by Norma Walton, President and CEO, Rocket Property Ltd.
Real estate is a stellar investment for a number of reasons.
Yes, it is certainly more complicated than other investments. Yes, you have to be pro-active in managing your real estate. No, you cannot liquidate real estate quickly. And yes, you require more capital to buy real estate than to buy a stock or a bond. But assuming you can overcome those hurdles, you will usually find that your investments in real estate provide superior returns to any other financial investments you make in your lifetime.
It is trite to say that most people’s largest asset and largest source of wealth is their home. There are many reasons for that, the three main ones being that it is often their only investment, the world is not manufacturing any more land, and the way mortgages are typically set up forces people to pay off debt and increase their equity.
In my view, there are six reasons why real estate provides superior returns to other investments:
1. Real estate provides cash flow.
Real estate can be rented. This is standard with residential, commercial and industrial real estate. There are always individuals and companies that either cannot afford to own or don’t want to own hence they need to rent. This creates a ready market of renters for your real estate.
Ideally the rent pays all of your costs of owning the real estate and also provides some cash flow. If that is the case, you can then use that cash flow to make other investments, re-invest in the property to make it better, or pay down your mortgage faster.
Even if all that your real estate does initially is cover its costs, you are still typically paying off debt principal every month because that is built into your mortgage. Mortgages generally require the payment of interest and principal. Thus you are creating wealth even if the investment is only cash flow neutral initially, as equity increases with every mortgage payment made.
After 20 to 25 years, you will have paid off your mortgage but the rents will still be flowing. It is at that point you will really appreciate the ongoing cash flow real estate provides because it will fund your retirement, whether you elect to receive the monthly rent payments or whether you elect to re-finance your real estate to pull out a lump sum of cash. Hence if you can swing it, buy some real estate in your 40s so it provides retirement income in your 60s.
2. Real estate can be purchased with debt, permitting you to improve your return on your equity.
Banks prefer to finance real property more than any other asset class. Mortgages form a core component of Canadian banks’ investments. There will be some properties that are not yet attractive to a bank. In those cases, there are generally other lenders more than happy to provide mortgages to purchase those properties. Those other lenders range from credit unions and life insurance companies to mortgage investment funds to private individuals with money. Lenders like the security that real property provides.
The availability of lenders means that if you have $100,000 to invest, you can typically buy real estate worth up to four times that amount. Hence a $100,000 down payment funds a $400,000 real estate investment.
The benefit of leverage is that assuming your real estate investment increases in value 10% over a three year period, your $100,000 initial investment will be worth not $110,000, which would represent a 10% return on the $100,000, but $140,000. Because the property you bought was worth $400,000 initially, a 10% increase in value on a $400,000 asset is $40,000, not $10,000.
Although it is never simple to deal with a lender, the benefit of buying with 25% of the total purchase price is obvious because your returns are dramatically increased.
3. Real estate has inherent tax advantages.
Income tax regimes are set up to encourage the ownership of capital assets, of which real estate is the main one. Countries thus provide incentives to their residents to encourage ownership of real estate.
When you own real estate, you can shelter income because you can write off against income non-cash expenses. In Canada, you can depreciate the value of your building over a period of time even though it is likely increasing in value during that same time period. That means you likely will pay no income tax or minimal income tax on rent producing assets in the first number of years after ownership.
When you sell real estate in Canada for a profit, only a portion of the profit is taken into income, thus providing a cut rate of tax on capital gains. Hence if you sell real estate for a $1 million profit, you normally only have to take into income half of that amount, thus halving your tax bill.
Owning real estate permits you to keep more of your profits.
4. Real estate permits insider trading.
You can develop personal expertise and experience in a specific place. You can create insider knowledge and information about a location that will give you an advantage over other buyers and sellers.
For a specific neighbourhood, you can determine average real estate prices; the highest and lowest range of prices; appraised values; tax-assessed values; market trends; the identity of the largest buyers and sellers in the market; tenants who want to locate in that market; the best realtors; and the available lenders. You can then exploit this knowledge to purchase property for under market prices, for example, or in an up and coming area that others are not aware of.
This gives you a leg up or an advantage that others do not have.
5. Real estate provides a lot of control over the investment.
You have the keys. You can drive by the asset. You are the registered owner of the property. This is much different than purchasing a stock or a bond where you are one of millions of investors, all of whom individually have no control over the investment.
Also before you purchase the property, you can do your own due diligence on the investment. You can conduct building inspections and environmental tests; you can review all of the leases; you can investigate the neighbourhood; and you can satisfy yourself with your own financial analysis before you buy.
After you purchase, you can improve your real estate to add value. You can renovate the property or parts of the property. You can re-position the property in the marketplace. You can re-zone the property or sever off part of the property. You can change the tenant mix of your property.
If you want to know what your asset is worth, you can have it valued. You can decide to whom you wish to rent. You can decide when you want to sell. You can do what you want, within reason and subject to your lender’s requirements, with your property.
6. Real estate is a limited resource.
The world is not manufacturing any more land. This puts an ongoing and ever increasing premium on the land we do have. The value of land will never go to zero. This means that long term appreciation is likely. It is expected that there will always be a use for land and as a result it will always increase in value over time.
For the above reasons, and despite the challenges, real estate is a stellar investment, superior in my view to all others.