Looking to get into the real estate game but lack the funds to get started? No biggie, real estate income trusts (REIT) index funds may be your next best option!
Real estate has long been an attractive investment options for many individuals. Most people “accidentally” become involved in this type of investment when they purchase their first house as a place to live. After the sale of this first house a few years down the road the homeowner may notice they sold for a lot more than they originally paid (all of which is tax free if the home is your principle residence).
The house price index in Canada has almost doubled since the year 2000, which has lured a lot of eager investors into the market. That means on average in Canada that if you bought a $100,000 property in 2000, it would be worth about $200,000 today (this index averages out cities across the country).
This 100% increase doesn’t include any rental income a lot of investors receive from their properties, nor does it include the cost of mortgage interest, maintenance and other expenses relating to property management.
In a previous article I compared the investment returns of a house to the stock market to see which came out on top – it was more less a tie and came down to investor preference rather than outright return.
Now that I’m in the wealth generation phase of my life I’m constantly looking at investment options (usually more looking than actually buying). Real estate has shown great returns throughout the past decade (probably due to HGTV and that handsome Scott MacGillivray), but I would be hesitant to put a large chunk of my savings in one basket due to the lack of diversification. Another hurdle is the 20% down payment minimum required on your second property in Canada, which would require anywhere from a $50k to $200k buy in. For me this buy in amount would represent 50%-100% of my current savings, which would be way too much exposure in any one given asset!
The other drag about rental/investment properties is dealing with potentially brutal tenants. This can usually be mitigated with some decent due diligence beforehand (reference/credit checks, income verification) but there will certainly be some level of interaction involved unless you hire a property manager.
The high buy-in, lack of diversification, and potentially unruly tenants are enough to scare me away from purchasing a rental property on my own, however, I still like the potential returns and wouldn’t mind a piece of the action…Enter REITs.
What’s a REIT?
A Real Estate Income Trust (REIT) is similar to a mutual fund in that it bakes a whole bunch of real estate properties into one pie and you get a slice when you purchase a share. Typically shares of REITs sell for under $100 per unit, which is much less than the 20% buy in required for a full property.
REITs may focus on specific types of properties (residential housing, apartments, condos, retail, hotels) or they may be broad and have some of each. To go one step further, iShares provides a REIT ETF (symbol: XRE) that takes a group of REITs and bakes them into one pie, for even additional diversification. Here’s how the iShare ETF has done since 2002 (its first year of inception):
Notice the similar trend in the house price index and the ETF graphs above. While the ETF has come out on top in these graphs in terms of growth, the house price index does not include potential rental payments so it’s not exactly apples to apples.
The obvious drawback to purchasing REITs versus an investment property is missing out on the larger potential upside of an investment property (just ask anyone that purchased property in Toronto or Vancouver in 2000). You’re also likely to be paying management fees and investment fees for owning REITs whereas with property ownership you are able to reduce costs by putting in some sweat equity.
Given my personal preference for a low-maintenance, low-risk I’m more inclined to buy REITs rather than actual property to include some real estate exposure in my savings portfolio. While the gains in REITs may not always exceed that of hard real estate, the piece of mind I gain is just as valuable.by