Real estate has always been the refuge of investors burned by volatility in the stock market. After the tech bubble in the early 2000s and yet again after the financial crash of 2008, money poured from the stock market into what many investors considered a safer bet due to its tangibility and insulation from market shocks: Real estate.
As real estate prices continue to soar despite a severely weakened global economy and with interest rates at all-time lows—is there a better bet than real estate?
First of all, despite the seemingly endless growth in home prices, I would be remiss to present real estate as a completely dependable, reliable source of investment growth. Although it doesn’t typically experience the same volatility as the stock market, real estate is, after all, still an investment and as such, susceptible to market forces. Eventually, prices will start to fall and there will be some investors who lose money, but that’s the nature of any investment—there’s always an element of risk. Those who are successful are typically those who understand risk and have a healthy appetite for it. Investors playing too loose or too tight with risk are generally the ones who end up getting burned.
So, You Want To Own An Investment Property
Given the healthy supply of new construction, low interest rates, and the continued growth in property values, many investors have purchased condos and townhouses as investment properties. With low mortgage rates and down payments of 10% or 20%, finding a tenant that can generate positive leverage has been an easy endeavour for many landlords.
Of course, when times are good, it’s easy to be a landlord. It’s when times are tough that we see who is truly cut out to be a landlord; or as Warren Buffet puts it: Only when the tide goes out do you discover who has been swimming naked.
An investment property, like any other investment, requires a certain amount of ability to handle risk. Those that are highly risk averse will shut themselves out of lucrative opportunities and those that throw caution to the wind may end up losing everything.
As a landlord, how does your risk tolerance rank?
A Tale of Two Landlords
How risk averse is too risk averse? Of course, it all depends. There is no magical risk formula that distinguishes successful landlords from wannabes. To give you an idea of how being too risk averse can impact your return on investment (ROI), consider the following real-life example.
A couple is looking to rent a condo from a private landlord in the Oakville area. They are moving from Etobicoke as Oakville is closer to their employment. Both renters are gainfully employed with excellent credit scores. However, finding a condo to rent is not as easy as they had hoped.
After thorough research, they found two condos that fit their needs exactly and reached out to the landlords.
The first landlord (let’s creatively call him Landlord #1) said outright he wouldn’t rent to them. He felt that if a second wave of COVID hit, one or both may be out of work and unable to pay the rent.
The second landlord, Landlord #2, agreed to rent to them but only if they provided her with a total of four months’ deposit! That includes first and last as well as two additional months held as security.
Which landlord is correct? Technically, neither.
Landlord #1 is simply being way too risk averse. You cannot achieve a zero-risk investment as a landlord, it just cannot be done. Taking on two gainfully employed tenants amidst a global pandemic is not a risky move, it’s simply good business. The chances of finding a tenant able to pay the rent and also have an income stream that isn’t likely to be affected by a second wave of COVID are slim to none. This landlord will no doubt see his “investment” sit empty for quite some time, all the while he’ll be paying the mortgage out of his own pocket.
Landlord #2 is trying to hedge her bets by securing a rather large security deposit, which she thinks will insulate her should her tenants find themselves in a position where they can no longer pay rent. She’s actually making a worse judgment call than Landlord #1 as what she’s asking directly contravenes the Residential Tenancies Act of 2006. This act clearly states that a landlord can request no more than one month’s rent as a deposit and the deposit is to be applied to the last month’s rent. As a landlord, you probably won’t be a fan of the Residential Tenancies Act as it definitely favours tenants, but you still have to abide by it. Landlord #2 may not only find herself with no tenants but also having to defend herself to the housing tribunal should potential tenants complain.
Are You Cut Out For Investment Property Ownership?
The key concept to grasp before buying an investment property is that, like any other investment, it carries a certain amount of risk. If you don’t have the resources to let your property sit vacant or the confidence to rent to someone with an imperfect credit score, you may sleep sounder with your money invested in T-bills.