Many people believe that real estate is the best investment. That includes those that buy Apple stocks, weed stocks or even Bitcoin. From a historical perspective, real estate has always had a steady upward trajectory in price, very much similar to stocks and equities. However, real estate has suffered less significant and frequent crashes that have plagued stock markets. Additionally, it has forever been ingrained in our minds by our ancestors as the safest and best long term investment.
That said, holding physical real estate and becoming a landlord has its consequences. In fact, many amateur landlords underestimate the amount of work that needs to be done when you have an investment property. Being a landlord is actually a job. And sometimes, it’s not a nice job to have.
Those that have had good tenants will never complain, but there are plenty of tenant horror stories out there. For every great tenant, there’s a terrible one. One that destroys the home by staining the carpets, breaking the windows, defecating down your air ducts (yes that really did happen) or the one that doesn’t pay their rent on time. These are the risks involved in being a landlord. And they are very real.
No Entitlement To Income
Just like any business, renting out a home can incur large risks that may involve monetary consequences. The fact that one owns a rental property, does not automatically entitle the landlord to a profit. In fact, in expensive cities, this is especially true. In cities like Vancouver and Toronto, rental prices may not cover the mortgage and escalating maintenance fees.
Unlike other commodities, the amount any landlord can charge is driven by the economics of the surrounding area. Landlords would be left with empty units if they charged rent so high that people with normal salaries can’t afford them. That’s why being a landlord doesn’t guarantee positive cash flow. Just like buying stocks and equity, there is always a risk associated with buying rental property.
REITs To The Rescue
Many people know about real estate, but many people don’t know about REITs. REITs are stocks, but instead of owning a piece of a company, you own the underlying real estate that the company owns. I’ve written before about REITs and how they work. There are some great advantages of owning a REIT if you want to invest in real estate versus buying a condo.
For one, you never have to worry about leaky faucets or a backed up toilet. In fact, you don’t even have to deal with a tenant. All of the maintenance is handled by the company that you buy. They will take care of the maintenance, the lawyer fees and everything that goes around buying and maintaining a condo.
Secondly, REITs have the benefit of collecting monthly interest that is tax efficient. Whereas monthly income is declared as regular income (and you should be declaring to the CRA… tsk tsk…), REIT income is usually in the form of dividends or capital returns. This means you pay less tax on the income that your receive from your investment.
Third. There is no mortgage to pay. There is a less of a worry about making payments towards a condo and ensuring you collect the rent on time to pay it. This takes away a lot of the work and worry about making positive cash flow.
Lastly, REITs provide better diversity in your real estate holdings. Rather than just investing in a single condo, REITs will often hold various forms of real estate. Commercial, residential and even industrial REITs exist. If you invest in a REIT fund like ZRE then you are diversified across many regions and types in Canada.
Similar to buying a condo, REITs also have an element of capital appreciation. The fact that REITs hold real estate means that if prices for land increase, no doubt the value of the buildings the REITs hold increases as well. This makes them an equal to real estate investment because not only do you capture the income from a month to month basis, but it provides the capital gains that real estate investors hunt for.
Both Have Risks
REITs may decrease the work and diversify a real estate portfolio, but the risk associated with owning real estate still exist. Similar to owning a condo, or any real estate, REITs are highly sensitive to mortgage interest rates. That’s because most REITs use leverage in the form of mortgages to fund their property purchases. That’s no different than buying an investment condo.
With interest rates so low, REITs have done quite well. Surprisingly, some REITs, like Dream Global REIT have almost doubled in value over the last few years, all while having a yield greater than 5%. These are phenomenal investment gains with steady monthly income.
However, we can’t look at past performance and expect it to last. With central banks around the world raising interest rates, and protectionist measures enacted by many governments, we could see interest rates rising in the near future.
This means that even if you want to grab some REITs make sure to continue diversifying your portfolio. Additionally, if you want to continue to invest in real estate, it’s important to know that yields and capital appreciation could be at risk to rising rates. Just don’t put all your eggs in one basket. With the current political and economic landscape, it’s much more important to remain on the defensive.