Alternative routes to real estate riches
Avoid bad tenants and hassles, buy funds instead
Jonathan Chevreau, Financial Post
As an asset class, real estate tends to play second fiddle to stocks and bonds. Apart from their homes, average Canadians are likely underexposed to bricks and mortar.
The classic route to real estate riches is to buy a second home, perhaps a condo or triplex apartment, rent it out and get your tenants to pay the mortgage on it. But this is not a highly diversified approach. It can be a problem finding good tenants, collecting rents and keeping properties maintained.
For those who want exposure to real estate but prefer to dodge the perceived hassles, there are other options, such as real estate mutual funds or exchange-traded funds.
These spread your money across multiple properties, regions and even currencies, lowering risk. Some funds invest directly in commercial properties while others focus on publicly traded real estate corporations, says Fred Kirby, a certified financial planner in British Columbia. Of course, this convenience comes at the price of yearly fees that direct investors in real estate will avoid.
Most pundits view real estate as an essential part of a well-diversified portfolio, with the benefit being relatively low correlation to stocks or bonds. In his book Unconventional Success, Yale University’s David Swensen says real estate could make up as much as 20% of a total portfolio. Others, like the Canadian Capitalist blog, view a 5% or 10% exposure as “reasonable.”
We’ll assume you already have a principal residence. If you still have a mortgage, the first priority would be to pay it off to avoid interest payments that can end up being double the purchase price of the home.
Once that is achieved, however, wouldn’t it be nice to receive a regular stream of rental cheques or distributions from a fund? Rental income or fund distributions may have a slight tax advantage compared with pure interest payments.
But what about timing? Some argue housing topped out a year or two ago and that the subprime mortgage crisis is bound to create bargains for those who wait.
In 1989, when real estate prices began declining, “investors exited property mutual funds at such a rate that the redemptions created a liquidity crisis,” Kirby says. Some funds were forced to liquidate property at unreasonably low prices.
With the loonie approaching parity with the American greenback, Canada’s fund companies apparently believe the time is ripe for exposure to real estate outside Canada’s borders. Last week, the Guardian Group of Funds (GGOF) and Mackenzie Financial Corp. both unveiled global real estate funds.
The GGOF Global Real Estate Fund will hold 40 to 50 properties in North America, Europe and Asia. The Mackenzie Universal Global Property Income Fund focuses on global firms that pay out a dividend of at least 4% a year. It also hedges currencies. GGOF chief investment officer Gavin Graham says his fund will make regular distributions of income, capital gains and tax-deferred capital gains in the form of return-of-capital.
There are 21 other real estate funds available to Canadians, according to Morningstar Canada. There is $3.5-billion invested in them, Graham says. Only five have five-year track records, but those returns range from 16.5% in the Dynamic Focus Plus Real Estate fund to 11.9% for AGF Global Real Estate (as of June 30, 2007).
An alternative route is Real Estate Investment Trusts or REITs. Kirby says REITs offer the stability of real estate, combine the characteristics of bonds and equities, and have the added benefit of low or negative correlation to other equity investments. And they do so without the potential liquidity problems associated with open-ended property mutual funds.
A low-cost way to get a basket of Canadian REITs is iREIT, an exchange traded fund (ETF) from Barclays Global Investors Canada [XRE/TSX.] Its yearly fee is 0.55% a year - well below what any real estate mutual fund charges.
Full disclosure: Jonathan Chevreau owns it himself. True, it’s not a global fund but Barclays and several other ETF manufacturers sell U.S. or global real estate ETFs. An example is the iShares Dow Jones U.S. Real Estate Index Fund [IYR/NYSE].
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