Even though today’s house prices are high, mortgage interest costs are near historic lows. And owning your own home has a number of advantages.
For example, owning your house is a great tax shelter. That’s because gains on your principal residence are exempt from capital-gains taxes. However, this tax benefit only applies to your principal residence. You must still pay tax on gains on the sale of a recreational property, such as a cottage or a ski chalet. But these properties generally appreciate at a much slower rate than, say, a home in a major urban centre.
Many investors underestimate the risk and cost of owning rental property
Capital-gains taxes are also applicable to gains on homes you buy for investment purposes, such as rental properties. Moreover, this type of Canadian real estate investing involves a number of other commitments that can make it feel more like running a small business than, say, investing in stocks. With stocks, you only have to tell your broker to buy — everything else is done for you.
In contrast, when you own rental property, you have to spend time finding and dealing with tenants, arranging for maintenance, doing the accounting and so on. You can hire others to do these tasks for you, but that can get very expensive.
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Moreover, Canadian real estate investing can entail higher levels of risk than stocks. That’s because real estate is less liquid, expensive to manage and buy or sell, and highly geographically concentrated. Rising crime, unpleasant neighbours and other changes on the street or in your property’s neighbourhood can make it hard to find tenants or buyers. So can physical problems, like adverse traffic patterns, backed-up sewers and zoning changes that allow undesirable development, or limit what you can do with your property.
Many real-estate investing enthusiasts say that if you buy a property with a 20% down payment (which is the Canadian government’s proposed new minimum to qualify for government-backed mortgage insurance on a property that is not your principal residence), then a 20% rise in the property’s value means you have doubled your money.
However, that claim neglects the costs of selling (up to 5% or 6% for real-estate commissions, plus lawyer’s fees and related costs). It also overlooks any negative cash flow you may have experienced while you owned the property, because rents failed to cover expenses.
Real estate investment trusts offer an easier way to profit in Canadian real estate investing
We continue to believe that ownership of a primary residence is all the real estate exposure that most investors need. However, if you want to add to your real-estate holdings, one good way to do it is through real estate investment trusts, or REITs.
Real estate investment trusts invest in income-producing real estate, such as office buildings and hotels. That’s a segment of the market that is difficult for most investors to access through direct ownership of property. Moreover, real estate investment trusts save you the cost, work and risk of owning investment property yourself.
RioCan Real Estate Investment Trust (symbol REI.UN on Toronto) is Canada’s largest real estate investment trust. RioCan owns 258 shopping centres located across Canada. It specializes in big-box outdoor malls (these malls feature large stores that are usually part of a chain). We cover RioCan in our Successful Investor newsletter.
The best real estate investment trusts have good management and balance sheets strong enough to weather an economic downturn. They also have high-quality tenants, and they carefully match their debt obligations with income from their leases. The best ones are still doing well, despite the economic slowdown, and are taking advantage of low interest rates to refinance long-term mortgages.
If you have investment-related questions, or if you’d like to ask me about specific stocks you’re considering buying (or selling), you should join my Inner Circle service. Click here to learn more.
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Changes to this Policy
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