When I was growing up, my parents were slowly accumulating a portfolio of rental properties, a portfolio that ended up being somewhat impressive. In fact, all my Dad does for a living now is manage his rental properties. They keep him pretty busy too, it’s pretty close to a full time job between collecting rent and fixing stuff. He obviously loves real estate and he does a great job with his properties.
I also have investment properties. While my portfolio isn’t nearly the size of my Dad’s, I do have 3 properties that are completely paid for. If you add in the income I get from renting my basement, I have a very nice sideline income coming from rental properties.
I bought my last investment property 5 years ago and the house I live in 2 years ago. I don’t classify my house as an investment, as soon as I get a girl to move in with me (soon, bride from Russia, soon!) I’ll punt out the guy living in my basement so we have room to do the hanky panky all over the house put all of my girl’s crap.
Why am I not buying any more investment properties? There are all sorts of reasons.
Canadian Real Estate Is Overvalued
As a whole, Canadian real estate prices are sitting at record highs. Record low interest rates have helped keep prices up, as well as frenzied first time buyers who worry about future affordable housing. If you put these two things together (among other factors) and you have Canadian homeownership rates at 70% of the population, another number that is the highest ever. Interestingly, the U.S. real estate market peaked right around 70% in 2005.
I never really cared about price appreciation as a real estate investor. I knew that over the life of the house the value would go up, but I didn’t anticipate much more than inflation. For me, real estate was strictly a cash flow investment and any capital appreciation was just gravy.
Nobody Rents Anymore
Further to the first point, if the percentage of the population that owns a home is high, then the percentage of people who rent must be really low. Because of this, landlords are having to compete for good tenants, offering rents that are often cheaper than what the tenant could buy the place for. What a great place to be in for the tenant. Low interest rates are turning lots of good renters into first time buyers, often at a younger age than even 10 years ago.
Cap Rates Are Horrible
When I bought my houses back in the 2002-2005 range, real estate was an absolutely outstanding investment. I could borrow money at 5% and get 15-20% cap rates. Now, I live in a small town, maybe those return numbers just didn’t exist in the cities at that time. For me, I regret not buying more properties during that time. It just shows how an asset class can get very attractive when it’s unloved.
These days, cap rates are horrible. I can borrow money cheaper than before, but cap rates are only 5 or 6 percent. By the time I pay my property taxes and fix anything, I lose money. I am absolutely amazed anybody would borrow money to buy an investment they knowingly have to subsidize every month.
Leverage Makes It Risky
In general, real estate is one of the riskier asset classes. There’s always the small chance of something going horribly wrong, something that’ll cost thousands of dollars to remedy. I was okay with that- when I got a return 3-4 times what my carrying costs were. Returns aren’t anywhere near high enough these days to compensate me for the additional risk.
Leverage inherently makes an investment riskier. If you have a house worth $100k and you put $20k as a down payment on it, a 5% drop in the property’s value represents a 25% loss on your original down payment.
Be fearful when others are greedy. Be greedy when others are fearful.
Simply put, buying an asset at the top of the market generally turns out to be a bad idea. As Warren Buffett has famously said “be fearful when others are greedy and be greedy when others are fearful.”
I’m confident that real estate will look like a much better investment in Canada in 5 years. Cap rates will be up and investors will once again be compensated for the additional risk they’re forced to take on.
Maybe Look At U.S. Real Estate
There are areas of the U.S. where real estate is ridiculously cheap. Perhaps they aren’t at a bottom yet, but I think they’re close enough an investor shouldn’t care about the last 10% or so in price declines. I’m not buying any down there simply because I don’t want to be an absentee landlord. I think we’ll all look back on this decline as the fire sale of the century.
Are any Canadian readers actually buying investment real estate these days? What’s the thought process if you are?