Stocks can make you rich. But, for savvy Canadian investors, investing in real estate could make you even richer.
The mix of steady cash flow, tax breaks, and capital appreciation can make real estate investing a solid aspect of your investment portfolio. It can be labor-intensive, sure, but with so many different ways to invest in real estate, you can surely find one that fits your lifestyle. If you’re up for the challenge, here’s what you need to know about real estate investing.
What is real estate investing?
Real estate investors buy, lease, rent, or sell pieces of real estate for profit. Unlike stock investors, who don’t make decisions for the companies in which they invest, real estate investors are typically more hands-on. They may literally pound nails in walls (as in house flipping), or they may be responsible for outsourcing the hard labor (as in property management). Real estate investors could also take a more passive approach and invest in REITs or real estate ETFs.
How can you invest in real estate in Canada?
The great thing about real estate investing — it has no shortage of options. Whether you want to buy property and manage it yourself, or take a hands-off approach and invest in a fund, you can surely find a method that fits your budget and your time schedule. Let’s look at the most common ways to invest in real estate and see which ones might be best for you.
1. Buy a house
Most Canadians are real estate investors without even realizing it. Yes, when you buy a home, not only are you buying four walls to live in, but you’re also putting your money in a long-term investment called equity.
Equity is the difference between what you owe on your mortgage and the value of your home. As you make more monthly mortgage payments, your equity — your investment — goes up. Likewise, as your home goes up in value, whether because you chose a desirable place to live or you renovated it, your equity increases (if your home’s value goes down, the opposite happens).
If your home is the place where you live for most of the year, you’ll label it your “principal residence,” which can help you get a tax exemption for capital gains if you sell the house later.
2. Flip a house
Thanks to HGTV, house flipping is probably the most popular real estate investing strategy out there. It’s also the most misunderstood and underestimated in terms of work.
To flip a house, you start by buying a home in dire need of a cosmetic lift. As you make renovations, the value of the home rises. Once you’ve restored the home to its former glory, you can sell it for a higher price than what you bought, pocketing the profits.
In theory, house flipping can seem like a lucrative idea. And, if you know what you’re doing, it often is. But that’s the trick — you must know which houses to buy, as not all derelict and broken-down homes will automatically result in profit. Home flippers typically target houses with cosmetic damages, which is much easier (and cheaper) to repair than structural damage. If you buy a home with more damage than you were expecting, you could end up losing a lot of money.
3. Rent out residential property
If house flipping sounds like too much work, you could rent out residential property instead. In fact, as more and more Canadians are renting for longer periods of time, becoming a landlord isn’t such a bad idea. As a property investor, you could rent out single-family homes, condos, apartments, duplexes, or even townhouses. Rent from your tenants will produce extra cash flow, and you could also benefit from long-term appreciation of your property.
Of course, you’ll want to buy rental property in a desirable area, preferably one near major employers, schools, and hospitals.
Keep in mind, you’ll be in charge of the maintenance and upkeep on the property. The mortgage rates on residential property are typically higher than those on your primary residence. So, before you take out a mortgage with just anyone, make sure you compare rates among different mortgage lenders.
4. Rent out commercial property
Commercial property is a little different than residential property. Instead of renting out places for people to live, you’re renting out space where people will work. Commercial property includes malls, shopping centers, industrial complexes, grocery stores, and offices.
Similar to residential renting, commercial property requires a large upfront investment—just more. You’ll typically need more than a few million (possibly even billions) to even sit at the table of commercial investors.
5. Buy vacation property
Both residential and commercial property are long-term strategies: as long as you implement leases, you’ll profit from tenants and businesses for a guaranteed amount. But if you want to rent out property without tenants and leases, vacation property might be better for you.
Vacation property isn’t exactly a hotel. It’s more or less a furnished house or apartment that can accommodate tourists. Your vacation property doesn’t even have to be separate from your principal dwelling. With the intersection of technology and hospitality making it easier for people to find accommodation (think: Airbnb), you could easily rent out a room in your home.
More ambitious real estate investors will want to buy vacation property near key Canadian destinations, such as Blue Mountain, Jasper National Park, Niagara Falls, or in big touristy cities, such as Quebec City, Vancouver, or Montreal. If you can handle the maintenance and cleaning of your property, you could potentially make a killing off tourism. Plus — when you want a vacation for yourself, you have a vacation spot you can go to. Who knows, it could end up becoming your retirement home.
Just be aware of the investment costs: you’re in charge of the maintenance, upkeep, and cleaning, not to mention the extra mortgage payments. And, if we ever experience another 2020, you’ll have to figure out how to balance potential losses with your other income.
6. Invest in REITs
Not everyone wants to pound nails or manage property. Thankfully, for real estate investors who prefer a more hands-off approach, you can always invest in a Real Estate Investment Truth (REIT).
A REIT is basically a real estate company that owns and manages numerous properties. As a REIT investor, you and several others pool your money and allow the company to use it for their real estate endeavors. In short, they do the dirty work. You provide the money and earn profits.
As with other investments, REITs have investing risks. The biggest is losing money when the value of your REIT drops due to either the underlying property becoming less valuable or rising interest rates digging into your REIT company’s profits.
But if you’re okay taking on these risks, REITs can be a great investment for your portfolio. For one, REITs pay dividends. That alone can come in handy, as the extra money from dividends can give you a steady stream of income to supplement your normal paychecks.
Secondly, REITs can diversify your portfolio. Depending on your REIT, you could invest in numerous properties across Canada, not just one region. That can give you a major hedge against total loss if the real estate market performs poorly in one area.
Finally, REITS give you an easy way to invest in real estate without requiring you to actually buy property. As with buying property, you still want to be strategic about which REIT you choose. You don’t want an REIT that’s invested in poorly performing areas. But if you make a solid choice, you can expose yourself to real estate in a passive way.
7. Buy land
As Mark Twain once said, “Buy land. They don’t make it anymore.” When you own vacant land, you can rent it out for agricultural or recreational purposes. You could also sell it if it becomes more valuable, or you could build on it.
8. Issue a private mortgage
Instead of buying property or investing money in a REIT, you could take another approach to real estate investing. You could become a private mortgage lender. As a private mortgage lender, you play the role of the bank. You lend money to homebuyers, charge an interest rate on what they borrow, then slowly take back in what you lent out.
Why would homebuyers come to you for money? Well, they may have no choice. They could have poor credit, or their income threshold or job status may disqualify them from getting a traditional mortgage. Either way a demand for private mortgages does exist. And if you have a lump sum growing by a meagre interest rate, lending it out as a private mortgage could help you earn more.
What are the advantages of real estate investing?
When done right, real estate investing can be one of the most profitable investments for Canadians. It can give you passive income, which can supplement or even replace other sources of income. Here are some ways real estate can be advantageous to you.
1. More cash flow
Your cash flow is what you pocket after you’ve factored out the costs of owning and operating your property, including mortgage payments. Usually, as you pay off your mortgage and increase your equity, your cash flow will grow stronger over time.
Real estate has a low correlation with stocks, meaning the price movements of the stock market don’t necessarily affect real estate values. Having real estate in your investment portfolio, then, can help you reduce losses during market crashes.
3. Protection against inflation
Unlike other assets, real estate offers a hedge against inflation. That’s because inflation is basically built into your property value: as inflation goes up, so do home prices and rent.
4. Tax breaks
Savvy real estate investors often use real estate costs to lower their overall tax bill. The government looks at your real estate ventures almost as a business. Property taxes, property depreciation, mortgage interest, even maintenance and repairs can be written off as business expenses, helping you cut your tax bill.
5. Community Impact
As a real estate investor, you have an opportunity to make a wider impact on an area. You could build affordable housing, or you could add a much needed grocery store in a food desert. You could pump new lift in a dying rural town, or you could add new business space to boost the local economy.
What are the risks of real estate investing?
As with any investment, real estate has several drawbacks you should be aware of. Here are some of the most common.
1. More money upfront
The biggest drawback to real estate investing is the amount of money you need to start. The average price of a home in Canada has gotten unbelievably high, and though you could flip houses in the suburbs — where the prices are typically lower — you’ll still need money for the down payment and funds to fix the house.
2. Less liquidity
Buying property isn’t like buying stocks: you can’t just cash out whenever you want. You have to list your property, market it, sell it, wait for the mortgage process to finish, and finally collect your money. If you need money fast, don’t expect to get it from your real estate investments.
3. Time-consuming (and costly)
Flipping homes and managing rental property requires time and dedication. That’s why, for many real estate investors, it’s more like a second (or primary) job. Though you could hire a property manager to take care of your properties, that’s one more extra cost you’d have to pay.
On top of that, maintenance and upkeep can get expensive. Between lawn service, seasonal maintenance, and necessary repairs, you’ll need to have extra cash lying around to cover all the costs.
4. Real estate market is unpredictable
Similar to the stock market, the real estate market isn’t easy to predict. Many real estate investors make a deadly assumption and believe if the market is hot today, it must be hot tomorrow. But that’s simply not true.
While real estate prices do tend to rise over time, the market could change drastically (just like at the ‘08 real estate catastrophe). Supply and demand, interest rates, and changing demographics all play a role in which way the market will swing. And, though you could buy property in a hot market today, nothing guarantees it will remain hot in the future.
5. High vacancy
For those who have rental property, another major risk is vacancy. In order to offset the costs of owning property, you have to bring in tenants. If you don’t, or if you have long periods of low vacancy, you run the risk of spending more than you’re making.
How does real estate investing affect your taxes in Canada?
First off, in Canada, you pay a capital gains tax when you sell property for a value higher than the amount you paid for it. The keyword there is “sell.” Only when you sell your property do you lock in your capital gains. If you don’t sell, you won’t pay taxes.
Contrary to what some people think, your full capital gains aren’t taxed at your marginal tax rate. Only half of the capital gains are subject to your marginal rate. So, if you flipped a house and made a profit of $100,000, only $50,000 would be subject to the capital gains tax.
Finally, keep in mind, capital gains apply to properties and houses that aren’t your principal dwelling. If you profit from the sale of your main home, you’ll qualify for a tax exemption.
How does real estate investing compare to stock investing?
Stocks and real estate aren’t worlds apart. In fact, they share several similarities. Both can provide you with cash flow, passive income, and investment gains in the form of increased share prices or higher property value. Taken together, they can help you hedge market risks, as stocks may still perform well during a real estate crisis and real estate property could perform well during a stock market crash.
But beyond that, stocks and real estate have several key differences that might make one more suited toward your investing style. Here’s how they compare.
1. Stocks have a lower barrier for entry
With online brokerages and robo-advisors, you could start investing in stocks with as little as $1. The fees on online brokerages are typically extremely low (or non-existent), and though you’ll still want to pay attention to trading commissions, you could become a stock investor with little extra costs.
Real estate investing is a different story. Unless you invest in an REIT, you’ll likely need to have a large sum of cash to get started. That alone could stop many Canadians, especially given the state of the real estate market right now.
2. Real estate property can be hard to sell
When compared to stocks, real estate is far more difficult to liquidize. Unlike the stock market, which uses brokers and market makers to ensure there’s always a buyer for every seller, real estate investors have to find buyers, negotiate prices, and collect money on the sale.
3. Stock investing requires technical knowledge
Short squeezes, hedge funds, ETFs, mutual funds, short selling. Yes, stock investing may require you to learn a lot of investing strategies and concepts. And if you want to be a DIY stock investor, you’ll also have to learn the ins and outs of different stock companies, analyze balance sheets, and make informed decisions.
Real estate investing requires you to learn some key strategies, too, but the knowledge you need to succeed is usually far less technical. For some real estate investments, such as your principal home or vacation property, you just need to choose the best location, one that helps increase your equity.
4. Real estate investing can be taxing
You may not have to analyze a company’s finances or spend your weekend reading financial news to be a successful real estate investor. But don’t think it’s a walk in the park. If you own property, you’re in charge of maintaining and repairing it, not to mention paying property taxes, insurance, and the mortgage. And things could get rough if you rent property to troublesome tenants.
Should you invest in real estate?
Adding real estate to your portfolio could be a smart choice. You can diversify your investments, take advantage of certain tax breaks, and create a solid stream of income that could carry over into retirement.
But, as with any investment, you want to know what you’re doing. The gains on real estate investing can be immense. But so can the losses. And while you may feel motivated in the beginning to flip homes and manage rental property, the maintenance and upkeep, especially in storm prone areas, can get old fast.
If you’re new to investing, you could learn the ropes with a more passive approach, such as a real estate ETF or a REIF. Both of these can expose you to the real estate market without requiring you to buy property. That might be more suitable for Canadian investors, especially as buying residential and commercial property has never felt more out of reach.