A lot of things sound great in theory. Grilling steaks on a long weekend at your cottage by the lake, for instance. Or, opening a cheque from a tenant who is renting your condo for more than the cost of its mortgage. Both of these property investments can provide great returns – if not in the form of extra income, then at least in some well-needed family time.
But a second property isn’t the wisest investment for everyone. They usually sound like a great idea, but the way they fit into your portfolio (and yes, they’re a part of your portfolio) means they can quickly and easily spell financial trouble for the unprepared investor.
“What we generally advise is that you sit down and look at the big picture,” says Hatice Pakdil, vice-president and investment adviser with TD Waterhouse Group Inc. in Toronto. “You have to really assess everything; real estate is a pretty sizable investment.”
While an income property sounds like a great way to boost cash flow, and a cottage can bring the whole family together, the purchase of a second property isn’t often recommended as an additional asset to a portfolio.
When considering a second property, Ms. Pakdil says the best strategy is to “treat it like any investment.” Consider your tolerance for risk, for instance, as well as the time horizon of the investment and the shape of the market at the time you make the purchase. (Let’s remember the June OECD report that calls Canada’s housing market one of the most overvalued in the world.)
“Stocks move around; real estate prices also come down,” she says. Looking for returns with a longer time horizon – 10 to 15 years, she says – is reasonable, but there should be “no expectation that there could be a quick return.”
Brett Strano, a Mississauga-based financial adviser with Edward Jones, points to another conventional piece of investment wisdom: “You don’t want to put too much money in one asset class.” A second property means that even more of your portfolio would be in real estate. That could result in 70, 80, 90 per cent of your money being in one asset class – not a comfortable place to be in Canada’s frothy housing market.
“We certainly wouldn’t recommend putting 75 per cent of overall liquid assets into equities or bonds,” Mr. Strano says.
He takes clients’ hopes and dreams into consideration when recommending whether they should buy a second property. “Using a cottage, for example – clearly, the emotional pleasure it brings to a family is out of this world,” Mr. Strano says.
But he also advises clients to make sure they don’t jump into a second property just because they’ve had a mortgage approved. “There has to be a steady stream of income coming in to offset the costs of these properties.”
There will likely be initial costs to bring any second property up to snuff. At a cottage, count on additional costs for amenities such as a barbecue or a boat. At an income property, ongoing maintenance has to be considered, particularly when it can come at the beck and call of tenants. If it’s a condo, don’t forget regular maintenance fees.
When buying a second property to rent, consider the age of the building – the older it is, the more maintenance it could require. And if you’re buying a condo, older buildings could be subject to greater mandatory maintenance fees as time goes on.
Any of these could turn your income into a loss. Plus, for either investment, there will always be tax considerations.
In case of emergency, advisers point out that there’s no liquidity in real estate. “That’s a risk that runs with any real estate asset,” Mr. Strano says. “Unlike a stock or bond or mutual fund, there is no ready, open market to get your money within a [reasonable or guaranteed] settlement date.”
To avoid problems, he recommends having emergency funds available at all times, such as through a home equity line of credit on your first property. But that won’t necessarily solve how to split the property in the case of, say, a couple separating.
Do you want more exposure to the real estate market without all of these hassles? There are simple alternatives, Ms. Pakdil points out, such as real-estate investment trusts and mortgage-backed securities.
“But obviously something tangible is the traditional way [to get a taste of the market], and in the long term, it will make a better return,” she says.Report Typo/Error