It so happens that I got into investment real estate at the right time, which was literally at the bottom of the economic crisis in November 2008. When I was signing the papers, it seemed like the worst time to be closing on one of the largest financial transactions I had done up until that point, but fast-forward over 10years, and the timing couldn’t have been better.
My first building was a 21-unit apartment building in an area known as the Toronto Beaches.I bought my second building in 2009, the next in 2010, and the next in 2011– all in Toronto– and my fourth in South Florida in 2012.
The CAP rate on my first property was 8.5%, a number that’s unimaginably high by today’s low CAP rate standards. The other properties all had CAP rates north of 6%, and the South Florida property was close to 9%.
My timing into the market was obviously excellent, considering where we are today, so it’s easy to be a hero and suggest, for those looking to get into real estate, that they should purchase their own property rather than a REIT, but the reality isn’t necessarily as straightforward.
If I wanted to diversify into investment real estate today, would I buy my own property or a REIT? The answer depends on whether I’m looking for a long-term buy and hold or a buy and flip.
In the meantime, I’ve been looking for another building for the last couple of years. I’ve been to visit a dozen or so properties, all with CAP rates in the 3–4% range. It so happens that all of the properties I’ve looked at have been in Toronto, but I also keep an eye on the South Florida market, and once again, I’m not pulling the trigger there either.
REITs vs Real Estate Ownership: Should You Buy Your Own Real Estate Property or Invest in a REIT?
Having said the above, should I happen to find the right property– and that includes a property with rents well below market, in a building with good bones that needs work, in a great area– then I would definitely consider another purchase. The problem is, the rest of the world is looking for a similar type of property, so there’s plenty of competition, and that’s what is compressing CAP rates and margins.
So while I wait for the right property, I have been investing in a number of Canadian and American REITs, which clearly have their advantages.
So which should you choose? Let’s look at the advantages of our options.
Advantages of a REIT:
There are obviously some clear advantages to buying a REIT, the top few being liquidity, diversification, and ease of entry into the market.
Once you’ve decided which REIT you would like to buy, whether in the US or Canadian market, you’re literally 10 clicks and seconds away from being a new landlord, without the headache of dealing with bank mortgages, leaking toilets, roofs, or brick tuck-pointing.
Better yet, once you’ve decided that you no longer want to be a landlord (i.e., it’s time to sell the REIT), you’re once again 10 clicks away from cashing out, all within seconds.
When I decided in 2016 that I wanted to sell one of my buildings, it took almost six months to find an agent, provide all of the building financials, find a buyer, and close on the property. And whatever return I received on the building itself, which was fantastic, was eaten away by the 5% realty commissions.
There are so many REITs in Canada and the US that it’s almost hard to decide which one to buy, so to make things simple, you can buy them all. Almost literally.
You can buy a REIT ETF like the Vanguard Realty ETF (symbol VNQ) or the iShares S&P/TSX CAP REIT (symbol XRE) as two possible options. VNQ is an American REIT, and XRE is Canadian, and both ETFs own dozens of securities.
If you’re going to purchase individual REITs, you need to do your due diligence and research their prior performance, holdings, management, growth prospects, and financials.
You have the option of a public REIT, which you can purchase on the stock exchange, or you can also purchase a private REIT, which is not as liquid but is much less volatile.
In regards to your overall returns, that’s where things get tricky. You’re not always comparing apples to apples, even in the REIT space. For example, take a look at two REITs, both in the office sector, with very different results.
Boston Properties(symbol BXP)vs Office Properties Income(symbol OPI). One has a positive return of 195%, and the other has a loss of 66%, so it’s not as simple as just purchasing a REIT and leaving it alone. You really need to look at this as if you were the business owner.
Again, if you don’t have the time or inclination to research the various REITs, it makes sense to just purchase a REIT ETF.
Getting back to the Vanguard ETF (symbol VNQ) I was discussing above, the 10-year returns are super impressive with a compounded yearly return of over 15%. Your initial $10,000 investment made in June 2009 would now be worth over $40,000. Keep in mind, June 2009 was the depths of the economic recession, and it’s quite unlikely the next 10years will produce a similar type of return. According to the economic crystal ball reader, we’re likely headed into a recession in the next 18months now that the yield curve is seriously inverted.
Advantages of Property Ownership – Real Estate
There are some clear advantages, some financial and some life-related, to owning an investment property.
3 Advantages to Direct Investment Real Estate Ownership
- Life happens. People lose their jobs, get sick, and so on. If you have an income-producing property with some positive cash flow, and something happens on the personal front, then your property will continue to provide an income. Maybe even more importantly, as long as you continue to cover the mortgage, you’ll always have a roof over your head.
- If you own the property long enough, and the mortgage is paid off, you can leave your income-producing property to your kids when you pass, and they too can benefit from the passive income stream. It feels better passing an investment property than shares of VNQ.
- There’s a visceral feeling I get when I walk into my own property. It’s something I can touch, feel, and see. I have the control to make my own decisions in regards to how the property is run, and I can control the returns. These decisions aren’t getting made by some unknown entity, but rather I am calculating the risks and reaping the rewards.
The Financial Rewards of Direct Property Ownership
I’ve discussed in other blog posts how a building’s value is calculated. I’ve also addressed the multiplier effect on the value of a building when you increase the rents. This is where the magic of investment real estate happens.
It isn’t uncommon to find a listing for an MUR (multi-unit residential) that highlights the fact that rents are well below market (see the image below). What this sometimes means is that, if you can kick the current tenant out or on a vacancy, if you spend thousands on upgrading the unit, you can rent the unit for significantly more.
I highlighted an example in my book (which you can download for free) where I demonstrated how I spent $50,000 on upgrades of a particular unit and increased the value of the building by over $200,000.If you can do that a few times in your building, in a short period of time, it’s possible that you can flip your building for a tidy and quick profit.
If you plan to buy and hold, you’ve now just increased the cash flow on your building, potentially significantly.
In the example above, I spent $50,000 on upgrades and increased the rent by $700 a month. That’s $8,400 inflation-protected dollars a year. That’s a six-year payback and a 17% return on my dollar. If you buy a multiplex and can do this a few times, especially on a leveraged property, the returns are quite good. Then, and perhaps even more importantly, you spent $50,000 and returned $200,000.
You can’t get this kind of return from a REIT.
Summary on REITs ve Real Estate – Direct Ownership
As with any investment, you need to make the right decision. If you bought the Office Properties REIT in 2009, then you lost 66% until today. If you buy the wrong building at a really low CAP rate, with the units already retrofitted, then your upside is potentially very limited, especially since the next ten years in capital appreciation will likely not produce anywhere near what the last ten years produced.
If you have the time and inclination, do your homework, and hunt for the right property with upside in rents, the returns on your own property can well exceed what you’ll get from a REIT, both from a dollars and personal perspective. As with anything, though, success likely won’t come easily. It will take work.