The stock markets are roaring ahead and Canada’s housing market continues to climb higher, but Randy Dyck is getting a lot more satisfaction out of his core investments in other areas: land and buildings. Dyck owns his own home and some stocks, but the vast majority of his investments are multi-family and commercial buildings and land development across British Columbia’s Fraser Valley, which he holds outright or with other like-minded investors. “It’s my pension plan,” says the 50-year-old, who is also a real estate agent and owner of Eximus Real Estate in Abbotsford, B.C.
Dyck began branching out into non-residential real estate about 20 years ago because he wanted to see, touch and oversee what he was investing in. “It gives me this security of a hard asset that’s worth something substantial and monthly income. And I control it.”
It gives me this security of a hard asset that’s worth something substantial
Real estate has always been a key investment for Canadians, not to mention a national obsession, but more investors seem to be getting into the property game outside of owning their homes and vacation properties. Many have grown skeptical of the stock markets, especially after the most recent meltdown in 2008-09, and see real estate as more resilient. Rightly or wrongly, there are those who believe real estate is less risky, and that its long-term value can only increase given that there’s only so much land that can be developed to accommodate a growing population.
But it’s not just land and buildings that Canadians are snapping up. Given the constant nagging from financial experts to diversify within asset classes, many are also turning to real estate investment trusts (REITs), mortgage investment corporations (MICs) and other real-estate-focused equities as well as private funds, including crowdsourcing opportunities.
Nearly four out of 10 investors say real estate is an investment in which they will always see a financial benefit, notes a recent survey done by TD Bank. In the TD Investor Insights Index, released in July, 74% of respondents viewed their own home as a real estate investment, while 32% bought other properties as investments, 22% bought REITs and 8% picked up mortgage-backed securities. Asked which sectors they were most confident investing in, real estate — including securities and hard assets — ranked second behind financial services. Boomers were the most confident age group, not surprisingly given they’ve benefited the most from real estate’s rise since they started plunking down money on property decades ago. The total value of principal residences has risen 52.2% from 2005 through to 2012, while “other real estate” investments have risen 70.4% over the same period, TD notes, citing Statistics Canada data.
Of course, not all real estate investments have been winners, and some are getting harder to tap. For instance, REITs had a rough ride in 2013 and stand-alone commercial and industrial property is getting expensive and extremely competitive in some spots across Canada.
Still, experts continue to recommend investors hold a decent mix of real estate in their portfolio apart from their own homes. “A home has an emotional attachment and you can’t short your home,” says Derek Warren, a portfolio manager at Morguard Financial Corp. “The average investor needs a more diversified portfolio… and real estate in general continues to be a hot sector.”
The mistake most people make is believing that the housing market behaves in parallel to the commercial and industrial sector, Warren says. They can behave differently, and people should invest in them for different reasons. “It comes down to the desirability of a place to live versus the need for cash flow,” he says. Of course, there are pros and cons in investing in any type of real estate, but, as with any investment, the best choice depends on investors’ risk tolerance and how hands-on they want to be.
BYOB (Buy Your Own Building)
Of all the property investments Dyck owns, he has had the most success with multi-family buildings. That’s because they have tenants who make regular and, over the long term, rising monthly payments. “It feels the best in my tummy,” he says. “My gut says it’s a no-brainer. Every month it’s ka-ching, ka-ching, ka-ching… You can bank on it.”
He’s also done well with commercial properties, which can be less work because they often include just one tenant. That said, it can sometimes take longer to find a new tenant for a commercial property, especially with so many new, competing buildings going up all the time. Some business owners are also choosing to buy their own buildings instead of leasing them. “Finding the right tenant is a challenge,” Dyck says. “But when I do find the right tenant, that tenant can be there for 10 years.”
Getting into the commercial or industrial property market also requires a huge chunk of cash, often in the millions, which is why a lot of investors such as Dyck do it with partners, either through a joint venture or limited partnership. That can open up more opportunities and lower the risk compared to doing it on your own. On the downside, the investment is less liquid, especially if you want to sell and your partners are intent on sticking it out. There is also intense competition on the market for well-located properties, warns Bob Levine, a principal at commercial real estate company Avison Young (Canada) Inc. “The bigger barrier to entry right now in most major cities across Canada is that there’s not a lot of stuff for sale,” he says.
Because the commercial and industrial real estate market has been strong over the years, owners have been satisfied to sit back and watch the value of their properties appreciate. They aren’t ready to sell. That includes pension funds and other private investors that also have long-term investment horizons. “When they buy, they typically don’t sell for long periods of time. That kind of freezes up the market a bit,” Levine says.
His advice for investors looking to drop a few million in the commercial or industrial property market: Get an agent to knock on doors for you and find out who is willing to sell before it hits the market. “If it does go on the market and it’s a good location, you’ll be competing with 15 or 20 other offers,” Levine says. “It requires a lot of knowledge and a lot of patience.”
Private investors have accounted for between 38% and 55% of all commercial real estate transactions each year in Canada since 2007, according to real estate services firm CBRE Inc. “We have a very active private-investor universe” in Canada, says Ross Moore, director of research. That includes investors buying in smaller groups, and prominent investment families who have been gobbling up real estate for years and passing it on to the next generation. These types of investors see commercial and industrial real estate as an alternative to stocks and bonds in part because they don’t have the same regulatory constraints and other hurdles. “Private investors rarely, if ever, are reporting to a board and they can be a little bit more nimble and take a little bit more risk,” Moore says. “They are far more opportunistic.”
Going public (REITs, MICs and other letters)
Not all investors have the cash to buy a chunk of property or the patience to deal with tenants. Some also want the active management and regulatory rigor that comes with owning a stock or investment trust. That’s where REITs come in, because investors can access a wide variety of commercial real estate through a publicly listed tax-efficient security.
The performance of REITs in Canada has been “spectacular” over the past 15 years, says CIBC World Markets analyst Alex Avery. He crunched some numbers and found that Canadian REITs delivered an “astonishing” 13% average compound annual return from June 30, 1999, to June 30, 2014. That’s 600 basis points higher than the S&P/TSX Composite Index’s return. Put another way, Avery says $100,000 invested in the S&P/TSX Composite 15 years ago would be worth $275,000 today, while the same investment in the S&P/TSX REIT Index would be worth $630,000, or 2.3 times as much. And that gain is despite a bad year for REITs in 2013, its first negative annual return in five years, driven by a sharp increase in the Canada 10-year bond yield. Higher bond yields put downward pressure on REIT prices, as investors look for higher yields from all yield investments relative to the risk-free yield on government bonds. REITs are sometimes viewed as similar to bonds because they offer high dividend yields. The 10-year bond yield has since fallen, and REIT prices have bounced back in 2014. Their performance over the past several years has been boosted by lower interest rates, which raises the value of properties and the cash flow they generate.
For some investors, REITs remain attractive because they have professional management, investor and analyst scrutiny, can easily be bought and sold and invest in different property categories. For instance, Chartwell Seniors Housing REIT invests in old-age homes, Morguard REIT holds retail, office and industrial properties, and Boardwalk REIT invests in multi-family residential properties in Canada.
A recent RBC Capital Markets report compared an investment in apartment REITs to that of buying and then renting a condo in Toronto or Calgary and discovered the REIT investors were better off over the long term. Analysts Michael Smith and Neil Downey found that condos outperformed REITs over the past one and two years, providing total cumulative returns of 18% and 27%, respectively, compared to REITs, which generated 11% and 12%. However, over three to seven years, REITs returned an average of 78%, compared to condos at 41%. “Although purchasing hard real estate assets usually has a positive emotional aspect to it, the fact is that REITs generally outperform condo investments in both Calgary and Toronto over most time horizons,” the analysts noted.
But before investors consider selling their rental properties to load up on REITs, experts such as CIBC’s Avery caution they are still relatively new to Canada. With just a 20-year history, they haven’t been tested in a faster rising interest rate environment, which some economists forecast could be coming toward the end of the decade. “We are flying in the dark not really knowing how REITS will perform,” Avery says. Still, he believes the asset class will perform well, driven in part by a growing seniors’ population looking for real estate and REITs to provide income support during their retirements. “It’s already apparent in the direct property market, where the professional property investors, who think in terms of decades, are paying record high prices to secure the best properties with the most reliable incomes,” he says.
Another alternative to buying buildings is investing in the companies known as MICs that provide the short-term mortgages on commercial and residential properties. They distribute all of their income to investors as dividends. Some examples include two MICs offered by Timbercreek Asset Management Inc. and one through Firm Capital Corp.
Both MICs and REITs offer investors exposure to steady, recurring cash flow from real estate, but GMP Securities LP analyst Jason Kepecs says their outcomes are “meaningfully different.” For instance, MICs aren’t as sensitive to interest rates because they are short term, about one to three years, and able to frequently adjust lending rates. They also outperform equities in sideways markets. “While MICs are unlikely to appreciate materially in value, they offer investors a stable and attractive return with a low probability of capital impairment relative to REITs,” he says.
(crowdfunding and other off-market investments)
For investors who don’t want to venture into the public markets, but don’t have the funds or the forbearance to buy their own land, there is a growing number of private funds to invest in. Each has its own investment criteria and upfront financial requirement. For example, Whitetail Capital Corp. is a Toronto-based private-equity firm that buys distressed real estate with a current focus on the U.S. Midwest, including cities such as Chicago. The fund is open to accredited investors, and typically requires a minimum investment of $150,000. “Most of the guys we have are real estate investors who have a lot of exposure to Canada,” and are looking for opportunities in the U.S., where they see more upside, says Whitetail co-founder and managing partner Ryan Smith.
Investors with less money in their pockets are also considering crowdfunding through firms such as Optimize Capital Markets, where the minimum investment is $25,000, though it can increase to about $150,000. “Real estate is becoming one of the more active sectors,” says CEO and president Matthew McGrath, whose company also raises funds for sectors such as technology and life sciences. “We are a nice bridge between the individual investors… and real estate groups in need of this type of investment capital.”
There are also a number of private funds where investments are based more on who you know, rather than how much you can put down. An example is B.C.-based Diverse Properties Ltd., which invests in residential and commercial real estate in Western Canada. It has a select group of about 30 high-net-worth investors, including doctors, lawyers, farmers and business people, who are friends and family or their referrals. Each has put in a minimum of $150,000. “We are pretty selective with who we have as investors,” says managing partner P.L. Meindertsma. The goal is to work with a team of investors who know each other and share similar investment values. “There’s a lot of money out there, but people are nervous about where to put it,” he says. “Trust is a huge part” of investing.
About 90% of Meindertsma’s personal investments are in real estate and the rest is in stocks, which he says is just enough to force him to stay on top of the public markets. “Some people make a lot of money in the stock market. I don’t have the time, motivation or desire to follow fund managers and internal changes at companies. I don’t understand that,” he says. “I don’t know anything as predictable as real estate over time.”