“Is real estate a good investment?” “Is buying a house a good investment, or is investing in a commercial property a better idea?” are just two of the questions that real estate agents get asked often. Long-term real estate investments have historically generated excellent returns. However, how much you pay for the property, how much it appreciates, and how long it takes to build an ROI comparable to or better than other investments varies greatly.
If you’re wondering, “Is investing in real estate worth it?” read on and let us help you decide if it’s right for you.
- Average Rate of Return on Real Estate
- Are Real Estate Investments Safe
- Steps to Help You Get Started Investing
- Is Buying a House a Good Investment?
What is the Average Rate of Return on a Real Estate Investment?
For most investors, the appeal of real estate as an investment vehicle is the promise of a strong overall return and the opportunity for a steady monthly income from the rental of the property to residential, multi-family or commercial tenants.
But what does the data say? Let’s look at the numbers and determine what profits investors in real estate in Canada can expect.
Understanding the Components of Real Estate ROI
Why is real estate a good investment? Two primary components contribute to real estate’s potential for a significant return on investment: capital appreciation and rental income.
Capital appreciation refers to the increase in the property’s value over time. Rental income represents the revenue an investor could receive from tenants. The profits from both components vary based on factors such as the property type, location, condition and real estate market trends, as well as on external economic conditions.
Capital Appreciation
Property prices tend to rise over the long term – and historically, real estate has been a good investment in terms of capital appreciation – but keep in mind that future market performance might not mirror past trends.
So, is investing in real estate worth it? According to Canadian Real Estate Association (CREA) stats, there’s no doubt about it.
Over the past few decades, the average annual rate of return for Canadian real estate investments has been around 7-10% for residential properties and 8-12% for commercial properties.
And what’s more, the CREA HPI (Home Price Index), which tracks prices in 60 areas (in 9 provinces and 51 cities or residential areas), shows that over the past 10 years:
- There is no area tracked where the HPI has declined in the last decade.
- The lowest of the 51 areas tracked increased by 5.2%
- The highest of the 51 areas tracked increased by 220.4%
- 35 of the 51 areas tracked saw an increase of 100.0% or more
- The average of the 51 areas tracked is a 109.1% increase
Because this sort of rapid appreciation isn’t the norm, it shouldn’t be the only reason to invest in real estate, and that’s where rental income comes into play.
Rental Income
Rental income, the other important component of ROI, can provide a steady income stream to property investors. Typically, rental yield, or annual net rental income expressed as a percentage of the property’s value, ranges between 3% and 5% for residential properties.
Combining The Annual Return from Capital Appreciation and Rental Income
Over the past decade, the combined annual return from capital appreciation and rental income has ranged from 8% to 10%. Again, this is simply an average, and individual returns can vary widely, as illustrated in the stats above,
Are Real Estate Investments Safe?
As long as you buy property at the right price in an area where market data gives you confidence that the value will rise, real estate is safe and lucrative.
In fact, real estate tends to have less volatility when compared to stocks and bonds. With real estate, you can minimize risk by holding on to your property longer should there be a drop from the price you paid and continue to build equity as you wait for prices to rebound. When you’ve built enough, you can leverage your equity to qualify for HELOCs and home equity loans, which can help you renovate or invest in more property.
Real estate is a safe investment because:
- It will almost always increase in value over time
- It has a high tangible asset value
- It adds diversity and helps reduce risk in your overall investment portfolio
- It comes with tax benefits
Steps to Help You Get Started Investing
Property investment takes planning and budgeting. Here are some steps to help you get started:
Clear Your Debts
Start paying down your debt as soon as possible to establish a strong credit rating. This step is also crucial as the less debt you carry, the easier it is to qualify for a mortgage.
Start Saving
As your debt is paid down, start putting money aside for the down payment on your first property. Make this a habit, and the next thing you know, you‘ll be ready to purchase your first residential or commercial property.
Do Your Research
Important things to research and explore include real estate investment tactics and timing, how to evaluate market trends and how to find up-and-coming neighbourhoods in your city.
Find a Trusted Agent
Work with a trusted agent to find the best properties with the best growth potential.
Find Your First Purchase
If you don’t already own your own home, you’ll need to save enough for your down payment and scope out your first potential purchase. What you want is a small, affordable house in an up-and-coming neighbourhood to help ensure you can sell it for more later. It’s best to put down at least a 20% down payment, as not only does your down payment directly affect the mortgage amount you borrow and the mortgage terms you get, but it also impacts what you’ll pay in interest over the life of your mortgage. Additionally, you won’t need to buy mortgage insurance. It’s also a good idea to only purchase a home with mortgage payments less than your current rent.
Save Again
Continue to save so that you can look for your next property. You’ll want to make this one a space you can rent to a tenant, so make sure you are buying in an area that will provide you with enough rent to fully cover your mortgage payments plus all applicable taxes and home insurance. Don’t overlook fixer-uppers that you can upgrade with minimal investment to get more rent. Ideally, you will not just break even but also accumulate a few hundred dollars per month to put toward your next real estate purchase. This money will also come in handy to cover maintenance costs.
Pay Down Your Mortgages
Your goal should always be to pay down your mortgage as soon as possible. If you pay off your mortgage or see a potential gain in selling your home, that’s how you begin to grow your real estate portfolio.
Is Buying a House a Good Investment?
For the rookie real estate investor, purchasing a house represents the best of both worlds. As a rental property, it can provide an additional income while offering an investment that will also appreciate over time.
You can choose from two types of rental opportunities:
- Single-family: You rent out the entire house or condo to one tenant.
- Multi-family: You rent separate units to separate tenants on each floor.
- Many factors will affect how much you can make from each type of rental investment. Here is a comparison between the two:
- Single Family Homes
Advantages:
- Typically appreciate faster
- Easier to sell, making them more liquid
- Just one tenant to find and deal with
- No need to worry about complaints and issues among tenants
- Easier to collect bills and set up utility payments
- Easier to finance
Disadvantages:
- In most cases, there will be less cash flow generated than with a multi-family home
- Can be riskier if you end up with a bad tenant who does not pay rent or skips out
- Harder to find a good tenant as you have to charge quite a bit for rent
- No economies of scale if you want to hire a property manager
Multi-Family Homes
Advantages:
- Better cash flow with more units
- Lower unit price makes it easier to find tenants
- If one tenant is a dud or moves, you still have the cash flow to help cover your expenses
- Economies of scale
- Less expensive to manage on a per-unit basis
Disadvantages:
- Higher maintenance costs due to more people, more appliances to repair, more tenant turnover, and so on
- Takes more of your time as there are more tenants to worry about, collect rent from
- Slower appreciation in value
- Fewer buyers when you want to sell
- More potential tenant complaints about things such as noise, messiness, smells and more
- More challenging to find financing
Is Real Estate a Good Investment? You Asked, We Answered
Real estate investment lets people grow their net worth by amassing more and more properties. It’s a good investment in the long term due to appreciation and the potential for steady rental income to cover the mortgage, maintenance costs, and other costs. As you pay down your mortgage, you build equity, which can be leveraged to help you land a HELOC or home equity loan to finance renovations that will drive your home value higher or help finance your next property.
Since the real estate market is substantially less volatile than the stock market, investing in real estate is considered less risky than investing in stocks and bonds, making real estate a safer investment than many other options. As well, by adding real estate holdings to your overall investment portfolio, you add diversification that can help when other investments experience pullbacks.
Ready to start on the road to real estate investing? Connect with a RE/MAX agent and see the difference that adding an experienced real estate professional to your investing team can make.
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