The stock market has long been a popular choice for investors to place their money. While buying stocks is a well-known form of investing, not everyone is aware that investing in real estate can be a great alternative.
The ideal investment portfolio varies from person to person. The best place to start is by understanding the differences between real estate and stock investments and determining which option might be best for you.
While we are not providing you with any investing advice, we are going to point out some of the common pros and cons to both. At the end of the day, we recommend that you do your own research and if you are so inclined to, you can always seek out the guidance of an investment advisor.
Investing in Real Estate
Real estate investments can be divided into two major categories: residential and commercial. Residential properties are limited to homes, whereas commercial properties include buildings such as offices, retail areas, and more. Investors can generate profits from their investment in a few different ways:
- Value Appreciation: the goal with value appreciation is to buy a property while the value is low, and sell it years later when the value has increased. GTA homes worth over $1 million today might have been bought less than twenty years ago for just $300k.
- House Flipping: rather than waiting for a home’s value to appreciate naturally over time, some investors prefer to take matters into their own hands. House flipping involves buying a property for cheap, renovating it and adding enhancements, and selling it for a profit (usually within a short timeframe)
- Rental Income: one of the most effective ways to generate profit from a real estate investment is to lease out properties that you own and collect rent payments from your tenants. Rent collection creates a passive stream of income for the investor and can even help pay off the mortgage on the property.
While there is no perfect formula for generating revenue through real estate, there are a few concepts you can consider. One great guiding point is what is called the 2% rule. This rule states that if the price of your rent (that you charge to your tenants) is at 2% of the property purchase price, then the investment is likely to generate positive earnings.
Stocks vs. Real Estate
When comparing stock investments to real estate investments, it is important to consider who you are as an investor and what you are willing to invest. An investor who does not want to invest a large amount of money may prefer stocks over real estate. An investor with a low risk tolerance may prefer to invest in real estate over stocks.
The decision to invest in either stocks or real estate will ultimately come down to your financial situation, risk tolerance, investing goals, and timing. Each type of investment has pros and cons, so it is important to carefully consider your options before making a decision.
Stock Investments: The Pros and Cons
When you invest in stocks, you are really investing in companies. When you buy stocks, or shares, you are purchasing a small percentage of a company. When the company’s value goes up, the value of your shares also increases. Buying shares for a low price, and then selling them for a higher price once the company’s value increases is the main way that stock investors make money.
Another way that stock investors make money is through dividends. Sometimes, companies will pay you a dividend, or a small sum of money, for every share that you own. This payout will likely occur once a year, and will often be very minimal.
Stock investments can be a great option. Here’s why:
- Low Capital Requirements: while Canadian property costs trend upwards of $500,000, you only need $1 to begin investing in stocks. Stock investment can be a great option for investors who do not have large amounts of capital.
- Highly Liquid: stocks are considered to be highly liquid because you can buy and sell them off whenever you would like. It takes very little time to complete the transaction, you can even do it from your phone!
- Corporate Matching Programs: some companies may allow you to add stock investments to your retirement plan, thereby paying less taxes when you eventually cash out your earnings. In some companies, they may even match your contributions.
Of course, there are also a few downsides to investing in stocks:
- Higher Risk Profile: compared to real estate, stock investments tend to come with higher risks. Stocks are extremely sensitive to changes in the market, economy, and/or government policy. Stock investing is not a great choice for emotional investors, as dips in share price can lead to panic selling.
- High Volatility: the value of your stock investment can change in mere seconds! While real estate investments are also impacted by changes within the market, government, or economy, these changes occur at a much slower pace, giving the investor time to react.
- Taxes: selling stocks often comes with hefty taxes. You may end up losing a significant portion of your earnings, reducing your overall profit.
Real Estate Investing: The Pros and Cons
When you invest in real estate, you are purchasing assets in the form of land and property. Real estate investors make money when their property appreciates in value, or through charging rent to tenants within the properties they own. Generally, rental income is the most effective way to profit from a real estate investment.
Real estate is enticing to many potential investors because it is a controllable, physical asset with the added advantage of diversification. Real estate investors that purchase real estate have a tangible asset they are responsible for.
Here are some of the major advantages of real estate investing:
- Rental Income: leasing out properties you own can be a great way to generate passive income from rent collection. In some cases, the mortgage may effectively pay for itself through the rent income you are generating.
- Hedge Against Inflation: real estate is often considered to protect investors since property prices often increase as inflation increases.
- Tax Benefits: not only are home sales not subject to the same taxation as stocks, providing that your home is legitimately being used as your primary residence, but mortgage payments may make you eligible for a number of tax-shields and government programs. We recommend doing your due diligence and/or speaking with a knowledgeable and certified accountant for that.
- Smaller Learning Curve: investing in stocks can be complicated. Oftentimes, significant research is required to succeed. Investing in real estate can be simpler to understand and execute, but make sure to do the right research beforehand and speak to the right professionals.
Despite these benefits, there are also potential downsides to consider. Here are just a few:
- Greater Upkeep: unlike investing in stocks, real estate investments come with greater responsibilities. If renting, investors must source tenants, oversee maintenance, and collect payments.
- Hidden Fees: as an investor, the property maintenance and repair fees will fall on your shoulders. It is important to be aware of these fees ahead of time. If you plan on paying off your mortgage with rental income, you must also take on the risk of not finding a tenant and remaining vacant.
- High Cost: buying a property is not cheap. In order to invest in real estate you must already have a strong income stream and significant savings.
- Depreciation: Although the tendency for real estate in strong pockets is to increase in value over the long run, any real estate investment is at risk of losing its value temporarily or even permanently.
Canada’s Real Estate Market & Predictions for 2022
In April of this year, the Canadian government raised the overnight lending rate in an effort to cool the overheated housing market and reduce property prices. While prices have dropped, and will likely continue to drop for the next four to six months, they will not drop forever.
By the end of the year, it is likely that the government will increase amortization periods to 40 years and reduce stress test requirements. As a result, prices will begin to climb once more, at a slow and steady pace.
Although purchase prices are currently dropping, rental rates are rising. Immigration into Canada continues to surge, and rent prices are growing according to the demand generated by this influx of potential tenants. The combined effect of these market conditions makes now a great time to invest in real estate, especially for those looking to capitalize on rental income.
Whether you choose to invest in real estate now or are waiting until you are more financially able to do so, Clover Mortgage can help. Our expert team of brokers can connect you to the best lenders and mortgage contracts for your unique investing needs. For a free consultation, contact Clover Mortgage today!