Is real estate a good investment?
Few topics generate more interest - or a wider range of opinions - than real estate. Once, it was a source of wealth mainly for landed gentry and real estate barons. Over the past few decades, it has become common for middle-income Canadians to buy and sell or rent out multiple properties.
Depending on where you stand, the boom in real estate has been a windfall or a barrier to home ownership. But nobody can escape the topic because we all need a place to live and our home is typically the biggest financial decision of our lives.
Today, you might have clients asking you if real estate is a good investment. Broadly speaking, you could answer that yes, real estate is a good investment and almost every serious investor owns at least some. But the real question is whether real estate is a good investment for this particular client, and if so, how best to approach it. And that answer is a bit more complicated.
In our previous article, we discussed a number of do-it-yourself investment trends, and real estate is perhaps at the top of the list. If clients ask your opinion, we believe the best way to find an answer is to start by discussing their goals, their risk tolerance and their financial plan.
For those who want a place to live
If a client’s goal is just to own a home, it is probably best to look at it as a home first, and an investment second or perhaps not at all.
Like stocks, the long-term trend of real estate is positive. And, also like stocks, the short-term trend is nearly impossible to predict. So, rather than trying to time the market, more attention should be paid to the issue of affordability.
The cost of home ownership can be high, and as recent interest rate increases have shown, it can rise suddenly. Add to this the possibility of an economic downturn, and the primary concern of a homeowner should be to avoid overextending themselves. That means having some emergency savings and breathing room in their budget in case something goes wrong.
One way to ease affordability is to purchase a residence that contains a rental unit. In this instance, you are a homeowner and also an investor. While this can be effective, relying on rental income to cover part of the bills comes with some added risks and responsibilities.
If affordability is managed successfully, then the short-term real estate outlook doesn’t really matter. Over many years of homeownership, odds are you will build up equity and things will turn out well.
For those who want to make money
If a client’s goal is primarily to make money, the calculation is significantly more complex.
Years of falling interest rates and rising home prices have made real estate investing look easy. But now we’re in a period when rental incomes no longer cover mortgages and renovation finance costs are skyrocketing while resale prices fall. Market dynamics that once seemed unthinkable have become reality.
To be fair, every investment has their ups and downs. But the question clients have to ask is: relative to my long-term goals and to my personal risk tolerance, how much upside am I aiming to achieve, and how much downside can I really afford?
If your investment portfolio is down one year and rebounds the next, there is generally no harm done. But if you borrow tens or hundreds of thousands for a real estate investment that ends up under water, the financial damage can be severe and lasting.
Unfortunately, there are no free lunches in investing. Many of those who made above-average returns from real estate did so with above-average risk, and as the market environment shifts, the consequences are beginning to show.
When everything is averaged out, real estate is just another asset class that, like stocks and bonds, can provide a competitive rate of return over time, and is best considered in the context of a diversified portfolio.
Keep in mind that if a client owns their home, they already have significant real estate exposure. If it makes sense, they could consider adding to their exposure by buying Real Estate Investment Trusts (REITs) that trade on a stock exchange, or investing in a professionally managed portfolio that includes real estate.
For those who simply want a place to call home, similar thinking applies. Frame the cost of home ownership in the context of their overall financial plan so the client can purchase a home that meets their needs without sacrificing their long-term financial goals or their short-term financial security.
As an advisor, it’s always risky to speculate about the future of stock markets, real estate or interest rates. It’s better to focus on the things that are actually under your control, like sensible financial planning and recommending high-quality, diversified investment portfolios like the ones we manage here at Beneva. We think this approach is a guaranteed home run.