Is Now the Time to Invest in Real Estate?
Global equity markets are at an all-time high and while some advisors are predicting the bull market to continue, others are warning of a correction to the market, or even a crash. From President Biden’s proposed increase to the capital gains tax, to Elon Musk’s tweets about bitcoin and Reddit forums driving insane valuations, volatility in recent weeks has been extreme. For investors looking to diversify their investment portfolio and find safe investments without sacrificing return on investment (ROI), real estate and property development have always been great options.
MATCH THE INVESTMENT TO YOUR GOALS AND SKILLS
Do you have excess cash to invest, or will you need financing? Do you have income from other sources or will you rely on the investment income for your living expenses? Are you in the construction industry and can manage a development yourself, or do you need to be a passive investor relying on experts to manage your investment? You’ll need to find the investment that not only provides a high rate of return, but also matches your short and long-term goals and personal skill set.
If you’d like to enter the real estate investment market you should consider one of the following options:
- A Real Estate Investment Trust (REIT) is an entity that owns, operates, or finances income-generating real estate. Similar to mutual funds, REIT’s pool the capital of many investors allowing the investors to hold real estate in their investment portfolio without having to manage properties themselves. Most REIT’s are publicly traded like stocks, which make them very liquid, and can be held in tax advantageous accounts like your TFSA or RRSP.
- A Mortgage Investment Corporation (MIC) is an investment and lending company designed for mortgage lending. While not typically owning the real estate itself, this allows investors to participate in the mortgage investment market without the risk of holding individual mortgages personally (a lesson my grandfather learned the hard way when a mortgage he provided defaulted and he became the owner of a dilapidated resort hotel, which he and my grandmother had to operate for several months before they could sell it). MIC’s can also be held in registered investment accounts. While mortgage interest rates hit all time lows in 2020, they are currently on the rise and many predict the rise to continue which would result in higher returns for MIC’s in the future.
- Residential or Commercial Real Estate Property can be purchased if the investor is willing to be a landlord. This involves a high degree of personal involvement, and can’t be held in registered investment accounts. The upside is that unless the investor hires a property management company, all profits are earned by the owner without having to pay others to manage the investment. And while the U.S. recently proposed an increase to the capital gains tax, Canada still only taxes 50% of capital gains which means the gain on the sale of the investment may be taxed at half the rate of employment or interest income.
- Development Projects can be the most lucrative, but involve the highest level of risk, investor experience and involvement. These can be done with partners, but wouldn’t be advisable unless the investor is going to be highly involved. There are a wide range of development options from single family or multi family residential, to small or large commercial, to large industrial. The majority of Smythe’s real estate and development clients either own real property or are involved in development projects. Working with Smythe ensures the structure of the investment is setup to meet the objectives of our clients, minimize tax and maximize the return on investment.
- Short term rentals through an online renal platform like Airbnb, HomeAway or one of many others allow you to rent out personally owned residential property or rooms. This is an easy way to get into the market, as it can be as simple as renting out a room in your house or renting your apartment while away on holiday. There are many risks involved in short-term rentals, including losing your principal residence exemption, GST issues and disrespectful houseguests.
Capitalization rate (cap rate) is used in real estate to indicate the rate of return that is expected to be generated on a real estate investment property. Cap rates fluctuate broadly from the type of investment to the geographical market. Vancouver for instance is highly competitive and 2021 Q1 cap rates have been as low as 2.25% for multifamily high rises, to an average of 4.0% for downtown office spaces, to highs of 8.0% in suburban hotels. Compare that to Victoria, which saw 2021 Q1 cap rates as low as 3.25% for multifamily high rises (1.0% higher than Vancouver), to an average of 5.25% for downtown office spaces (1.25% above Vancouver), to highs of 9.0% in suburban hotels (1.0% above Vancouver)1. These variances in cap rates are even higher when investing in smaller more rural areas such as Nanaimo, Port Alberni and even up to the top of Vancouver Island in Port Hardy. As there are fewer large investors and historically lower appreciation in property values, cap rates in smaller more rural areas can be very attractive. There are of course reasons for the higher cap rates, as you may need to travel to these areas to manage your property and the economies in smaller centers can be more volatile as they may be reliant on one or two industries. If for instance, Port Alberni’s largest industry is forestry. If government regulations tighten, the effect on the roughly 18,000 residents would be drastic. The Port Alberni Mill, owned by Catalyst paper, employs 310 workers. Changes to the forestry industry would affect property prices, potentially reducing the value of an investment. A larger center like Vancouver is considered less risky, as the city is not dependent on one industry and large declines in property values are less likely.
Cap rates are typically tied to risk, so you have to weigh your appetite for risk with your desire for high returns. If you can find an investment with a high cap rate, and you’re in a position to invest either due to your own knowledge and skills, or appetite for risk, the payoff could be huge. Clients often work with their Smythe advisor to analyze a project and weigh the risks against the expected cap rate to ensure the investment meets their objectives. Smythe finds creative ways and uses our industry expertise to ensure the investment is sound and structured properly to meet the unique objectives of each client.
Whether or not now is the time for you to invest in real estate, ultimately it should be part of any savvy investor’s portfolio. The decision for any investor is when to get into the market and what type of real estate investment suits your needs.
The Smythe CPA Real Estate & Construction group assists hundreds of developers and real estate investors and can put together a plan to ensure assets are protected and tax is minimized. Before investing in real estate or starting a development project you should discuss the plan with your Smythe Advisor. Please visit our Real Estate & Construction page on our website or contact us directly and we can put you in touch with the right advisor to help you and your organization succeed.