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Choosing A Real Estate Investment Path
There are many avenues that investors can take when it comes to investing in Canadian real estate. Each requires different commitment levels of money, time, and energy. Some offer greater risks and benefits than others, which means that they can appeal to different investor personalities and cater to different investment goals.
What options are available for real estate investors, and which one is right for you? Below, we discuss five real estate investment methods, analyzing their pros and cons to help you decide which approach is suitable for you.
House Flipping
House flipping is the process of buying, upgrading, and reselling a home for profit. Upgrades can consist of significant fixes or superficial renovations that add resale value to a property. House flipping usually involves quick turnarounds of less than a year, as holding onto a property adds to the cost over time (mortgage payments, property taxes, utilities, etc.).
This method of real estate investing is regarded as high-risk with potentially high rewards. House flipping can be a very costly venture if you lack the skills, knowledge, funds, time, and patience to renovate homes successfully.
Fundamentally, you will need to be able to find undervalued properties with excellent resale potential, accurately assess the cost of repairing them, and predict short-term market favourability in order to make them a worthwhile investment of your time and money. Without the right expertise, you may end up with a net loss on your hands.
You will also need to decide whether to make the repairs yourself (which often requires a great deal of technical expertise) or rely on a reputable contractor. You will also need to pay for safety inspections and a listing agent.
If anything goes wrong, you run the risk of carrying a low-value property for an indefinite period of time, eventually paying more than what you expect to receive. While you can fund this venture on your own, you can also choose to rely on a bank loan, utilize your home equity, or even turn to crowdfunding in order to start house flipping.
Additionally, Canada implemented new house-flipping tax rules starting in 2023, which may impact your decision to become a house-flipper. Under the new regulations, profits from house flipping would be considered business income, not individual capital gain, which means 100% of profits will be taxed. In Ontario, the tax rate for businesses ranges between 3.2% and 11.5%.
There are house flipping exceptions that someone may be able to claim in order to avoid business income tax and just pay capital gains tax instead. These legitimate reasons include family changes (death, divorce or separation, adding family members to the household), job changes (involuntary termination, moving to be closer to work), disability or illness, threats of violence, property destruction (man-made or natural), and bankruptcy. You must be able to provide documented proof to the CRA in order to make these claims.
These tax considerations and other expenses related to buying and renovating a property may drastically impact the return on your investment. However, any losses that you suffer from house flipping will deem your taxes to be nil.
Real Estate Investment Trust (REIT)
Real estate investment trusts (REITs) are a form of indirect real estate investing. Structured similarly to mutual fund investments, REITs involve investors pooling money into a company that owns and manages a portfolio of income-producing properties; investors do not own or manage any properties themselves. There are many types of REITs, including residential, commercial, healthcare, office, and storage.
As a relatively newer investment method, REITs became an option for Canadians in the 1990s, with the first REIT offered on the Toronto Stock Exchange in 1993. Each month, around 90% of a REIT's taxable income is paid out as dividends to shareholders, which is a nice bonus.
The advantages of REITs include:
- Accessibility: there is a lowered threshold for investors dipping their toes into real estate, as a single share can cost less than $20
- Cash liquidity: you can buy and sell at any time, meaning that your money isn't locked into a commitment for months or years
- The relative ease: you don't have to go through a tediously long or complicated purchasing process nor manage any of the properties yourself
The disadvantages of REITs include:
- Industry/market sensitivity: certain sectors (like offices, hotels, and retail) are struggling to recover post-pandemic, which means REITs that focus on those areas are struggling too
- Individual quality of a company: you should do your due diligence and look for REITs that have a good track record for asset management and provide consistent returns for investors
- Tax considerations: any dividends that you receive from REITs are considered taxable income unless you invest through a TFSA or an RRSP
Investors should consider the trade-off between REITs' simplicity and passivity and their return on investment over time. While real estate historically outperforms stocks, REITs offer lower returns than other real estate investment methods.
Real Estate Private Equity
Real estate private equity (REPE) investment is less commonly discussed than others. It is a mid-to-long-term investment strategy for high-net-worth investors, which usually requires locking in your capital for several years before payout.
With this method, investors typically put their money into an investment vehicle that works on the acquisition, development, and management stages of a building project. Individual investors become limited partners within a limited partnership agreement and will receive their returns after the units in the project are built and sold. Investors may typically be promised a full return on their original investment plus a per annum percentage and a portion of the profits, all of which are paid out in stages by the fund manager or general partner.
This form of passive investment offers high risk and high potential returns while asking for serious time and money commitments. While investors may be initially enticed by an anticipated high rate of return (often between 8% and 10%) and a cut of future profits, there is no guarantee of profitability when the building project is completed.
Developers could struggle to sell units and start construction if the market takes a downturn, as it did in 2022 and 2023 due to interest rate hikes. These conditions can significantly impact the timeline of returns and the actual profit margins.
Additionally, this investment avenue requires a sizeable amount of initial capital for investors to have on hand—a minimum commitment of $100,000 to $250,000 is not uncommon. There is also very little cash liquidity afforded to investors; once the capital is poured in, you will have to wait until the project reaches certain stages to receive your returns.
Disappointingly, the rate of return is not guaranteed either, as the actual profits are still dependent on the real estate market at the time of completing and selling the project. There is also the risk of the project being cancelled because it becomes unfeasible or is poorly managed, which means that investors can lose their entire investment in some cases!
REPE investments are less regulated than REITs, which makes them riskier. Some fund managers also take advantage of the lack of transparency required, sneakily finding ways to decrease investor profits and increasing their own when it becomes time to pay the partners. If you plan to invest in a REPE, make sure you trust the general partner and can comfortably handle all the risks associated with the project venture.
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Private Mortgage Lending
Instead of owning a property, you can become a private mortgage lender and help someone else purchase their home while setting the rate of return you desire, which is expected to be higher than what other lenders offer.
This method can also be considered high-risk as individuals who turn to private mortgage lenders have often been rejected by traditional bank lenders, which translates to having poor credit and being a high lending risk. If you decide to become a private mortgage lender, make sure that you find a reliable borrower who has a good reason for borrowing the money (i.e. not to cover other debts). Set the terms that you are comfortable with, and if it comes to it, be prepared for the worst-case scenario: forcing the sale of the property upon failure to pay back the loan.
Rental Property Ownership
Our preferred method for investing in real estate is a low-risk, long-term approach that puts complete control in the investor's hands: rental property ownership. Buying and holding on to a property will allow you to earn equity in Canada's resilient and growing real estate market. The rental income the property generates can also pay off some or all of your mortgage payments, making this option more accessible than others.
Homes are in high demand in Ontario, especially within the GTA, where most people, jobs, and opportunities are found. As more and more newcomers come to Canada each year, high demand and low supply constantly drive the value of homes up. By leasing out your investment property, you will provide someone with a home and contribute to Canada's desperate housing market — a win-win situation!
Additionally, you can leverage your funds by investing in pre-construction units. This means you can take advantage of the growing equity of the entire home before it is built while only paying the initial downpayment. The return on investment is much more appealing when you can benefit from the value of an entire new home while only paying for 20% of it upfront and covering the other 80% with rental income.
Once the mortgage is paid off (typically within 25 years under an average amortization schedule), you will have full ownership of your property, which will continue to grow in value over time, as well as act as a source of passive income while you continue to rent it out. This income can fund your children's education, your future retirement, or whatever else you may wish to do — in any case, you can look forward to having long-term financial security.
The best part is that you will have complete control over your investment. You decide what unit to buy, how to design the interior, how much to rent it out for, and whether to add to its value by renovating. If necessary, you also decide when to sell the property, choosing the time that suits your schedule or waiting for the most favourable market conditions.
Comparing Real Estate Investment Methods
There are different ways for investors to add real estate to their portfolios. Each requires a different degree of risk, potential reward, time commitment, and active control. Now that you know how each one functions and what risks and benefits are involved, you can determine which suits your investment style and goals.
For real estate investment advice catered directly to your budget, goals, and risk tolerance, reach out to a GTA-Homes Platinum Agent today — our dedicated team of industry professionals is ready to help you achieve long-term financial success through real estate.
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