Real estate has become a prevalent investment vehicle, especially in hot markets like Vancouver. It's essential to understand the different types of real estate investments you can be involved in and their benefits.
When you purchase your principal residence (the home you live in), you are hoping the value of that home appreciates over time. When this happens, you build equity. Equity is the value of your financial interest in the property. See below for an example:
Purchase Price: $1,000,000
Mortgage Loan (80%): $800,000
Down Payment (Equity): $200,000
After a couple of years: You have paid down a portion of your mortgage, and the remaining balance is $750,000. At the same time, the value of your home has increased to $1,100,000. Your equity has grown to $350,000 ($1,100,000 - $750,000). Your initial investment was $200,000; now, you can sell the property and receive $350,000. That's a 75% ROI.
Rental properties are a great way to generate cash flow. The amount of cash flow mostly depends on the location of the property. Rental properties typically do very well near city centres, transit hubs, educational institutions, and shopping/grocery malls.
Being a landlord is very hands-on. You'll be responsible for paying the mortgage, property taxes, and insurance, maintaining the property, finding tenants, and dealing with any problems. You can hire a property management company to find and manage tenants. However, they will charge a fee, and it's crucial to find one that's trustworthy and reputable.
You can also benefit from property value appreciation. Similar to a principal residence, the value of your property may increase over time. Typically, if you are generating high cash flow, appreciation will be slower, and vice versa. Finding a location with solid cash flow and appreciation can be very tough. Decide which you prefer more before beginning your search for a property, income or growth.
Real estate flippers are short-term investors. They typically hold a property for a few months and then sell it for a profit. The primary way to profit from these properties is by adding value. For example, a flipper may purchase a run-down property and renovate it before listing it on the market for a higher price.
Another way of making money from flipping is by buying and selling properties in a rapidly rising market. Instead of adding value by renovating, you hold the property for a few months during an uptrend and then sell it for a profit.
Flipping real estate can be a lucrative business if done carefully. You need the capital for improvements, a network of contractors, and enough funds to hold the property if it doesn't sell.
A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate. You can buy units (shares) in this company as an individual investor. REITs are traded on exchanges, meaning you can buy and sell them like stocks and ETFs. This makes REITs a very liquid investment, unlike physical real estate.
REITs invest in most real estate property types, including apartment buildings, cell towers, data centers, hotels, medical facilities, offices, retail centers, and warehouses. Some of the largest REITs in Canada are Canadian Apartment Properties REIT (CAR.UN), RioCan REIT (REI.UN), and Granite Real Estate (GRT.UN).
REITs generate a steady income stream for investors but offer little in the way of capital appreciation, much like regular dividend-paying stocks. Their dividends are fueled by the stable stream of contractual rents paid by the tenants of their properties. U.S. REITs must pay out 90% of taxable income as shareholder distributions vs. a 100% rule for Canadian REITs.
All three real estate investment vehicles have their pros and cons. It would be best if you considered the following before deciding which one is right for you:
- Capital: How much money do you have to invest?
- Financing: Do you qualify for a mortgage?
- Timeline: How soon do you want to earn a return and cash out?
- Risk Appetite: Are you a risk taker, risk-averse, or in-between?
- Goal: Are you seeking steady income or equity growth?