Where does a newbie start to invest?
As this has become a big of a series here is the index of what has been written before.
Part #1 : Savings account here
Part #2 : GIC/Time Deposit here
Part #3 : Bonds here
Another investment to know about: Real Estate
I'm tempted to just assume that everyone knows about real estate as an investment. However as this is a newbie post I'll assume that not everyone does. People need places to live. Shelter is a basic human need and without it life gets very rough very quickly.
There is also a limited number of homes and a limited amount of space. That means houses and places to live are valuable. In addition there is a saying "They aren't making any more land" which means there space on earth is limited and getting a piece that is personally owned and that can be given to family for legacy is a dream for many people.
Houses, condo's, apartments, office buildings, storefronts and so forth is all real estate.
It all tends to be very expensive and for many it is aspirational and certainly not a stepping stone in their investment portfolio. Indeed where I live buying a house can 20 to 50 times a persons annual wage or far more for really nice places. In that regard talking about buying a first home, rental property or condo unit isn't really applicable to newbie investments
However, real estate trusts which are also known as REIT's can be a very interesting addition for new investors.. The reason? They can be purchased fairly cheaply, they pay regular distributions, and they have the potential to go up over time.
Let's look at an example
Imagine that there is a property for sale and these are the details.
- Purchase price : 1 Million dollars
- Suites : 4 (Two x two bedroom units and Two x one bedroom units)
- Interest rate : 4% APR. 25 year amortization. 5 year fixed.
Now a friend tells you it is a once in a lifetime opportunity to make money. However you think there is no way that I can afford it right now! A quick look at a mortgage calculator shows that the payment will be $5300/month! The interest alone is $40,000 per year!
That is exactly what most people think. They wish they could buy a property but it is simply out of their reach. They know that properties often go up in value over time. They know how nice not to give away rent money every month. They know how nice to not have a landlord but they just can't afford it...yet.
But the friend persists
They tell you it is such a good deal. With the current tight rental market that the 2 bedroom units are rented at $2,000/month (x2) and the one bedroom unit at $1500/month (x2). You only pay $5300/month but the rent every month is $7000.
$7,000 rent - $5,300 mortgage payment means $1,700 every month in profit.
Now it starts to sound like a good deal! Live in a one bedroom unit, rent out the other units. You get $5500/month income, pay $5300 a month mortgage payment. Live for free. No Rent! Horray!
Except :
- 5,000 / year in property taxes
- 4,000 / year in home insurance
- Plus maintenance
- Plus months where units aren't rented or the renters are late on rent.
- What if rates go up?
Now things look a little less "Sure Thing" and a lot more "I think I'll pass".
That is the harsh reality for individuals buying a house for themselves for rental income. It is really expensive and there are a lot of things that can go wrong.
That's exactly why I said private ownership of a property can be profitable but it isn't for a novice investor.
But what if a bunch of people got together to buy that very same property?
What if 1000 people paid $500 each?
Same House: $ 1 Million
Same Rental income : $7,000 / month
But the financing looks very different:
5% HELOC rate (home equity line of credit) which means interest only at 5%
Sure it is just a lot of numbers right now but here is where it gets interesting.
the 1000 people who paid 500 each? The collectively own half the house. The remaining monthly payment of interest only is $2083 / month.
If each unit is still rented?
$7000 income
$2038 interest
$4916.67 / month after interest to cover expenses and pay money back to the owners.
Assuming a regular year with $5000 tax and $4000 insurance and everyone pays their rent on time?
$50,000 / year in income.
Distribute that money to everyone?
Everyone paid $500 and gets $50 / year as income. A 10% potential annual return. Well, actually 4-6% is more typical because of maintenance fees, operating fees, and much more. Also the borrowed VS owned is not a 50:50 split and not a simple HELOC but rather complex financing scenario.
In a very simplified way that is what a REIT is
Many people buying a small portion of a property or more typically a group of properties.
Now in the example I gave I didn't put in management fees. I didn't include missed rent. I didn't include vacancies. I didn't include repairs. All of those make the return go down. However, I didn't include the potential for the property to go up and increase in value either. There are a lot of moving parts with real estate. Even more moving parts when there are multiple people owning it.
But the basics remain the same.
A typical REIT has a low price per share. I have many different REIT shares and most are in the $20 to $100 range. It is small enough for a new investor to get into without an issue.
REIT's are fairly simple to understand. At its heart the investor is buying a portion of a real estate portfolio. The real estate if professionally managed and maintained. Each month they get money and each money the investor gets a portion sent their way.
If real estate prices go up? REIT's tend to go up.
If rents go up. REIT's tend to pay out more.
If interest rates go up? Then the interest payment goes up leaving less money to distribute to the owners.
Well, that is way to simplified. However, the share prices do go up and down due to many factors especially interest rates. The shorter version is that shares can absolutely go up over time or down over time. Interest rates are one big factor because of debt on the properties but perception and other market factors make a difference also.
In comparison?
REITs aren't guaranteed like a Savings Account or a GIC. They don't have a guaranteed value and interest (with exceptions) like a bond. They do have the ability to go up long term, the ability to pay out regular monthly income. Sure there is more risk but at least you know the idea behind what you are getting.
But read the Prospectus
There are a lot of REIT's out there. Some invest in office properties which have very different vacancy rates than homes and apartments. Some invest in industrial or specialty properties. Some have high levels of debt. I'm sure there are even more parameters to look at also...but those are the big ones I like to check out.
At the end of the day REITs are still a "regular" income type of investment. However, this is the first one I've mentioned where many people pool their money together to fund something larger. Next in the series I'll look at stocks, ETFs and mutual funds. However, I figured one last "monthly" income type investment before that.
Real estate is fun in my opinion. If you can't afford a whole house? Buy part of a house regularly and eventually you could have enough to buy one whole one. Probably one of the nicer ideas to invest around.
And thank you for reading this far. Appreciate the eyes on the article and as always I love feedback. Did I get anything wrong? Was I confusing on anything? Just have a curious question? I would love feedback. Thank you.