and potentially any fees associated with hiring a Management Company.

Hiring a Management Company might serve well if a person does not want to have all the duties a Landlord would, as that in itself can be a massive headache, especially if there are multiple rental properties in the portfolio. However, this also comes at a cost and digs into the return on investment.

One of the things many investors don't actually consider is the taxes upon the sale. Currently as it stands, there would be a capital gain (if there was a gain), in which half of gain would be taxable. There are whispers of the tax code being changed so as to reduce 'speculative' buyers, and push investors to hold onto properties for longer - the new tax could be regressive, starting at 100% of gain being taxed within the first year, reducing to 50% (as it is now) after 5 years. This may definitely take a big chunk of the investor market out of the pool.

Pros:

• can have a regular income stream from the rented property
• potential property value increase over time
• as mortgage is paid you can refinance the property to take some money out (and reinvest if needed)

Cons:

• large lump sum required up front (for down payment)
• must qualify for a mortgage
• need to find a tenant
• multiple expenses outside of down payment (realtor fees, property taxes, renovations, home insurance, etc...)
• susceptible to rate increases
• often the rental income is not enough to offset all the expenses, and people have to pay some money out of pocket
• headaches of being a landlord
• tax on sale

2. Flipping Houses

Flipping houses is something not a lot of people get into, and is more common in the high demand areas around the country. It is also more common with those who have more experience as well as time to manage their projects. This is essentially where someone would buy a property, renovate it, and then sell it right away with no expectation of renting it out.

Most people who choose to do this strategy will do so with either ‘fixer uppers’, a foreclosure property, or a house that is selling well below market value in the area. This can be a great way to make profit, especially on properties that are far below market value (specifically foreclosure properties), but it does not come without its responsibilities.

When doing this type of strategy, there are several pieces of the puzzle that have to be dealt with, specifically in regards to costs/fees. Most of the costs incurred are up front, meaning you have to ‘spend money to make money’, which can be a challenge for some people. Generally the costs/fees would involve:

• Down payment on the property
• Real Estate Fees on Purchase
• Mortgage Interest during the time you have the property
• Renovation costs (i.e. parts & labour)
• Potential zoning costs
• Real Estate Fees on Sale
• Closing/Legal Costs
• Other (appraisal, home inspection, designers etc…)

Along with the costs, it also takes time to go through the entire process, from picking out the property, to starting the renovation, to completing the renovation, and finally selling the property. This can become quite a headache for some people as, often in the construction world, things don’t always finish on time and on budget. Overall, it would require more capital up front than just buying a rental property, as you need to account for all the other costs in regards to renovating and flipping a property.

Pros:

• purchase to renovation to sale can be done within short time frame (generally 4-6 months)
• no headaches of being a landlord
• relative fast return on money (4-6 months)
• can have a sale agreement in place prior to project start, to mitigate/eliminate risk of finding a buyer

Cons:

• large lump sum required up front for down payment
• large sum of funds required for development
• materials costs may fluctuate
• mother nature may delay construction
• heavy involvement in the project
• paying realtor fees twice (once on purchase, once on sale)
• likely to require short term financing (mortgage) and/or construction loan
• potential rezoning, permit costs etc...
• may not find a buyer right away
• tax on sale (capital gains)

3. Real Estate Development

Real Estate Development is probably one of the faster growing avenues that people use when getting involved in Real Estate investing. This strategy allows investors to take part in the development of Real Estate, whether it be a commercial building, a condo, a community etc... In this strategy, investors would invest their money into a Real Estate Development Company. The Company would have 1 or more different real estate projects that they are working on, ranging from commercial to residential, low-rise to high rise, single family homes to townhomes etc..., and raise capital through individual investors. The investors would choose which project they want to invest in, and would generally be ‘locked in’ to that investment for a specific term or until that project is completed. Most projects are between 4-6 years, so the investor would generally not have access to their funds for that amount of time. On their information and marketing material, they would have their projected returns, which can be anywhere from 15-25%/year, depending on the type of project, timeline, costs etc..

Many like this type of investment because of its 'hands off' nature -- most people don't like to be involved in their investment. There may, however, be restrictions on which investors can get into this type of strategy. Depending on the province or territory the investor lives in, there might be an ‘accredited investor’ restriction, which means an individual would have to have a minimum net worth or capital base before they can get involved. Some companies also have a certain minimum investment which could range from $50,000 to $150,000, depending on the project or amount of capital they need to raise.

This type of investing is generally one of the least ‘involving’ strategies, as essentially the investment would be given to the Development Company, and they would take care of everything in regards to the project. For someone who wants the least amount of headache and responsibility in regards to Real Estate Investing, this option can be very intriguing.

There are still some risks involved in this type of strategy, as not every single Real Estate Development project gets completed or finishes. Investors should definitely do their homework in regards to the type of project, the location, the demand in that area, as well as the company’s history and previous projects.

Pros:

• 'hands off approach'
• attractive potential returns
• don't need to worry about qualifying for a mortgage
• can often invest through TFSA/RRSP etc.. to defer or shelter gains from taxes
• don't need to worry about tenants, property taxes, maintenance etc...
• may require significantly less capital than rental property or flipping

Cons:

• funds locked in for several years
• risk of project not being completed or going over costs - can reduce returns or lose significant amount of your invested capital if project fails
• risk of project construction delaying

4. Real Estate Investment Trusts

The simplest and often ‘least capital requirement’ way to get into Real Estate is through Real Estate Investment Trusts (REITs). A REIT is essentially a collection of Real Estate Assets (a pool) that you can invest in all at once, often with a small amount of capital needed, as compared to the other options. A REIT is an income producing product that can be public (trading on the Stock Exchange) or private. It can be considered like a Mutual Fund, except instead of stocks and bonds, it's comprised of only Real Estate Properties. REITs offer a regular income stream, diversification, and potential for long term capital appreciation.

Whereas the previous 3 options will generally deal with 1 property at a time, REITs have multiple properties within one investment product. This can be a positive or a negative depending on the persons overall objectives, risk, intended outcome as well as Time Horizon, but generally investors will be attracted to this type of diversification. REITs can be considered more of a long term, gradual growth type of investment, which might not suit someone looking for short term gains.

Another thing to consider is that you aren’t actually investing in or owning the property when you invest in a REIT, rather, you’re just investing into the pool and getting share of the income produced through those properties. REITs use the pooled money from all the investors around the country to purchase, rent and sell properties. Income can be generated from rent, sales or mortgages on these properties. The returns can be attractive as well, depending on what type of REIT you purchase, and can range from 7-12%/year, over the long term.

Pros:

• 'hands off approach'
• minimal capital required (especially compared to the other options)
• can invest within TFSA/RRSP to defer or shelter from taxes
• pooled product, to reduce risk
• have a bunch of options, based on location, property type, commercial or residential etc...

Cons:

• income stream isn't guaranteed and can be inconsistent
• no ownership of any of the properties in the pool
• may be early redemption fees to get out within the first several years
• returns may not be as attractive as other options

?

When investing in anything, it is crucial to understand the details of what is being invested in, all the different options, as well as the pros and cons of each option. Real Estate is no different. Each option comes with different results, responsibilities, objectives, risks, and should be researched thoroughly before being pursued. The advice of a Financial Planner and Legal Professional should always be considered before making any investment, as there is no ‘one size fits all’ solution for everybody.

#RealEstate #Investing #RealEstateDevelopment #REIT