Have you always wanted to be a real estate investor but don’t have the cash or time to manage a property?
This was my case a few years ago. I had some extra cash sitting around and was looking for ways to diversify my investments across various asset classes.
Ever since I was young I had read books on real estate investing, property flipping, and seen the endless TV shows on HGTV. I admit I was hooked like so many others out there, thinking real estate was the way to go. The excitement of picking out tile patterns, paint colours, cabinets; it’s easy to get caught-up playing house with all the planning and decorating. Thankfully, I had a revelation.
Don’t be a plumber if you don’t have to be
One day while looking through property listings I thought to myself, do I really want to have to go fix a toilet at 11 pm on a Tuesday? The answer was a resounding No. I figured there had to be an easier way for me to get in on the real estate game without all the headaches of being a landlord.
Unless you're OK parting ways with a nice chunk of your monthly rental income by hiring a property manager being a landlord can certainly suck, and it’s not something I had the time or desire to do.
What if the stove breaks? the furnace goes? the AC burns out in mid-July? a pipe bursts behind the bathroom wall?
These are all realities of home ownership, realities they never talk about on HGTV, realities I could not afford to deal with because I was busy running my own business.
Do the math…actually
In books and TV, they glamorize real estate investing, rarely including all the fees and taxes that actually come with the purchase and rental of a property.
For example, I was living in Toronto at the time and was thinking of buying a condo to rent like so many others. According to the Huffington Post, the average price for a condo in Toronto is now $519,000! With a 2.64% land transfer tax that adds an addition $13,710 to the price, ouch! On top of that, including an extra $12,975 in realtor fees I was looking at nearly $27,000, and for what? I didn’t get any extra square footage, no new appliances, or an increase in property value. That’s $27,000 with literally nothing to show for it, and I was still responsible for fixing that leaky toilet at 11 pm. There had to be a better way.
The average doctor in Canada makes $225,000 per year. Great money, yes, but they go to school for 15 years and can save my life if I’m dying – I’ll happily pay that, they deserve it. If we break that down into an hourly wage, assuming a normal 40-hour work week and 3 weeks vacation each year, that's approximately $115/hour. Compared to some lawyers and accountants that’s quite reasonable!
Now, I’m not here to bash the hard working women and men of the real estate industry; I’m an independent contractor myself and know how difficult it can be. However, according to a recent article in the Financial Post, it takes the average real estate agent in Toronto roughly 15 hours of dedicated work to sell a property. With me paying $12,975 in commissions that’s nearly $865/hour! My doctor who can save my life only makes a fraction of that.
I just couldn’t justify the fees. I also couldn’t ignore the City’s ability to continuously raise property taxes, or the banks' ability to raise interest rates on my mortgage. There were just too many unknown costs outside of my control.
As for tax, I was surprised to learn that any income I made from renters living in my investment property was taxed at my full personal income tax rate. This would have pushed me into a higher tax bracket meaning less money in my pocket – not fun. Once again, I figured there had to be a better way.
Enter: the REIT
I had heard the name before but never really looked into them - Real Estate Investment Trusts.
I did some research and discovered that REIT’s are these amazing investment devices that let me own real estate with the click of a mouse while paying a commission of only $9.99. Even better, they instantly start paying me a return on my investment ranging anywhere from 5% to 10% in the form of a monthly cheque deposited right into my bank account. It was quite the "holy crap, for real?" moment. And best of all, if any toilets broke at 11 pm on a Tuesday I didn’t have to do anything!
Click here to learn all the basics if you're not exactly sure what a REIT is.
I could take the $27,000 that I would have paid in fees and buy myself a no-hassle REIT that would pay me a 7% annual return on my money.
Sure, it’s not the “double your money in 6 months” spiel they glamourize on HGTV but think of the taxes, fees, and headaches I’d save.
As for taxes, not only are REIT’s taxed at a far lesser rate than my personal income tax rate, if I bought the REIT inside my RRSP I’d pay no tax at all. This was absolutely mind blowing.
So, my rational had now shifted. If I took my original down payment along with the $27,000 in taxes and fees, and instead spread that money across several REIT's, I’d save tens of thousands of dollars in taxes and fees, not have to worry about managing a property or fixing leaky toilets, and I’d get the diversified benefit of owning hundreds of various properties across the country.
You see, buying a single property on a single street in a single neighborhood was not a smart way to limit my risk and diversify my investments. What if the local market takes a hit and property values decline? I could get locked into that condo for years, unable to get out without taking a huge loss in property value.
I also couldn’t ignore the laborious task of finding renters. It would be difficult enough finding people who wouldn't wreck my property, and if they ever decided to move I'd have to start looking all over again, which could take months if the economy goes down the drain (prime example: Calgary). I could be stuck paying the mortgage on a property for months before finding a reliable renter. Furthermore, if rental prices go down I may have to lower my rent to the point where I’m losing money each month in order to attract renters and complete with other rental properties. It had 'bad news' written all over it.
Why I like REIT's
Sure there are no fun tiles to pick out or walls to decorate, but with REIT’s I would have renters like Walmart and Canadian Tire whom I'm pretty confident are not going out of business anytime soon.
The REIT managers are the ones who collect the rent cheques and simply cut me my piece of the pie each month.
I benefit if property values rise while paying no tax on my monthly distribution cheques.
Rather than paying a monthly mortgage with potentially rising interest rates, I could decide a monthly amount I wanted to contribute to my REIT investments. If I lost my job or got laid off I could put my monthly contribution payments on hold, no problem.
Best of all, if at any point I wanted out of the real estate game I could do so in 10 seconds with the click of a mouse and pay only $9.99 in commission to my online brokerage – a lot less than $12,975 in realtor commissions!
The Pro vs. Con list was becoming increasingly tilted in favour of REIT’s; it was an absolute no-brainer for me.
What to buy?
Now, I’m not an investment advisor so I’m not going to tell you what you should buy, but you can do some simple research of your own.
You can see a full list of Canadian REIT’s at REIT Report along with the amount they’ll pay you in monthly distributions (yield %). Each REIT has their own website where you can see their various properties and tenants. Individual REIT’s can own hundreds of properties in dozens of different cities across the country, however, just like buying a property of your own, the local real estate markets can fluctuate, so you’re never totally insulated from risk.
Each REIT owns different amounts of property in different cities, so try to avoid ones that own a large concentration of properties in any single city. Get the benefit of a well diversified REIT that owns a good mix of both commercial and residential properties across numerous large markets.
You can diversify your investment one step further and buy an ETF that owns multiple REIT’s. XRE and ZRE are great examples of this.
Furthermore, you can buy an ETF that holds various REIT’s all over the world, giving you a globally diversified real estate portfolio rather than purely Canadian. This strategy works quite well if you want to own a piece of the US, European and Asian real estate markets without having to worry about foreign currency exchanges. The iShares Global Real Estate Index ETF is a solid example of this and can be held in one of your registered accounts to save on tax.
What lifestyle do you really want?
Using the average condo price of $519,000, if I were to put that money into a diversified basket of REIT’s (or REIT ETF’s), paying an average annual return of 7%, that’s $36,330 per year or $3,027.50 per month. I may not double my money in a hot real estate market but it satisfies the primary goal I set out to accomplish with real estate investing which was to generate monthly rental income.
I also consider the massive time savings of not having to visit the property on a regular basis, cut grass, fix wobbly railings, or find renters. For me, having this extra free time meant more evenings and weekend doing the things I enjoyed.
It’s not simply about the money, it’s about the lifestyle I wanted.
Do I really want to spend my Saturday's sitting in traffic on the QEW driving to fix a broken dishwasher at my rental property?
Life is incredibly short. For me, the question was:
How can I achieve the results I want with the least amount of time and energy input required to make it happen?
They may not be for everyone but for me, REIT’s have been an effective way to help me reach my investment goals and are an integral part of a broad, globally diversified portfolio.
Think about the lifestyle you really want, not simply the money you'd like to have (and turn off HGTV).
Key takeaway: buying an income property isn’t as glamorous as seen on TV.
Remember, it's a TV network whose primary goal is to boost ratings so they can generate more advertising revenue. If they didn’t make it look easy and fun nobody would watch and they’d loose viewers. Don’t get caught up!
Take the time to crunch the numbers and add up all the fees. The true cost to buy a property isn’t simply the list price. Here’s a great breakdown from MoneySense that includes all the fees you need to consider when buying or selling a property.
It’s one thing if you plan on living there for the next 25 years, but if you’re looking to own an income property it’s a whole different ballgame. I can think of a few more enjoyable ways I’d rather spend my weekends than fixing leaky toilets!
Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions.
Before you invest be sure to download your free copy of Building a Bullet-Proof Portfolio, the complete guide on how I built a winning portfolio that sailed through the 2008 stock market crash without losing a dime.