You may not aspire to be the next Donald Trump, but real estate still deserves a place in your portfolio. It’s a low-risk way to diversify and generate steady returns that can help put your investments on solid ground for the long term. That’s what drew Bernie Ross to the asset class. Two years ago, the president of Frank T. Ross & Sons, a manufacturer of environmentally safe cleaning products in Toronto, purchased his first rental property, a triplex in Toronto. So far, so good. He has been blessed with reliable tenants, an annual rate of return of 10% and tax deductions on interest payments and the cost of improvements and maintenance. “There’s a lot of risk in anyone’s business,” says Ross, “so it’s important to spread the risk.”
Ross is slightly ahead of the game. According to the Investment Property Databank, a U.K.-based property research firm, the average return (appreciation plus income) from Canadian real estate was 8.9% in 2002 and 8.2% last year. While that’s less than on stocks, the standard deviation (the measure of risk in a portfolio) is significantly lower. “We definitely recommend considering real estate as a diversification strategy,” says John Nicola, president of Nicola Financial Group, a Vancouver-based financial adviser to high-net-worth clients. Still, anyone who lived through the early 1990s crash knows that real estate has its ups and downs. Lack of liquidity, high interest rates and tenants from hell are just a few of the pitfalls. The bottom line: to be successful, you need to do your homework.
First, decide whether you want residential or commercial property. While you can find good properties in any market, the profits are higher when you buy during a down cycle. With generational lows in interest rates driving housing prices sky-high, now might not be the best time to buy residential properties. “The prices just don’t make sense to me,” says Nicola. Instead, he recommends commercial properties. “Right now, we’re looking at retail spaces, storage facilities and medical / dental buildings.” Whatever property you choose, the key is ensuring the net operating income is significantly higher than the cost of borrowing.
Location, location, location? It’s true. It makes sense to buy in a good neighbourhood. Ross spent a year and a half searching for the perfect place before settling on his property, largely because he liked the area: “We could see ourselves living there if, some day, we were unable to rent it.”
Nicola suggests looking for fully occupied, mature commercial property in areas with attractive demographics, such as a retail centre in a suburban area with room for growth and household incomes above the national average. Single-tenant properties have the highest risk. “Even big companies can go bankrupt and default on their leases,” says Nicola.
Don’t want to plunk down big bucks to buy property? Private consortiums allow you to pool smaller amounts of money, typically $100,000 to $300,000, with a group of investors. They also spread the risk and can offer more liquidity. For example, purchasers can agree to a sunset clause that defines when the property must be sold. And there’s always the increased possibility of selling units to one another. As well, such limited partnerships typically hire professional property managers, saving you the time commitment and hassle of being a landlord.
Of course, owning property is not all rent cheques and appreciation. As a landlord, you’ll need to find tenants and keep the property in good repair. Ross prefers to maintain his triplex personally. He’s happy to spend the 10 hours a week it requires to maintain it. If you don’t want to get your hands dirty, you can hire someone to do it for between 5% and 10% of the building’s gross income.
How much of your portfolio should be in real estate? One rule of thumb is 10%, says Doug Brown, a managing director at Newport Partners, a Toronto-based wealth-management firm. Still, you’ll want to factor in your age, income needs and risk profile. Real estate represents about 20% of Bernie Ross’s portfolio, and he plans to invest in more soon: “I’m very pleased with my investments.”
© 2004 Caroline Cakebread
