Why Invest in Real Estate? The Pros and Cons of an Income Property

This is a complex topic and I could probably write a 2,000 word article discussing each of the pros and cons listed below. Not to mention the more obscure points I have left out. For the sake of brevity and a desire not to bore my readers to death I have tried to keep this brief and stick to what I believe are the main benefits and drawbacks of real estate investing.

Pros:

Multiple Avenues for Wealth Creation

A real estate investment can simultaneously make you money in 4 different ways. Those 4 ways are capital appreciation, mortgage pay down (i.e. equity gain), rents and tax savings. Stocks and bonds can match some of these when held in registered accounts like an RRSP, but they can’t consistently offer all 4 at once like real estate can.

You can define and quantify this wealth growth in a few different ways. The easiest methods are in terms of total net worth and in total income. When a tenant pays you rent, your income is increased, and when you use those funds to make a mortgage payment you gain equity in the property. Likewise, when the market appreciates and your property gains value, your total net worth increases and you are thus rewarded for your patience and persistence. When you make updates or repairs to a property you are not only increasing the utility of the property and adding value, but also creating a taxable expense that can be used to offset otherwise taxable income. Depending on the legal structure of your portfolio that tax reduction can actually be applied to your regular employment income or profits from another investment. For high net worth individuals in some years these tax write-offs can be of equal or greater value than the actual rents earned because it gives them a tool to “smooth out” their annual income and remain in a lower tax bracket each year.

Another important but somewhat intangible metric that I don’t think gets as much attention as it deserves is the opportunity cost/benefit of investing your money. $25,000 sitting in a savings account is very safe but likely can’t earn much more than 1% each year. That means it probably isn’t even matching annual inflation and its true value is actually being eroded over time. That same $25,000 invested in real estate could be used to leverage the purchase of a property worth $125,000. That property could earn you rental profits of hundreds of dollars every month, is likely to appreciate in value over time, will gain equity with every mortgage payment that the tenants make for you, and can be used to create large tax write-offs in some years. The latter sounds like it will have a way bigger impact on your finances and path towards financial freedom, right?

Real Estate Investing Creates Multiple Income Streams

Each property is in effect a separate business and source of income. This can be a very powerful source of diversification and means to grow your total income. Every rent payment you receive is in effect an extra paycheck. One of the biggest benefits of this is actually the way it kills two birds with one stone from a financial planning point of view. You are achieving two goals at the same time; your money is being invested and now has the chance to grow and it’s generating additional monthly income. Every property you purchase represents a new source of income that is independent of your day job or other investments. You can use that income to fund your lifestyle or to invest and start compounding your return on investment.

You Have Control of the Business

Most stock market investors don’t have the ability to truly exert any strong influence on the way a company operates. Sure there are wealthy investors out there that own 5%+ of the outstanding shares in a company and can make their voting rights matter at corporate general meetings. But the average investor will never own enough shares in a multi-billion dollar company to be able to have their voice heard and get a say in how the company executives run the business. In real estate you directly own (at least partially) the asset in question has your name listed on the legal title. If there is a problem with the business or a change you would like to see made to better fit your investing goals, you can simply instruct your property manager or have a direct conversation with your active partner (like Dwell Logic).

If you own 1,000 shares or even 10,000 shares of Tesla, Elon Musk is not likely going to give you the time of day and let alone ask for your input on the company’s direction. If you own even a small 10% stake in an income property, then your input matters and has to be considered before any big decisions like selling or refinancing are made.

Less Red Tape

The government has complex rules that limit how much you can invest in your RRSP and TFSA each year. In the case of RRSP’s there are also restrictions on when and how much of your own money you can access each year. There are no arbitrary government restrictions on how much you can invest or withdraw from your real estate portfolio each year.  

Cons:

Real Estate Investing Requires Expertise and Special Training

Real estate transactions are a complex legal process and the most profitable investing strategies are often complex and require large amounts of time and effort on top of specialized knowledge. In addition each jurisdiction (i.e. province in the Canadian context) has unique legislation that governs the intricacies of landlord tenant relationships and property management in general. To succeed at real estate investing you have to either devote a great deal of time and effort to education and expertise before putting in the hard work required to actually execute a real estate investing business plan. Alternatively you can skip all this by partnering with an experienced investor/investing company like Dwell Logic! The cost to this, is that you have to share the profits with said partner. Your available time and degree of interest in real estate will decide which approach is best for you.

Risk Factor

Real Estate is a more risky asset class than something like bonds or GIC’s. All investments offer a return that somehow corresponds to the level of risk they entail. I think most financial advisors would agree with me that a well-structured and professionally managed real estate investment is more risky than a bond portfolio but less risky than an investing strategy focused on high growth stock trading. Both are common methods for retirement investing. With real estate you get a balance between the ability to generate a steady income stream and the risk of capitalizing on large jumps in market appreciation.

Real Estate is an Illiquid Asset

It can take several months to sell or refinance debt on a property and get your cash out. Having a home equity line of credit (HELOC) already in place helps to mitigate this but it is not a perfect solution. In short real estate is not the right investing vehicle for any funds you expect to need to access on short notice sometime in the next 12 months. A timeline of 2-5 years is often required to allow time for sudden changes in the economy or local housing market to run their course. A great quality investment of almost any asset type can be ruined by an inflexible liquidation schedule.

Real Estate is Not a Perfect Tax Shelter Like a TFSA

Through careful planning you can drastically reduce the total tax owed on your real estate profits. You can also determine when that tax is owed by choosing when to sell and use strategies like holding corporations or vendor take back mortgages to spread your profits across multiple years of income. However real estate will never be a perfect tax haven. If you make money you will eventually have to share at least a small portion of it with the government. It’s just the price we pay for living in an organized society. A TFSA holding stocks or bonds is a simpler and more efficient tax shelter than purchasing an income property. The drawbacks are that there are hard limits to how much you can invest annually, like real estate you can only invest after-tax income, and there are certain types of investments that you are not allowed to hold in a TFSA.

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