I decided to write this post because it’s an interesting topic as more and more people looking for different ways to build wealth. Some people build wealth by investing in real estate, others build wealth by investing in stocks.
Just to be clear when I talk about real estate I’m talking about rental properties, and when I mention REIT I’m talking about Residential Real Estate Investment Trust.
Rental property
Rental property is not considered as your primary residence. Rental property is when you buy a property and rent it out. You become a landlord and you collect rental income from your tenants.
REIT
When you invest in REITs, you don’t own any properties, you only own units in that trust. REITs raise money by issuing units. Usually they raise millions of dollars to fund property acquisitions. They manage rental properties, collect rent and distribute profits to unit holders. Most REITs in Canada pay distribution / dividend every month.
So now you know the difference between real estate and REIT.
Let’s move forward.
So the questions is. Is it better to invest in real estate rentals or invest in REIT instead? To be honest, the answer will depend on numerous of factors. There are so many different situations. It will depend on the location, property price, return on investment, and the actual investor. Are you willing to the risk of being the landlord? Would you be able to handle bad tenants? Can you do minor renovations to upgrade your property and increase rent? The list goes on and on.
Now I’m going to show two scenarios of two investors.
Rental Property
Let’s assume you bought a 2 bedroom condo for $250,000 with $50,000 down. You financed $200,000 for 25 years with 3.5% rate. Your monthly property cost would be:
Total monthly cost – 1,480
That means to break even you need to rent your property for at least $1,500 per month. It’s not easy to find a tenant in Montreal who will pay $1,500 rent for a 2 bedroom place. The average rent rate in Montreal for a BDR is about $1,300. But let’s assume you found a tenant who paid you rent $1,500 per month for 10 years. The $1,500 per month equals to $18,000 per year or $180,000 for the span of 10 years.
Let’s assume you want to sell the property in 10 years because you want to pursue other opportunities or bigger rental deals. Let’s see how much money your initial $50,000 investment made.
Property Sale
You sell the condo for $350,000 and book $100,000 of capital gains. If you sold the property with an agent, factor in 5 - 6% commission from the sales price (350,000*5-6%=$20,000). Your net capital gain is now $80,000 which is also taxable.
In the span of 10 years you also built an equity by paying off your mortgage. Assuming that out of $1,000 for mortgage payments, $600 was used to pay the principal amount and $400 was used to pay for interest. That means that that every year you earned $7,200 ($600*12) in equity, or $72,000 earned in equity in 10 years. After 10 years you would owe the bank $128,000 ($200,000-$72,000).
Here’s how much money you would make from selling the condo.
You sell for $350,000 – $20,000 commission - $128,000 mortgage balance = $202,000.
Return on Investment – Rental Property
So after 10 years your initial investment of $50,000 turned into $202,000. Keep in mind I’m not factoring in any taxes, repairs, vacancies, rate increases, etc.
REIT
Now let’s see how much money you would make if you invested $50,000 in REIT 10 years ago. Since I’m comparing residential properties, it would make sense to invest in residential REIT as oppose to retail, office, or industrial REITs. A good Canadian large cap REIT is CAPREIT (CAR/UN.TO) traded on the Toronto Stock Exchange. They buy big apartment buildings, invest in upgrades and renovations and increase rents to maximize returns. For example, they buy a building with an average $900 rent, invest $5,000 in each unit to do the floors, countertops and fresh paint and rent them back for $1,100. The increase in rent will pay back for renovations in 2 years and then it’s pure profit! That’s what that company is focused on.
Return on Investment
Anyway, assuming you invested $50,000 in CAPREIT 10 years ago. Back then the stock price was about $13 per share. For $50,000 you would have bought 3,845 shares of CAPREIT. Since then the stock price is up by 291%, trading at around $50 per share. If you were to sell your shares, you would receive $192,250 and your capital gain would have been $142,250. Keep in mind that only 50% of capital gains are taxed. That means you would need to pay the tax on $71,725.
CAPREIT also pays a monthly dividend at the yearly rate of 3%. After 10 years of investing you would earn at least $20,000 in dividends.
The total return on investment would be $192,250 + $20,000 = $212,250. That’s slightly more compared to the rental property.
Conclusion
As you can see both wealth building strategies are good. As long as you invest in a good rental property, or a good residential REIT, you will do fine in the long run. Do your homework and make sure you understand that you’re getting into before investing hard earned money.
Just to be clear when I talk about real estate I’m talking about rental properties, and when I mention REIT I’m talking about Residential Real Estate Investment Trust.
Rental property
Rental property is not considered as your primary residence. Rental property is when you buy a property and rent it out. You become a landlord and you collect rental income from your tenants.
REIT
When you invest in REITs, you don’t own any properties, you only own units in that trust. REITs raise money by issuing units. Usually they raise millions of dollars to fund property acquisitions. They manage rental properties, collect rent and distribute profits to unit holders. Most REITs in Canada pay distribution / dividend every month.
So now you know the difference between real estate and REIT.
Let’s move forward.
So the questions is. Is it better to invest in real estate rentals or invest in REIT instead? To be honest, the answer will depend on numerous of factors. There are so many different situations. It will depend on the location, property price, return on investment, and the actual investor. Are you willing to the risk of being the landlord? Would you be able to handle bad tenants? Can you do minor renovations to upgrade your property and increase rent? The list goes on and on.
Now I’m going to show two scenarios of two investors.
One invested in real estate, the other in REIT in the span of 10 years.
Rental Property
Let’s assume you bought a 2 bedroom condo for $250,000 with $50,000 down. You financed $200,000 for 25 years with 3.5% rate. Your monthly property cost would be:
- Mortgage – 1,000
- Property Tax – 200
- Condo Fees – 200
- School Tax – 40
- Insurance – 40
Total monthly cost – 1,480
That means to break even you need to rent your property for at least $1,500 per month. It’s not easy to find a tenant in Montreal who will pay $1,500 rent for a 2 bedroom place. The average rent rate in Montreal for a BDR is about $1,300. But let’s assume you found a tenant who paid you rent $1,500 per month for 10 years. The $1,500 per month equals to $18,000 per year or $180,000 for the span of 10 years.
Let’s assume you want to sell the property in 10 years because you want to pursue other opportunities or bigger rental deals. Let’s see how much money your initial $50,000 investment made.
Property Sale
You sell the condo for $350,000 and book $100,000 of capital gains. If you sold the property with an agent, factor in 5 - 6% commission from the sales price (350,000*5-6%=$20,000). Your net capital gain is now $80,000 which is also taxable.
In the span of 10 years you also built an equity by paying off your mortgage. Assuming that out of $1,000 for mortgage payments, $600 was used to pay the principal amount and $400 was used to pay for interest. That means that that every year you earned $7,200 ($600*12) in equity, or $72,000 earned in equity in 10 years. After 10 years you would owe the bank $128,000 ($200,000-$72,000).
Here’s how much money you would make from selling the condo.
You sell for $350,000 – $20,000 commission - $128,000 mortgage balance = $202,000.
Return on Investment – Rental Property
So after 10 years your initial investment of $50,000 turned into $202,000. Keep in mind I’m not factoring in any taxes, repairs, vacancies, rate increases, etc.
REIT
Now let’s see how much money you would make if you invested $50,000 in REIT 10 years ago. Since I’m comparing residential properties, it would make sense to invest in residential REIT as oppose to retail, office, or industrial REITs. A good Canadian large cap REIT is CAPREIT (CAR/UN.TO) traded on the Toronto Stock Exchange. They buy big apartment buildings, invest in upgrades and renovations and increase rents to maximize returns. For example, they buy a building with an average $900 rent, invest $5,000 in each unit to do the floors, countertops and fresh paint and rent them back for $1,100. The increase in rent will pay back for renovations in 2 years and then it’s pure profit! That’s what that company is focused on.
Return on Investment
Anyway, assuming you invested $50,000 in CAPREIT 10 years ago. Back then the stock price was about $13 per share. For $50,000 you would have bought 3,845 shares of CAPREIT. Since then the stock price is up by 291%, trading at around $50 per share. If you were to sell your shares, you would receive $192,250 and your capital gain would have been $142,250. Keep in mind that only 50% of capital gains are taxed. That means you would need to pay the tax on $71,725.
CAPREIT also pays a monthly dividend at the yearly rate of 3%. After 10 years of investing you would earn at least $20,000 in dividends.
The total return on investment would be $192,250 + $20,000 = $212,250. That’s slightly more compared to the rental property.
Conclusion
As you can see both wealth building strategies are good. As long as you invest in a good rental property, or a good residential REIT, you will do fine in the long run. Do your homework and make sure you understand that you’re getting into before investing hard earned money.
Interesting. Never heard of a school tax thought that was just built into property taxes. Maybe thats a Quebec thing.
ReplyDeleteNice writeup, and imagine how much higher that total would be if you were dripping those shares the whole time.
Now cap reit is also a stand alone reit. Most of them havent performed that well..
cheers man!
Yeah, probably it's only in Quebec that we pay school tax separately. If you left those shares DRIP, you would make much more. Also I did not factor in dividend raises, which CAPREIT tend to do every year. Other residential reits did pretty well too. For example IIP.UN is up by 1,134% in the last 10 years. KMP.UN was formed 3 years ago and it's already up by 77%. The only one that didn't perform well is BEI.UN. It's up 60% from 10 years ago, but that's because of Alberta housing market. Alberta economy is finally turning around which will benefit Boardwalk. Cheers!
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