Investing in real estate can prove to be a smart financial move towards your long term goals. A rental property can provide a steady source of income, while you build equity as the property (ideally) appreciates. There are also tax benefits that come with investing in real estate. Here are 5 Financial Pros of Real Estate Investing.
#1: APPRECIATION
Appreciation, or the increase of home prices over time, is how the majority of wealth is created in real estate. Over the long run, although prices fluctuate, real estate is still considered a great investment, and for many investors the reality is that wealth is created in real estate by taking the long term view and holding properties for decades, not by flipping properties every few years.
One more thing to consider when it comes to real estate appreciation is the fact that appreciation combined with leverage offers huge returns, which we will get to later in this article.
Real estate markets move in cycles and have ups and downs, as long as you have a cashflow producing asset then you are safe and protected and you don’t have to worry year in and year out if your property has gone up or gone down in value on paper – you’re making money either way. That being said, wise investors don’t bet on appreciation alone. They purchase properties on a sound judgement that the property will generate more income than it costs to own. Which brings us to our next point.
A Focus on Toronto Real Estate:
Over the past 10 years Toronto's Real Estate prices have been appreciating drastically, the average price for a home in Toronto in 2009 was around $375,000, the average price for a home in Toronto in 2019 is roughly $775,000. That is over a 106% increase in just 10 years.
#2: CASHFLOW
Cash flow is the money you have left over from the rent you have received after all your expenses have been accounted for. Most properties have expenses such as a mortgage, property taxes, insurance, maintenance, and sometimes property management fees. When you buy a property that brings in more rent each month than the expenses it costs to own it, your cash flow is positive.
You wouldn't get rich quick off of cash flow alone, but you will always be able to sleep comfortably knowing that you’re making money every month and your tenants are paying all your expenses for the property.
For wise investors that focus on cashflow, if prices drop, they are safe. If prices rise, they have more options. Cashflow is the foundation of all real estate investing, but it is one of the few aspects that makes real estate the most effective asset class for wealth creation.
A Focus on Toronto Real Estate:
Cashflow in regards to Real Estate investing is directly tied to the amount of money a person is willing to pay to rent a unit. In Toronto, rent prices have dramatically gone up in the past few years, jumping from around $1,300/month to approximately $2,000/month for a one bedroom in downtown Toronto. The increase in rental prices significantly improves the cashflow and ROI for Toronto Real Estate investors.
#3: LEVERAGE
Leverage is such an important part of real estate ownership that is often taken for granted. There aren't many investments where you can borrow money from A. A Financial Institution, pay that loan off with money from B. the tenant, and keep the difference for yourself. The key to safe leverage is maintaining positive cash flow and purchasing at the right time.
Consider the common real estate purchase requirement of a 20% down payment – or $100,000 on a $500,000 home. When a buyer puts only 20% of the money down, and borrows the rest, they are essentially using a relatively small percentage of their own funds to make the purchase; the majority is being provided by the lender. Assuming the property appreciates at 5% per year, the borrower's net worth from this purchase would grow to $525,000 in just one year. Comparing this gain to the gain from a purchase made outright, without any loan, highlights that value of the leveraging strategy.
Beware, just as leverage can work to your advantage, it can also work against you. In real estate markets where prices fall significantly, homeowners can end up owing more money on the house than the house is actually worth.
A Focus on Toronto Real Estate:
Leverage is directly related to the appreciation of the Real Estate and as Toronto's housing prices increase so does the leverage power of property owners. So if an investor purchased a home in 2009 for $375,000 and held it until it appreciated to $775,000 in 2019 they would have access to obtaining a 2nd mortgage or the like against the property and it's appreciation ($400,000).
#4: PRINCIPAL PAY DOWN
When you take out a mortgage to buy real estate, you typically pay it off with the rental income from the tenants. One of the best parts of investing in real estate is the fact that not only are you cash flowing, but you’re also slowly paying down the balance of the loan with each payment to the bank.
In the beginning of these loans, the majority of the payment is going towards the interest of the mortgage, not the principle. This means you aren’t making much of a dent in the loan balance until you have had the loan for a significant period of time. With each new payment, a larger portion goes towards the principle amount of the loan instead of the interest.
After sufficient time passes, a good portion of every monthly payment comes off the loan balance, and wealth is created in addition to the monthly cash flow. The best part is, it’s your tenant paying this for you. Paying off your mortgage is another way real estate investing works to grow your fortune passively, with each payment taking you one step closer towards financial freedom. The longer you hold a property, the more you can take advantage of principal pay down and growth of your net worth.
A Focus on Toronto Real Estate:
If for instance you purchased a home in Toronto for $500,000, paid a 20% down payment ($100,000) to obtain a mortgage of $400,000 at a 3.24% rate, amortized over 30 years. You would have a blended mortgage payment (Interest & Principal) of $1,734/month. After just 5 years you would paid off $42,974 of the principal amount.
#5: DEPRECIATION
Even though the name could be deceiving, depreciation is not the value of a property dropping. It is actually a tax term describing your ability to write off part of the value of the asset itself every year. This significantly reduces the tax burden on your income, giving you one more reason real estate protects your wealth while growing it.
The CRA (or the IRS in the United States) allows you to depreciate the value of your property (not including land value) against the income that it produces. This is also called the Capital Cost Allowance (CCA). This is a write-off that you don't actually pay for out of pocket. For many investors, it provides a powerful tool for tax deferral or potentially tax reduction.
If for example you rent a property, you typically report your rental income and expenses for each rental property when you file your annual tax return; the net gain or loss is then added to your tax forms. Depreciation is one of the expenses you’ll include on the forms, so the depreciation amount effectively reduces your income and thus the tax liability for the year.
It is important to note that the CCA has pros and cons in the sense that if you do elect to claim the CCA on a year to year basis, you are required to add the amount claimed back to the selling price in the event that you sell the property. This increases your profit on a sale, which would increase your tax payable. So it allows you to not reduce your taxes today, but you will have to pay taxes later, depending on your tax bracket and other considerations.
A Focus on Toronto Real Estate:
The Capital Cost Allowance for most properties in Toronto (acquired after 1987) fall under the Class 1, meaning they have an allowance of 4%. So for the $500,000 condo you would have a $20,000 depreciation expense at your disposal.
As with any large investment, professional advice from a mortgage brokers accountant and/or lawyers is highly recommended.
To learn more about investing in Toronto real estate or in the Greater Toronto Area, feel free to message us on Dwelly. We have a number of resources to help you, determine if a real estate investment is a good fit for your investment portfolio.
