Of the Toronto millennials considering buying a home, Royal LePage says 93% of them believe homeownership is a good financial investment. Real estate can be one of the safest ways to earn money, depending on your risk tolerance. As an investor, you can build home equity and wealth based on the amount of appreciation your property gains and any other cash flow coming from your rental income.
But, like any investment, you should understand the market you’re getting into — and there is a lot to consider before investing in real estate! You should understand your risk tolerance, the risks that come with investing, how diversified your investment portfolio is, how much you should be investing in real estate, what property type you're investing in and the current market trends.
We’ve outlined three common ways people can invest in the real estate market, and some of the risks that come with them.
1. Own your home as a primary residence
Owning one home as your primary place of residence is a first step in investing your money in real estate. It can give you personal financial freedom and security in retirement.
Achieve financial freedom — Your home provides you with an asset and a place to live, which can increase your wealth if you need to change your living space at some point in your life. Over time this investment can lead to a financial bonus. But you shouldn’t include the home as part of your income plan, think of it as an asset that you can always use to provide you with a place to live. You may need to trade it for a different type of living space, but it’s there for you.
Access home equity via HELOC — A home equity line of credit, or HELOC, is a loan in which the lender agrees to lend a maximum amount within an agreed period, where the collateral is the borrower's equity in their house. You can access some of your home equity through a HELOC, learn more here.
Pass your home down through inheritance and estate planning — You can add your home to part of your estate if you wish to pass it down. You can find more detailed information in this post.
Risks to consider — Rising interest rates can make owning a home a risky investment. If interest rates rise, how likely are you to be able to make those increased payments? Also, if you need to renew your mortgage will you be able to at a higher rate?
2. Become a landlord or vacation home owner
Investing in a second home can be fruitful, but there are a few things to consider, such as the type of home and the area where it’s located. Here’s how you can build your assets through a second home.
Buy and hold — In this scenario you would buy a single-family, multi-unit or multi-family home and rent out all units or live in one unit and rent out others. The idea here is to hold onto the property and reap the benefits of mortgage paydown, cash flow and eventual appreciation. Understand that these gains are not guaranteed, so there is some risk. The risks can be mitigated through due diligence.
Invest in vacation homes and cottages — Consider using your second property for short-term rentals. If you buy a cottage or vacation home, owning a second property creates another asset of wealth for yourself. But that also means another mortgage to pay. If you buy a property in cottage country, and would like to use it yourself occasionally, becoming a landlord is not your best option. But you can use your property for short-term rentals through companies like Vrbo or Airbnb. This strategy could generate enough income to help pay the mortgage and give you an asset to grow your wealth. Bear in mind that rental income is not guaranteed and your property is vulnerable to damage from renters.
Risks associated with landlordship — People invest in real estate primarily to have someone else pay for their asset... but this also has risks that come with it:
- Vacancies — there is a risk that you won’t be able to find renters, or renters will break their lease.
- Landlord and tenant regulations — There are strict policies that protect both sides of a rental relationship.
- The area you buy in — There could be safety risks for renters or damage to your property.
Due diligence can avoid some of these pitfalls by getting a home inspection, vetting tenants, and researching the neighbourhood before you buy.
3. Invest in REIT shares
What are REITS? — REITs, or Real Estate Investment Trusts, are companies that own and operate income-generating properties. These companies own a large portfolio of properties, like retail stores, shopping malls, medical buildings and apartment buildings. When you invest with a REIT they collect the rental income on their properties and pay approximately 85% of remaining income to unit holders (you!). Investing your money in a REIT is not having the asset yourself but contributing to an asset that will grow your money, like stocks or mutual funds.
Why invest in a REIT? — Investing in a REIT lets you have a portfolio of assets in real estate without needing to purchase a property or manage it. It’s an effective way to benefit from the real estate market without the responsibility of ownership. REITs have also (historically) produced solid returns. They also provide investors with several other benefits, like dividend income and diversification. Because of that hey may be a good addition to an investment portfolio, depending on your circumstances.
Risks of investing in REITs — REITs are susceptible to rising interest rates which could impact your investment. When investing in a REIT you should also consider how diversified their portfolio is. If the company is only investing in one sector (such as hotels) and that sector falters, you could see a substantial loss in your investment. Understanding your risk tolerance is important before investing in a REIT.
Is Real Estate investing right for you?
Real estate is a good investment to consider and can help you diversify your portfolio. But every investment comes with risks and you should spend some time understanding what those risks are up front.
Investing in real estate can be daunting, especially if you’re unsure of how to invest or which investment option is right for you. By speaking to a trusted advisor, we can help you understand the impact of purchasing an initial investment property and help to expand your portfolio. One of our advisors will be happy to discuss your portfolio with you to see if real estate investing is something you’d like to consider. Contact us today.