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.