Topic: How To Invest

How to cut your risk in Canadian real estate investing

Members of our Inner Circle service ask us a lot of very interesting questions. For example, one member was buying a new home at what he considered to be an extremely attractive price.

However, he had not yet sold his current home. He worried about the risk of owning two homes, even for a few months. He wanted to hedge against a drop in the value of his existing home in the period before it sold.

To hedge against this Canadian real estate investing risk, his broker suggested that he buy some put options on Bank of Montreal stock.

(Put options give you a right to sell a security at a specific price within a specific time frame. These options are profitable when the investment in question goes down, as the holder of the put option can buy an investment at a lower price to replace the one just sold.)

Options are a great way to make money — for your broker

Many brokers take a favourable view toward options, but they have a conflict of interest. A client’s options trading is highly profitable for a broker, compared to buying or selling stocks. Options are far more profitable than stocks for the broker, in relation to the amount of money involved, and to the short time during which investors generally hold an option.

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Our view is that a good broker advises his or her clients to stay out of options under virtually all circumstances. That’s because most investors who get involved in options eventually wind up losing money. The fact that you own two houses won’t have any effect on that likelihood. A trustworthy financial advisor would explain to his or her client that there is no practical way to hedge against the risk of owning two houses.

Information is key to lowering risk in Canadian real estate investing

In Canadian real estate investing, you rarely get the opportunity to buy a new home and sell the old one simultaneously. Instead, you usually have to decide between two kinds of risk. One is to temporarily own two homes, and hope that you can sell the old one at an acceptable price. The other is to sell the old house first, and hope that you can buy a new house at an acceptable price.

The best way to deal with this dilemma is to gather as much information as you can. It may be that this Inner Circle member’s existing home was taking a long time to sell because his asking price was too high. Or, it may be the new home was realistically priced, and that’s why it seemed cheap. But it’s possible that the new home only seemed cheap because of some hidden or overlooked fault.

Stick to the fundamentals of successful real estate investing

Our Inner Circle member would have been better off doing more research into the value of the home he owned, and the second attractively priced house he wanted to buy. One way to start would have been to have a second look at other nearby houses for sale, and try to get a better understanding of home pricing and value in the area.

If you have questions about real estate or any other investment-related topic, including stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.