Real Estate Investing: Why you should consider itOctober 12, 2018
Investing in real estate is one of the oldest forms of investing. Not only has it pre-dated modern stock markets, it has actually been around since the early days of human civilization.
It is one of the five basic asset classes that every investor should seriously consider adding to their portfolio. Real estate can be profitable, give an investor cash flow and growth, can take advantage of leverage, and often has tax benefits.
First, let’s start with the basics: What is real estate investing?
What Is Real Estate Investing?
Real estate investing is a broad category of operating, investing, and financial activities centered around making money from tangible property. Examples include investing in a commercial plaza with retail businesses as tenants or generating profits from a condo development or earning interest from making a mortgage loan.
Why Invest in Real Estate?
A key feature of many real estate investments is that a significant portion of the total return can come from rental income. This income can increase as rents tend to increase with time, but mortgage payments can remain stable when fixed terms are used. Active management can also increase revenue and lower expenses through value-add activities, which can also increase cash flow.
Real estate, especially rental properties, tend to appreciate with inflation. Growth in value can also happen quicker than inflation using active management strategies. In addition to the growth in the overall value of a property, one gets growth in the equity of a property through mortgage principal pay down. This equity increases through increases in value and principal recapture can often result in long-term wealth creation.
Unlike many investments, such as stocks, an investment in real estate is backed by a high level of “bricks and mortar.” Hard assets can provide an excellent store of value and a hedge against inflation. In addition, hard assets like a rental property can retain its value even if those managing the property were to cease to exist.
Hard assets are typically less susceptible to the emotions of the investing marketplace and can be a hedge against economic upheavals. They do not disappear in the middle of the night and an amateur cannot lose it with a bad bet on the stock market. Its intrinsic value will likely not go down to $0 like shares in a defunct company. Nor does its value evaporate because of an economic scandal.
Real estate is fundamentally valuable because there’s limited supply, and the need for it extends to everyone. It is also relatively easy to understand for it is not some complicated financial instrument.
When you use borrowed capital to enhance the earning potential of an investment, you are using the full power of leverage; and since real estate is a tangible or hard asset, financing is readily available (typically in the form of a mortgage). The potential return on your leveraged real estate investment is substantially increased compared to a typical non-leveraged investment.
Like a Registered Retirement Savings Plan (RRSP), the value of appreciation of your real estate investment is sheltered from tax until you sell the property. For instance, if you purchase an $80,000 property that increases in value to $120,000, this capital gain of $40,000 is sheltered from tax until you sell (i.e. realize the gain). When you own multiple properties, this benefit compounds, since there is no limit to how much growth you can shelter with real estate investments.
Preferential tax rates.
When you sell your Canadian investment property and thereby trigger a capital gain, you will benefit from the capital gains status of this profit. This means 50% of your capital gain is taxed at your marginal tax rate, while 50% of the gain is tax-free.
Real estate investment funds.
Distributions from real estate investment funds can often be classified as a return of capital for tax purposes, which means the investor is not taxed on that distribution in the year it is received.
The Bottom Line
Real estate is a distinct asset class that is simple to understand and can enhance the risk and return profile of an investor’s portfolio. On its own, real estate offers competitive risk-adjusted returns, with less principal-agent conflict and attractive income streams. It can also enhance a portfolio by lowering volatility through diversification.