Real estate investing can diversify your portfolio, but it comes with warnings – Yahoo Canada Finance

By Neil Kumar

Home ownership is likely the first thing that comes to mind when thinking about investing in real estate but buying a house in today’s market can feel incredibly challenging, if not impossible.

Indeed, six in 10 Canadians feel homeownership is completely out of reach, according to a poll by Ipsos SA earlier this year. Yet, including real estate in your investment portfolio can be a smart move for a few key reasons.

First, it’s a great way to protect your money from the eroding effects of inflation. Over time, property values tend to rise with the cost of living, helping you keep the real value of your investment intact. Second, real estate can add a healthy dose of diversification to your portfolio, smoothing out the ups and downs of stock and bond movements.

Traditional home ownership may not be the right choice for everyone, but there are investment alternatives such as real estate investment trusts (REITs) and private real estate investment funds that offer exposure to the real estate market. Like any investment, however, thorough due diligence is crucial to understand how real estate fits into your overall investment strategy.

Homes and rentals

Homeownership can indeed act as a safeguard against inflation, given the tendency of residential property prices to keep pace with rising costs. Leveraging your investment and capitalizing on favourable interest rates can also be a strategic path to building wealth, all while providing a reassuring sense of emotional security.

The dream of owning a home is a common aspiration, but it’s vital to tread carefully and avoid becoming “house poor” — the state of paying too much on housing expenses relative to one’s income. It is essential to balance these benefits with the potential downsides of homeownership, including a lack of diversification, reduced liquidity, steep transaction costs, tax implications and the ongoing burden of maintenance expenses. These costs often catch homeowners off guard, highlighting the need for careful planning.

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Additionally, property-specific risks, such as environmental factors and interest rate changes, can impact the financial stability of homeowners. Without expert guidance to navigate these complexities, homeowners may find themselves ill-prepared for unforeseen challenges, like the recent case of the Seawatch subdivision in Sechelt, B.C., where homeowners were forced to evacuate due to the threat of sinkholes, making their homes inhabitable and worth a lot less.

For those already on the homeownership journey, expanding your real estate investments through rental properties is a compelling option. This allows you to maintain control over property management, tenant selection and provides a dependable source of income.

Nevertheless, it’s important to acknowledge the considerable responsibilities, initial capital demands and property-specific risks that come with this territory. Maintaining a prudent balance between investing in real estate and having adequate reserves for ongoing maintenance is crucial. This will help secure your financial well-being and achieve your investment goals.

REITs

In contrast to purchasing a property, real estate investment vehicles — such as REITS — are intangible assets that provide financial exposure to the real estate market, all while benefiting from professional management.

Unlike the traditional homeownership route, which demands a substantial down payment, investing in REITs can be done with just a few hundred dollars. They are often prized for their high liquidity, low initial financial commitments and transparency.

Though REIT prices often closely correlate with equities — rather than deliver entirely uncorrelated exposure such as some alternative assets — they allow investors to buy and sell at their convenience.

With the wide variety of REITs available, spanning from commercial to residential REITs across various sectors and locations, investors can achieve an adequate level of diversification compared to buying individual properties.

Investing in REITs also involves relinquishing direct control over property management. This shift of responsibility to professionals and the freedom from the hassles of maintenance can be a compelling factor for many.

For those yearning for real estate exposure, but lacking the capital required for property purchases or private fund investments, REITs offer an effective and accessible alternative.

Private funds

For those seeking more sophisticated solutions, private real estate investment funds offer diversified portfolio management that can potentially outperform other forms of real estate investment under certain conditions.

These funds are managed by professionals and may offer solid returns, but also risks that may not be right for everyone. For instance, the investment strategy — including leverage rules and property types — varies among different funds. Investors should always account for factors such as lock-up periods, which can extend for more than a decade, and the potential for redemption suspensions during market stress.

Adequate due diligence on real estate investment funds often involves advisers conducting six to 12 months of research, including face-to-face meetings with fund managers, site visits and fund provision analysis. With these complexities and restrictions, private funds are usually only suitable for those with a high net worth and long-term horizon.

Overall, there is no one-size-fits-all solution to investing in real estate. Everyone possesses unique goals, personal circumstances, time horizons and risk tolerance levels that influence how real estate aligns with their investment strategy.

Also, given the complexities associated with some real estate investments, the guidance of an adviser can prove invaluable in both simplifying the due diligence process and helping you achieve your financial objectives.

The key to successfully incorporating real estate into your portfolio lies in conducting thorough due diligence, with special attention to liquidity constraints, and assessing how this asset class complements your individual circumstances.

Neil Kumar is a portfolio manager, investment adviser and founding partner of JSK Partners.

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