The current and continuing rise in real estate prices may have you seriously considering a second property as an investment.  Even though some experts are cautioning that the housing market may soon cool off, attractively low mortgage rates, a steady income from tenants, and the opportunity to “flip” a property for a fast profit seem to make a compelling case for real estate as a “bulletproof” investment. But before you rush out and plunk down a significant amount of cash on a non-principal residence, let’s take a closer look at the pros and cons of this type of investment.

Good reasons to invest in real estate …

·         You can still find bargain-priced properties, even in this very hot market. 

·         You use a relatively small amount of your money to obtain a very large asset.  This is known as “leverage.”  A typical down payment is usually 25% of the value of a property, but can be much lower in certain circumstances.

·         You have a lot of personal control over your investment.  You can buy, rent and manage the property yourself.

Good reasons to think twice about an investment in real estate …

·         You’ll now have to meet all the obligations that come with ownership on your principal residence and another property including mortgage payments, insurance, the costs of maintenance and property taxes.  The costs of obtaining a mortgage on a non-owner occupied property (especially if it has more than one unit, such as a duplex) are often higher than for an owner-occupied property.  Mortgage interest rates may also be higher on a rental property because lenders see these as being a higher risk.

·         You’ll have to devote a significant amount of your time to finding reliable tenants, replacing them as needed, resolving disputes, ensuring repairs are made in a timely fashion and at a reasonable price – in other words, carrying out all the large and small duties that go with property management.  Or you can hire a property manager so you don’t get calls in the middle of the night when the furnace breaks down – but this is an expense that may not be supported by your cash flow from the property.

·         You can claim a capital gains exemption on your principal residence, but not on an investment property – so you’ll be taxed on half of any profit from the sale of your second property, assuming you can sell it at a profit!

Good strategies for choosing the right real estate investment …

·         Buy close to home.  You’ll need to reach your property quickly in case of problems.

·         Keep a cash reserve in case you are unable to replace a tenant for some time.  Experts recommend a minimum reserve equal to three to six months’ worth of mortgage payments and other expenses – and that should include enough of a reserve to cover these type of costs on both of your properties. 

·         Know the cash flow.  Research rental rates and patterns in the area of your proposed investment and carefully analyse the cash flow you can expect from your property.

·         Don’t buy to sell quickly.  In most cases, you will need to hang onto a property for an extended period – the experts say up to ten years – to realize a worthwhile profit.  And while it’s reasonable to expect to make money over the long term, it’s also true that real estate prices do go down.  Leveraging can cost you, too: if you put down $25,000 on a $100,000 property and its value drops by $15,000, your return is not negative 15%, it’s negative 65% – and you still have to pay the mortgage and other expenses!

You should approach an investment in real estate just like any other investment and only if you have a solid financial plan and available resources.  Before you make any decisions, review your investment portfolio.  Your investment success in the long term will depend on how well you allocate your assets between different types of investments.  Be sure that you will not have too great a proportion of your total portfolio invested in one property.

A financial advisor can help you make the right investment choices for your unique financial situation.