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Real estate: Critical questions in today's questionable market

Contributor: MRSB consultant Rob McCloskey, MBA

Among the various options that exist for financial investment, no other entices such widespread interest as real estate. Long touted as the foundation for your portfolio, and despite our willingness to over-extend ourselves to acquire it, real estate is becoming increasingly criticised by academics, investors, analysts, and even the Bank of Canada. We consumers and investors are left wondering what to believe. On one hand we read warnings about the real-estate market in Canada and its “long overdue bubble burst”.  On the other hand we read stories of sustained growth and strength in this market on a national scale – suggesting we “buy in now” before we’re priced out of the market. Furthermore, we’re intrigued by the idea of large returns and eventual financial security that real estate has provided many Canadians in the past. 

Real estate is traditionally the largest single investment a person makes. Couple that with the fact that this investment is supposed to provide us with considerable return upon sale and act as a physical roof over our head in the meantime, and it’s obvious why emotions play a role.

So what are we to do? Do we invest or not? Rent or buy? Expand our portfolio to include an income property? These decisions are very delicate ones, and should be made with as little emotional influence as possible. Here are my top tips for deciding whether to jump into the market, dip your feet, or stay out of the pool altogether.

Think about the 'where' as much as the 'what'

In preparing a thesis on this very subject in graduate school, I was moved by the reference that until only the last twenty years or so, housing was thought of as a manufactured product. It was, essentially, a box to live in. It held value, but it wasn’t the wealth creation engine we expect it to be now. As difficult as it has been, I have made every effort to think of real estate in this regard – this would be my first piece of advice regarding real estate investing.

It could also be paraphrased as the age old, “location, location, location.” A wise family friend once told me, “buy the ugliest house on the prettiest street.” I laughed at the time, but he had a point. If we strip real estate back to its core, we’re buying a piece of land, and that land should be chosen to carry its own share of the total value. A neighbourhood that’s walkable with good schools and is close to centres of employment will always be a safe bet. If that doesn’t tickle your fancy and you crave more space, seek rural property that’s close to basic amenities. This part is important, but we’re talking about real estate, so eventually we have to talk about money. 

Heed your finanical limits

Now that you’ve found the perfect piece of property that may or may not have the perfect house on it, step two involves financing, and this is where things get complicated. Here are some of the concerns our friends the academics, investors, analysts, and the Bank of Canada have addressed that directly relate to real estate investment:

  • Household credit: Total household debt in Canada is now >160% of disposable income, totalling $1.82 trillion, of which 1.3 trillion is for residential mortgages
  • Housing prices: Since the 1990’s, Canadian house prices have enjoyed an unprecedented and basically uninterrupted rise. This has obviously impacted certain areas of Canada greater than others – take Toronto, where the average detached single-family home sells for over $1 million. Or try Vancouver, now ranked the second least affordable city in the world. In December the Bank of Canada suggested prices were overvalued by as much as 30% in Canada.
  •  Interest rates: Rates, especially those on residential mortgages, have continued to be low. This has driven consumer spending on real estate, and potentially influenced people to spend more than originally planned. The concern going forward is serving this debt should interest rates rise.


          (Graphic presented by, 2015)


So, that was bleak.

With this information in hand, my second tip for smart real estate investing is to know your financial limit, play within it, and if you cannot find anything in that range, wait until you can. Many analysts have provided recent documentation suggesting that in many cities it makes good financial sense to rent until you reach a point where you need to buy (family expansion, etc.) or can truly afford to buy. The most important ratio to remember here is the debt service charges of your real estate investments compared to your income. The general rule is that your mortgage payment, including principal, interest, real estate taxes, and homeowners insurance, should not exceed 28% of your gross monthly income. It’s easy to understand how people struggle with this ratio, especially as home prices continue to rise, significantly outpacing income growth.

Expand your portfolio, when possible

But let’s say that you’ve found the right house, in the right location,  it’s within your financial limit AND it presents an acceptable mortgage to income ratio. What is tip three? Tip three involves your overall portfolio. Benoit Poliquin, chief investment officer of Exponent Investment Management Inc., is just one of any number of investment analysts who will tell you, “don’t put all your eggs in one basket.” It is always a concern when one asset class is the overwhelming feature of a portfolio, real estate being no exception. Even more worrisome is investors who carry their primary residence as the perceived largest potential revenue generator in their retirement portfolio. These people are subjecting themselves to incredible real estate market risk, should Canada find itself in a prolonged period of housing price decline.

However, let’s say you have your house and everything is fine, but what you’re really interested in is adding investment properties to your portfolio. Tip number one still applies. In fact, it’s even more strategic. If you want renters, you want to be in the right area. Don’t rush into this. My first rental property (which I still own), is two blocks from a college. In other words, my income property is two blocks south of a tenant producing factory. If students aren’t your thing, target areas that reflect the type of tenant you want. 

The potential for investment in income properties is still based around your financial capacity, so tip two also still applies here. Banks will require a larger down payment as this is not your primary residence (note: if you’re buying an income property as your primary residence, A+ for you). Be cognizant of the fact that you’ll have to carry any empty units in the building with your own income or any potential income the building is generating.

The larger issue remains the impact these properties will have on your overall investment portfolio, I mean, they’re supposed to be INCOME properties, right!? 

Real estate investments are unique as retirement vehicles. RRSPs are required to pay out their value with specific minimums at predetermined times. There is no such measure in place for real estate investments. Furthermore, these are often leveraged investments, meaning only a small portion of the eventual sale value is return for the investor. This will, of course, grow with time, but don’t expect rapid financial reward with income properties. This is a slow and steady game.

With income properties, as with primary residences, it’s best to play it safe, do your homework and talk to both your investment manager and banker. You want this significant investment to work in your favour in the long run, and to provide you with endless years of happiness, not headache.

A closing, and somewhat humbling, thought is to remember that all gains in real estate are speculative, current value is subjective, and future returns are uncertain. When put in this context, real estate sounds just like the stock market, and you wouldn't go all-in with your stock broker if you couldn't afford to take a loss; you’d play it safe. Real estate is the same. Play it smart, try to limit emotional decisions, find a home or income property that works for you, make it great, and enjoy it for many years. When it comes time to sell, hopefully your prudence will pay off with financial return. 

Supporting PEI's food banks

As one of our fundraising initiatives for 2015, the MRSB Audit & Accounting and Bookkeeping & Reporting teams issued a challenge to all divisions of MRSB Group - to collect items for the Charlottetown and Summerside food banks for their Easter season.


The staff at both our Charlottetown and Summerside offices rose to the challenge and, as you can see from the photos, we successfully collected several boxes worth of non-perishable food items for both food banks. 

If you are interested in supporting the food banks, visit their websites for information on how you can give:



Deciphering the CRA's foreign property question

Contributor: MRSB senior tax manager John Connolly, CPA, CMA


"Did you own or hold foreign property at any time during the taxation year with a total cost of more than CAN$100,000?"

Canada Revenue Agency (CRA) has been asking taxpayers this question on their personal tax return since 1998. If the answer is YES, then you must report the details of your foreign property to CRA on form T1135.

Unfortunately, what appears to be a simple question is a potential trap for the unwary or inexperienced. Those who are not familiar with the technicalities of the Income Tax Act can easily answer this question incorrectly. The result can be an expensive penalty for not filing form T1135 when it was required. Collecting unpaid taxes on unreported foreign income (accidental or deliberate) is the flavour of the month for governments looking to boost their revenue, and CRA is giving it a lot more attention now. So, let me provide you with some advice that can help clarify what each little word in the CRA’s foreign property question really means!

Sometimes the words “at any time” get overlooked as people (understandably) sometimes think only of what they owned at the end of the year. A person who owned foreign investments that cost over $100,000 on December 31st 2013, and sold it all on January 2nd 2014 is over the limit, and must file form T1135 for 2014.

Often, the broad meaning of “property” is not understood, as many people think of property only as real estate. They think the answer must be 'no', because they do not own any real estate outside of Canada, or they paid less than $100,000 for their foreign real estate. But “property” for tax purposes includes any type of physical object. It also includes intangible property such as shares of a company, bonds, units of a mutual fund, a patent, or a copyright. Property also includes money. A bank account, term deposit or GIC are all property. A personal loan is property even if you are not charging interest on it.

A life insurance policy is also property. A foreign life insurance policy is “foreign property” that counts towards the $100,000 and must be reported if you are over the limit. Its cost is not simply the total of the premiums that were paid. Rather, there are complicated rules in the Income Tax Act for determining its cost. Not only that, a foreign life insurance policy may cause taxable income while you are alive, and the death benefit may be taxable. Canadian life insurance companies follow complex rules in the Income Tax Act to ensure that this does not happen with most Canadian life insurance policies, and to ensure that their clients are fully informed when they buy a taxable policy.

Now that you have a better understanding of the word “property” from a tax perspective, let’s tackle “foreign”. You may think that your stock market investments are not foreign because you use a Canadian broker and have a Canadian dollar investment account. Shares and bonds of a foreign company are always foreign property whether you hold them personally, hold them in a Canadian brokerage account, or hold them in a foreign brokerage account. This is true regardless of whether or not the account is a Canadian dollar account. To make things a bit more confusing, the reverse is not true for shares and bonds of a Canadian company. Everything that is held in an investment account in another country is foreign property, including Canadian dollar deposits and shares or bonds of Canadian companies.

Whether or not a mutual fund is “foreign” depends on where it is resident regardless of what it invests in. A mutual fund resident in Canada is not foreign property even if the only thing that it owns is shares of foreign companies. A mutual fund resident outside of Canada is foreign property even if the only thing that it owns is shares of Canadian companies. Still with me?

Ok, here’s another one for you. The words “total cost” can be misinterpreted, because the cost of some properties involve a number of expenses incurred at different times. For example, if a person builds a cottage outside Canada and spends $20,000 for land, $5,000 for legal fees & permits, and $70,000 for construction, then the total cost of the cottage is $95,000. This sort of thing leads some people to misinterpret CRA’s question because they think of the total cost on an item by item basis. A person who owns that cottage and also owns shares of a foreign company that cost $10,000 may not realize that the “total cost” of their foreign property is $105,000. They are over the limit if the cottage is not for personal use.

Sometimes borrowed money causes a misunderstanding of what CRA is looking for in terms of “total cost”. The cost of a property is generally the amount that was paid for it regardless of where the money came from. Money borrowed to buy a foreign property is not deducted when determining its cost, even if the loan is from a foreign lender.

To complicate things a little more, the "cost" of a property for tax purposes is not always what was paid for it. The Income Tax Act includes a variety of rules that change the cost (for tax purposes) from the actual cost of the property to its fair market value when a particular event occurs. Receiving property as a gift or inheritance, immigration to Canada, and changing the use of a property from personal to income earning are some of the events that will trigger these rules.

Last but not least baffling, even CRA's interpretation of the words "own or hold" can be problematic. The attribution rules in the Income Tax Act say that if you give an income earning property or investment to a related minor, then you must report the income it generates on your tax return. From CRA's point of view, if you made such a gift of foreign property, you ust count that property's cost towards the $100,000 reporting threshold and report it on your T1135 if you are over the limit.

Personal use property does not have to be reported to CRA on form T1135, and does not count towards the $100,000 threshold. However, it is not always clear what is personal use property. A vacation property outside of Canada would typically be thought of as personal use property, but some people rent their vacation property for part of the year. If the property is available for rent more than half the year, or if the owner could reasonably be expected to make a profit on the rent, then CRA may not consider it personal use property.

Luckily, if you are a recent immigrant to Canada, there may be some good news. There is a one-year exemption from reporting foreign property the year a person "first becomes a resident of Canada". The word "first" is important. If the person was ever a resident of Canada in the past and is returning to the country, this exemption does not apply to them. Of course, the income earned on foreign property must be reported every year regardless of whether or not this exemption applies.

A person may be tempted to send CRA the T1135 form with copies of their investment account statements attached. Don't do it! If the information is not provided in exactly the same format as the form, CRA considers it incomplete. They can assess the same penalities as if the form were never filed. What you should do is contact your investment advisor and ask if they can provide a report in CRA's required format. If this isn't an option, your accountant can help you complete the form.

The amount of information CRA is asking for on the new T1135 form can be overwhelming for first-timers. When in doubt, do some extra research on CRA's website, call your investment advisor or pay your accountant a visit. Even if you don't have the time or energy to decipher the rules yourself, tax accountants like myself are always happy to translate them for you!