News from The Globe and Mail
Real estate is appealing but not risk-free
Saturday, October 05, 2002
Interest rates are at their lowest levels in four decades. The Canadian job market is booming, surpassing all expectations. The economy is steaming along. Yet many investors are getting the short end of the stick as the stock market swings wildly, moving lower with each passing week. Could buying real-estate be a way of steering clear of those deep losses?
"It's slow and steady income," said William Strange, a professor of business economics at the Rotman School of Management at the University of Toronto. "People are in the mood for buying assets where they can actually see income."
Investors are turning away from stock markets and putting money into assets that they perceive as offering safety, including bonds, investment trusts -- and real estate.
Real-estate stocks have posted strong gains this year -- Brookfield Properties Corp. is up 9 per cent, Boardwalk Equities Inc. has risen 27.8 per cent and O&Y Properties Corp. has climbed 7.8 per cent -- but there are other ways to invest in this sector besides stocks.
Real estate investment trusts (REITs) have become a source of safety for the average investor. Simply put, a REIT is a security that sells like a stock on the major exchanges and invests in real estate, either directly through properties or through mortgages.
A company sells trust units to investors, who then receive the income -- often relatively stable -- from the company's real-estate operations, in the form of regular cash distributions. Investors are more likely to be able to afford these units, as opposed to buying a second property and renting it out.
Among the advantages of owning a REIT, said Raymond James real estate analyst Harry Rannala, is the tax shelter aspect. They get taxed at an advantageous rate compared with interest income.
When an investor ultimately sells the unit and at a higher price, the return of capital creates a capital gain, Mr. Rannala said. Both distributions and capital gains are taxable unless the REIT is held in a registered retirement savings plan.
Unlike buying property, a REIT offers investors professional management, and less risk because a REIT will typically own a number of buildings that are spread out geographically.
But it's important to weigh the disadvantages as well. For example, because REITs are income-sensitive, they fluctuate with interest rates, typically falling when rates rise.
Pesach Goldman, another real estate analyst at Desjardins Securities, said that unlike a corporation, which has legislated limited liability, REITs have no such legislation to protect investors beyond their investment in the trust. However, he said "the concern of liability, I think, has been overplayed. The REITs are larger, more liquid and better capitalized."
Mr. Goldman said REITs have done quite well lately, outperforming many of the major markets. For example, RioCan REIT is up 1 per cent so far this year, compared with a 22.8-per-cent decline in Canada's benchmark S&P/TSX composite index.
While some REITs are pricey, others are undervalued, Mr. Goldman said. Among the REITs he recommends are RioCan and H&R REIT,which have long-term established records. He also recommends IPC REIT, which has access to the larger U.S. office-building market.
Mr. Rannala also recommends RioCan and H&R, among others, but said many REITs are now trading at a premium to their underlying market value. This is not a huge negative, especially if the REIT can continue to increase its income and interest rates remain relatively stable. "But it does present a vulnerability if interest rates move up or the level of income within the REIT starts to decline," Mr. Rannala said.
Although he recommends investors put some of their money in REITs, he advises caution. If the economy slows down, it may become more difficult for REITs to generate increases in income, he said.
Renting out property
"We're all very busy," said Sherry Chris, executive vice-president of network services at Royal LePage Real Estate Services Ltd., of real-estate agents across the country.
The Canadian housing market has been on a tear this year, driven by low mortgage rates and a strong labour market.
Many people are finding real value in buying as opposed to renting. Others are buying second homes and renting them out. But if you're taking money out of the stock market, be aware that the real estate market doesn't provide easy money at a quick pace.
Buying property and renting it out is the more difficult route in investing in real estate. Are you willing to wake up in the middle of the night to fix a broken pipe? Will you have the time to listen to your renters' concerns? Can you manage taking care of another property?
Mr. Rannala at Raymond James added that there's a lot less liquidity in this type of investment. If you want to sell, it may not be easy to do so down the road.
"If you are to invest in real estate today, into properties, you would have to have a far more optimistic outlook for the economic picture than I have today," Mr. Rannala said. The analyst has seen some early evidence of cooling in both the housing market and commercial properties.
Nevertheless, there are several advantages to buying a property and renting it out, including a chance to write it off against other income at tax time.
When buying a property to rent, investors should also consider potential risks. Interest rates, while low today, won't likely stay this way, and may come back to bite those who have variable-rate mortgages or whose mortgages are up for renewal.
There is also some debate on whether a housing bubble is forming. House prices in Toronto, Canada's biggest real estate market, hit a record high last month. The average home in Toronto sold for $282,765 in September, topping the previous high of $280,767 in October 1989.
But according to Michel Laurence, Canada Mortgage and Housing Corp.'s chief economist, "There is no gap happening right now between prices and fundamentals." Many economists say demand is keeping pace with supply. Furthermore, the economy is still strong and interest rates are low, Mr. Laurence said.
But Mr. Rannala is more cautious, saying that if housing development continues at a rapid pace, there is the fear that there may be more supply than demand.
"I think a slowdown here would be welcome before it becomes a bubble," he said.
Percentage change in increase in average prices in third quarter, 2002 over 2001
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