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Real Estate

Many people (including notable US Presidents) have made their fortunes on real estate and it is no unusual for people to have one or more rental properties as a component of their investment strategy. Real estate is attractive because it has two return components: 1) Rents and 2) Capital Appreciation.

The primary return on real estate is the rents paid by tenants. Ideally the rents paid less the cost of upkeep (management fees, taxes, condo fees if any, routine maintenance) create a good return on the investment made.  For example, if a rental property is purchased for $500,000 and the rents less the cost of upkeep amount to $25,000 per year, then the 5% return would be considered an mediocre return on investment in today’s market.  Ideally you should be targeting a rate of 7-8%. However, bear in mind that when you calculate this return, you also need to consider the cost of vacancy when your tenants turn over and also the cost of advertising to replace tenants when they leave. Make sure you build in the cost of vacancy into your calculations when you are considering an investment property.

The secondary return for real estate investors is the capital appreciation for the property itself. While, just like the stock market, there have been well publicized periods when housing prices have dropped, for most of history people have seen real estate prices rise over the long term.

If we look at housing prices over a long period, the average appreciation has been about 7% over the years, well outpacing the cost of a mortgage required to purchase the home. While Canada does not have a mortgage deduction (which makes owning a home in the US an even better investment), the average return on investment has been excellent.

So, returning to our investor, if they can achieve 5% return on investment from rents and an additional 7% return on investment from capital appreciation, an overall 12% return would be good considering the risk.

This is the reason that most people have most of their retirement assets in their primary residence and many people also have investment properties.

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