Many of my clients choose to work with me because of my focus on helping folks investing in Canmore real estate. A large part of my expertise has come from assisting dozens and dozens of families successfully acquire investment properties in our area; much of it has also come from personal and family experience in the space. A lot of what I’ve learned has also come from my own investment journey, as well as hundreds of hours of books and podcasts I’ve studied and have continued to study over many years now (Get an e-reader!).
I wanted to write an article that provided some key insights I often share with clients starting out in real estate investing, that apply to many investments across different asset classes. Much of it is common sense and simple math; things great investors like Warren Buffet and Charlie Munger have often repeated and applied to great success.
So today, let’s cover:
Note: this article is provided for informational purposes only and should not be taken as advice on any given investment or transaction. Feel free to consult me directly via text, call or email if you have questions on any properties you’re seeing, real estate investing in Alberta, or our area in general.
There is a disclaimer at the bottom of every investment prospectus, note, offering, and book:
Past performance is not a guarantee of future results. All investments involve a degree of risk, including the risk of loss.
This is critical to understand and it applies to not just the stock market. Just because something has gone up in the past, does not mean it is guaranteed to go up in the future in the same way. If I knew for certain my investment was going to double in value in a nice straight line over the next year, every year, it would be silly for me to not put every cent I had into such an asset and take on tons of debt to buy more.
Take a look at the above chart, from a study on over 200 years of housing market data in Amsterdam (one of the longest running datasets available for housing information). This is a great chart to look at data on a very, very long timescale. But a key thing to note here is that there were several times where house prices were cut in half. At the extreme end, a family home purchased in 1625, sold again over 200 years later in the 1800s, would see no return in terms of purchase price. Where could we be on such a large timescale in the present day?
Now, this isn’t meant to scare you. But it is illustrative that real estate can function just like any other investment, and no one can tell you what the future will hold. Things may not change in your lifetime even. But what about the next generation?
The supply of housing increases extremely slow. Because of this extremely inelastic and completely immobile supply, house prices behave differently than many other assets and can be extremely locally specific.
In fact, the supply of houses in the US grows more slowly than the supply of Gold worldwide! Plus – it can’t be transported to wherever demand is greatest, like other products.
We’ll talk about many of the key ways real estate investing is different below. But this key factor of inelastic, local supply is a big part of why real estate is different. Just because broad trends can effect an entire industry, doesn’t necessarily mean they translate in the same way to a specific town, street or building.
And if we move beyond the theoretical, I think anyone can see how real estate is different than trading tulips or other types of assets in broader marketplaces.
Leverage can be a smart way to lose all of your money, and then some, in investing. But – it can also be a way to magnify your gains as you take on additional risk. Unless you are very experienced and open to very high risk, very few people should be investing with leverage. However, in our culture, we tend to make one exception: leverage in real estate.
As prices have risen over the decades, so has the use of mortgage financing. Currently, over 35% of Canadians hold a mortgage. More that 70% of total loans in Canada are mortgages. Clearly both Banks and Canadian consumers like the way mortgage financing works, and feel it is a safe business to be in.
Let’s say you have $100,000 to invest. If you earn 10% on that investment in one year, it totals $110,000. But, if you were to put $100,000 as 20% down on a $500,000 property, and that asset increases by 10% in a year, the gain is magnified to $50,000, or +50% on your $100,000 investment. Well done!
Of course, the above example does not factor in transaction costs, service of the debt, and assumes a tidy return in a tidy time period. And I’m not saying you should go out and take on any kind of leveraged investment. Obviously mortgages have blown up in the past (see 2008 GFC).
But it does illustrate how leverage in real estate can work and perhaps why Canadians are so inclined to use it.
What we really get into when we invest generally, is into a line of business. Many people are employed by business or government in their everyday life, as opposed to being the owner of their own business.
When you buy an investment property (ie. a rental), you are getting into the rental business. This means there are costs of doing business, challenges, and ideally some rewards and profit that comes along with it. Welcome to the business world!
Some of my clients who are involved in business can expect business-like returns with real estate. They envision returns on their capital like those achieved in a tech business like Meta (or Facebook), where in 2021 they returned over 43% on capital. Of course, Meta is a high-risk tech business.
The truth is that real estate is not typically (or supposed to be) a wildly high-returning business. It can be good – no doubt. But typically if you’re using much of your return to pay your mortgage (see leverage above), you may not see cashflow in the first 5 years (beyond what is being paid into your mortgage).
Don’t sweat it though – real estate is a long term game, and we’ll talk about compounding below.
As an investor, you can invest in assets that are productive (generating cashflows), or non-productive assets. Examples of productive assets would be things like shares in businesses that generate profits, and debt that generates interest. The value of these assets are determined by their cashflows, and the potential for them to grow over time (as in business ownership via stocks). A non-productive asset is something like gold, cryptocurrencies, or original works of art. They don’t inherently generate cashflows or income; their value is based on someone else hopefully coming along in the future who will pay more than you paid for the asset.
So what about real estate?
If you have a property that is renting (long or short term), it is essentially a business – generating a cashflow. In my opinion, if your property is covering all of its costs and they include a mortgage, you are achieving cashflow since part of your mortgage principal is paid by the rents.
If you buy a home to live in, many people would view this as a non-productive asset (potentially financed with debt), as it generates no rents. But importantly, you have a personal use case for this kind of asset. Its like owning a one-of-a-kind Van Gogh painting simply because you love to look at it. If you get something out of that use, then in a way it is providing value for you.
And of course, just because you’re banking on someone else in the future being willing to pay more than you did, doesn’t mean its a bad thing. But you should make sure you love it and the use case is there for you personally if you don’t plan to rent it.
When thinking about any investment, thinking in percentage terms and fractions is very important. This is because an investment can really only go to 0 once; when thinking in terms of gains, we can go well above 100% (ideally again and again and again…).
I find its best to think of it this way: to turn $1 into $.50, you need a -50% loss. To turn $.50 into $1 however, you need a +100% gain. The larger the loss, the higher the gain to get back to where you started. An -80% loss will require a +400% gain to recover from.
With this in mind, would you rather lock in an -80% loss? Stay firm and don’t sell at the bottom. Likewise, if you’re looking for a +400% gain – and you’re absolutely confident an asset is being misvalued by the market – “buy when there is blood in the streets.”
Obviously, purchasing real estate at an “80% loss” is much more of a hypothetical. I’d say a house basically has to be literally on fire and uninsured to get even close to such a deal… so I wouldn’t bank on it! But, there have been times where relatively large drops have occurred in real estate: in 2008, some US markets lost up to 15%. In Calgary Alberta, MLS listing prices year-over-year dropped by 11.4% in 2008 vs. 2007.
A better strategy than waiting for some “bubble” to pop (Canada has been in a “real estate bubble” for what seems like a lifetime now), however, is to hold for the long term.
Those people above, who suffered the hypothetical -80% loss? Or even the -11.4% loss? Assuming they could hold on, they would have come out of it OK. And if they continued to hold beyond (particularly post-2008), they would have seen the gains continue and compound. By achieving average returns over an above-average period of time, compounding can really do its work.
An investment with a 10% rate of return will double in 7 years. Over 21 years, such an investment would grow nearly eightfold. But – that same investment held for an additional 7 years – to 28 years – would grow to almost fifteen-fold your initial investment, should it double again. Your initial investment will see the biggest gains on those later “doublings”, and the longer you can wait to achieve them, the better.
Is it realistic to expect a real estate investment to compound in a straight line? Probably not. But a long term focus is essential. How long you hold on to a property is perhaps the largest factor in determining your overall return. And is 28 years really that long to hold a property?
Buy a good property that you can consistently rent, or a home that you love to live in (and would be able to afford) if the world were ending, and hold for the long term. The only people who get hurt on a roller coaster are the ones who jump off mid-ride.
Real estate is often used as a way to diversify an investment portfolio. If you already have a large portion of your retirement savings in traditional financial assets, at some point you may want to branch out and add something different. It’s important to remember that if you own your home, you are already exposed to real estate. But adding additional properties can be a great way to add a new stream of income or plan for the future.
As noted above, real estate is perhaps the most widely accepted way of leveraged investing in Canada. With leverage, you take on more risk – but have a chance at a higher return. Something about real estate makes folks more open to taking this risk, and largely it seems to have worked so far.
Another thing about property in general is that it has a long-term bias. I work with clients to sell properties that they have held for decades. My own family has held properties across generations. When we think about compounding, this naturally longer time horizon typically tends to work out in investors favour.
Lastly, real estate is intensely personal and you or your family may have specific knowledge about your community that gives you an advantage. The nicest neighbourhood today is likely to still be the nicest neighbourhood 25 years from now. You may have a family member that could be a great tenant for a decade, or know exactly what kind of property your community will need now and in the future. Being satisfied with your home can also help you weather any storm and stick with it for the long run.
If you’re ready to start your real estate investing journey, and are considering a property in Canmore, Cochrane, Calgary or the surrounding areas in Alberta, let’s connect. I’m always available to answer any questions you may have personally via text, call or email. I’m here to help!
Cheers