The world of safe investments has never been a get-rich-quick playground. But at current interest rates, it’s more like a get-poor-slowly sinkhole.
Savings account rates are up a bit in the past few years though, and you’ll always get your money back, so how bad can they be?
Any time you’re thinking about what to do with your money, you have to consider the cost of inflation. Inflation is the silent thief that steals your net worth every day of every week of every year.
Currently, inflation is running at 1.61 percent in Canada. That means the proverbial “basket of goods” the typical Canadian consumer bought for $100 a year ago costs $101.61 today. That’s the target you must beat just to break even.
Fixed income is hardly a fix
An extra dollar or two a year doesn’t seem so bad. But when you consider that the best-paying online savings accounts right now are around 1.50 percent in interest, it’s quickly apparent that the money in your “high interest” savings account is actually going nowhere.
You can do a little better if you’re willing to lock up your money for a period of years. The best five-year guaranteed interest certificate will earn close to 3.50 percent, which gives you a real annual return of nearly 2 percent on your money, but if inflation rates rise during that time, you won’t even get that. Stretching the investment term even longer doesn’t help. A 10-year U.S. Treasury note will only pay close to 3 percent, and a Canadian 10-year bond is less than 2.5 percent.
Unless your investment goal is simply to not lose your principle, these numbers are going to leave you disappointed.
Time to stock up?
This reality has not been lost on investors, and it’s one of the big drivers behind the growth in the stock market over the past nine years.
However, as more people have looked to equities for higher returns on their money, the price of stocks has gone up. The current dividend yield of the S&P 500 in the United States is around 1.80 percent, which is above its lowest-ever level of 1.11 percent just before the dot-com bubble popped in 2000 but well below the historical median of 4.31 percent. The leading Canadian stock market index, the S&P/TSX, has a dividend yield of less than 3 percent.
Equities can still be a great long-term decision, but if you’re looking for stable investment income right now, you might want to look elsewhere. Real estate suffered a rough ride 10 years ago during the mortgage crisis, but it is a relatively stable asset class that offers immediate income coupled with long-term appreciation, which can be a nice complement to a diversified portfolio — especially when the cost of borrowing is so low.
The real (estate) deal
For many people, “investment real estate” conjures images of late-night maintenance calls for broken toilets and eviction proceedings at the local courthouse. But investing in real estate and becoming a landlord are not necessarily the same thing. There are many ways to enjoy the benefits of real estate without ever having to call a plumber.
Real estate investment trusts (REITs) are an easy way to invest in real estate without having to buy any property yourself. With a REIT (rhymes with street), you pool your money with other investors into a company that buys real estate properties and/or mortgages.
REITs can be publicly or privately traded. REITs that only buy and manage properties are called equity REITs. Those that only loan money to mortgage borrowers are called mortgage REITs, and the ones that do both are called hybrid REITs.
Canadian (and U.S.) rules require REITs to distribute at least 90 percent of their profits to shareholders as dividends. The dividend yield for Canada’s major REIT index fund is 5.29 percent [download the “factsheet”], which is quite attractive. South of the border, average U.S. REITs paid 4.59 percent in March 2018.
2. Mortgage Investment Corporations (MICs)
MICs are a Canadian entity that function like a small, private mortgage REIT. Investors pool together capital and loan it to mortgage borrowers. The borrowers are typically high-risk and have been turned down for traditional financing. The interest rates earned by MICs can be quite high — over 10 percent — but MICs have come under scrutiny lately for being overly exposed to a possible market downturn.
3. Syndicated mortgages and crowd-funded mortgages
Another avenue for making private mortgage loans is through a syndicated mortgage, where two or more investors pool their money to finance a specific real estate project. These are private, high-risk-high-reward deals that can’t be advertised, and financial requirements restrict this option to only wealthy investors. Investment minimums are typically $25,000 or more.
However, technology has offered a new alternative to syndicated mortgages for regular folk: crowdfunded real estate. In this case, an online crowdfunding platform (and there are some specific to Canada) will investigate various real estate investment opportunities and offer them up to individual investors to buy into with as little as $1,000. These are also higher-risk ventures. Investors can either lend money toward a specific project and get repaid with interest, or they can invest as a part-owner in a specific project and share in the profits at the time of sale.
Neither syndicated mortgages nor crowd-funded mortgages are designed to be liquid, so getting your money out before the loan is repaid or the property is sold can come with significant penalties.
Yes, you can be an old-fashioned landlord without having a plumber on speed dial. Property management companies will do the work of advertising your property, interviewing applicants, drawing up the lease agreement, collecting the rent and maintaining the property. You, as the owner, simply have to share 10 percent of the rent, on average.
If you’ve got a good property that rents for more than the cost of the mortgage, insurance, taxes, upkeep, vacancy rate and property management fee, this can be a great way to build equity in a property while increasing your monthly cash flow.
When you look for real estate investment opportunities, it’s important to keep the words of the master in mind. Most people don’t think of real estate when they think of Warren Buffett, but he has offered succinct, compelling advice on the subject through his annual letters to shareholders as CEO of Berkshire Hathaway. He sums them up in this Fortune article.
His bottom line in real estate is to look for opportunities where he understands the underlying asset and is confident he can earn, after expenses, a 10 percent return on his money each year, and where he has reasonable certainty that that number won’t be lower in 10 years.
It’s a simple logic done without regard for the future price of the property, which frees him to invest during a market downturn. It has led him to a wonderful investment in real estate sectors as diverse as an Iowa farm and a New York commercial building, which he was earning a 35 percent annual yield on after 20 years.
Done right, real estate can offer consistent, growing yields and equity appreciation.
This guest post was contributed by Zolo.ca – Canada’s largest private real estate brokerage. Zolo.ca is a full service real estate, brokerage and mortgage company that has real estate agents throughout Canada.