August 27th 2021
The Basics of Investing in Real Estate
Although many people don’t think of buying a home when they hear the word “investment,” purchasing a property is exactly that. The rising cost of properties across Canada are well-documented, with much of the activity occurring in areas outside of major metropolitan cities like Toronto, Vancouver, and Montreal. If you’re interested in getting in on the action, there are some important things to know before investing in real estate in Canada.
Understanding all the Associated Costs
Like all forms of investment, the first step is understanding all the costs and risks associated with investing in real estate. In terms of costs, real estate expenses can be broken into three broad categories: Upfront, carrying, and repair costs.
The upfront costs of real estate investment in Canada refer to all the expenses that occur before you take full possession of the property. This spans the entirety of the sourcing, offering, and closing process — including costs like home inspections, home value appraisal, down payments, and all applicable taxes.
Carrying costs accrue over the entirety of your time as a property owner. They’re the continuous cost of living in, or renting out, a building and include mortgage installments, taxes, home insurance, utilities, other applicable fees, and minor upkeep and maintenance costs.
This category refers to the big-ticket repairs that all property owners eventually need to undertake. They include repairs to structural components like the roof, walls, foundation, and major systems like the furnace and water heater.
While the first two categories are relatively calculable and don’t vary greatly from year to year, major repairs and other damage not covered by insurance represent a significant risk for real estate investors and can eat up a large amount of profits. That’s why having contingency plans and comprehensive insurance are so important to the investment process.
Determine if property ownership is right for you
Owning a condo, townhouse, or freestanding home comes with heightened financial responsibilities and extensive investment in time and resources. You need to be sure that property ownership is right for you before doing any real estate investing in Canada. Here are some of the major things to consider:
- Is your financial situation stable enough?
- Are you in possession of the necessary budgetary and financial management skills?
- Can you handle all of the associated costs?
- Will you have the time and bandwidth to maintain the property?
If the answer to any of these questions is a resounding “no,” you may need to reconsider your real estate investment timeline or consider looking in a different area.
Affordability rules for investing in real estate
Regardless of whether you’re looking to move into a home yourself or simply want a second property for income purposes, there are some general rules to follow that ensure you won’t become overleveraged.
Here are two main rules for affordability and securing mortgage loan insurance with the Canadian Mortgages and Homeownership Corporation:
- Rule #1: The monthly cost of your real estate investment shouldn’t be more than 32% of your monthly pre-tax income
- Rule #2: The total debt load you experience from your real estate investment shouldn’t be greater than 40% of your monthly pre-tax income
Affordability rules like these also help inform the online real estate investment calculators that are essential to success when purchasing property — whether it’s for family or as an income-generating rental property. There are many other best practices for financing the purchase of a new home, but for now, let's turn to some of the reasons why people might choose to invest in real estate.
Why people are investing in real estate
Aside from the obvious reasons (finding a place to live and having more control over your housing options), investing in real estate is also a foundational component of the Canadian economy. In fact, estimates from Statista put the GDP contribution of real estate, renting, and leasing in December 2020 at $264 billion CAD — nearly double the second-highest industry. Clearly, property ownership and management are key to successful economic activity in this country.
Any industry that drives economic activity to such a degree is bound to also drive investment and speculation. An increasingly popular form of real estate investment in Canada is purchasing property for both residential and commercial rentals or improving the home's value for resale.
Investing in rental property
As a rental property owner, you become a landlord who derives additional income from tenants who pay you rent monthly to live or work out of your space. This rent is used to cover the home’s carrying costs, allowing you to pay down the mortgage and cover utilities and other recurring fees. Although it may seem straightforward, property management does require active work and many people enlist professional services so they can continue to work while a third party oversees their property.
For those who are less interested in holding onto a property for a long time period, can’t hire property managers, and don’t want to deal with tenants, house flipping is an ideal option. This form of real estate investment allows property owners to purchase a home and quickly increase its value through construction and repair (or profit off general market increases). The length of these investments varies depending on regional and provincial laws, but they’re often months to years.
Other forms of real estate investment
Those with more traditional aspirations may opt for simple homeownership, while enterprising individuals and groups often select some or all of the options available. But, there are also ways of real estate investing in Canada that don’t require the individual purchase of a property. Similar to stocks, mutual funds, and ETFs, there’s a range of options that allow you to reap the benefits of increasing home and property values without extensive financing and risk. These include Real Estate Investment Trusts (REITs), Groups (REIGs), Limited Partnerships (RELPs), and Real Estate Mutual Funds.
As you can see, there are many options outside of traditional homeownership that constitute real estate investment. Becoming more comfortable with these basic concepts will open up a whole new world of income possibilities, all of which can be great ways of supplementing income if you’re in the right financial position.