Real Estate Is A High Performance
Long-Term Investment Vehicle
It is often said that time is on your side when it comes to investing in the stock market. This old adage also holds true with real estate, except that the returns over time are generally greater.
Leveraged and unleveraged real estate investments both compare favourably to stock market investments when historical returns are measured over multiple time frames.
As the chart illustrates, un-leveraged real estate outperformed the stock market over 5 years and 50% leveraged real estate outperformed the stock market over every period – including down markets.
Like stocks, real estate goes in cycles, and therefore you want to buy in an upswing market, in an area where people are moving to, where income is strong, and rents are going up or at least, are steady.
The Leveraged Investment Concept
While a bank would usually not put up 80% of the cost for an investment in stocks, bonds or mutual funds, a bank will provide up to 80% of the cost for an investment property, or even up to 100% if it is insured.
The chart below assumes a cash investment of $25,000 for a $100,000 property (for example a condo) and an
annual appreciation of 3%.
As you can see, in 25 years the property is worth over $200,000 and is still providing monthly income! You have increased your investment 8-fold. Even in the worst case scenario of flat real estate, you have an asset worth 4-fold, which you own 100% and which is still providing monthly income. Even if the real estate drops 50% in value (extremely unlikely) you have doubled your money.
Well-researched leveraged real estate investments, on the other hand, are not considered to be as risky because they are secured by real property - hence the name “real” estate - unlike stocks which often use factors like P/E ratios or projected future earnings to arrive at some share price. Remember ENRON ? They hid details about their debts in so called SPEs (Special Purpose Entity) to show higher profit. How about WorldCom ? Martha Stewart rings a bell ? Conrad Black and Hollinger International ? We like “real” assets with real value where real people pay real dollars every month, in every economy.
The Benefits Of A Leveraged Real Estate Investment
- An investment in stocks, bonds or mutual funds will buy the equivalent amount of equities. In other words, $50,000 buys $50,000 of equities, unless you buy on margin.
- A leveraged real estate investment buys real estate worth many times the down payment. A property worth $100,000 can be purchased with $20,000 down payment - or less if it is insured.
- You benefit from growth of the property total value, not just the original investment, which multiplies your returns.
- The principal of the mortgage is paid down by your tenant who essentially buys the investment for you.
Calculating Real Estate Returns
Unlike a stock where the only measurement of a return is the price increase of the equity (see chart above), there are 3 to 4 factors which contribute to the overall return in a real estate investment.
They are:
- Property Appreciation (the green area) – often the largest return over a 2-5 year horizon. This appreciation is tax free, until sold, like an RRSP, and then it is treated as capital gains which is taxed at only 50% of regular income !
- Principal Reduction of Mortgage (the blue area) adds to the equity but is paid by the tenant in the form of rent.
How The Investment Works On Your Behalf
- Your tenant or tenants pay down the mortgage which increases your return and essentially buys the investment for you.
- Each time your mortgage is reduced, your investment return increases.
- There is usually an initially small, later larger amount of money remaining each month even after mortgage and other expenses are covered (note this is usually taxable as income !).
- This money also contributes to your overall return.
- Even though you've only put up a portion of the cost of the entire investment, you benefit from the entire growth of the property value.
Income Streams From Real Estate
Once the principal on your investment is paid, or even well before it is paid off in its entirety, the monthly rental payments from your tenant become monthly income for you.
- Rent generally doubles in Canada every 15 years (this is over 4% annually – more than the 3% real estate growth we have assumed earlier !).
- Rental income is a great way to hedge against inflation as it increases with inflation, and in most cases at a quicker pace.
- Owning 5 or 6 properties, or a share in Prestigious Properties investments, can generate a substantial monthly income that will continue to increase with your life expectancy.
- The property is managed for you - there are no property management hassles (this is a major reason why many people shy away from real estate investments)—we make it easy for you!
- The key is POSTITIVE CASH FLOW: more money comes in than flows out! This is not possible in many parts of the world because prices are so high that rental properties don’t make sense unless purchased with very large down payments such that ROI’s get smaller and smaller.
