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real estate

Real estate is a hot topic these days. Given the possibility of interest rates rising sharply at some point, some say the property market is due for a correction. Others believe tangible assets are the best security in volatile times such as these.

Recently, I was invited to attend a family meeting of a clan we'll call the McKenzies, a family of long-time business owners to discuss this important topic. Since coming to Canada over 45 years ago, the McKenzies have done well by owning a specialty manufacturing business. But the bulk of their wealth has come from real estate. The family holds a substantial real estate portfolio, including residential, commercial and industrial property, almost all of it in the Greater Vancouver area.

Now that mom and dad were ready to pass on the family business to their four children, the family wanted to gather perspectives on whether this focus on real estate would serve them well in the future.

As I told the McKenzies, a lot of wealthy people have made a lot of money in real estate, particularly in Western Canada, and particularly here in Vancouver. I have no doubt that they will continue to do so over the long term. But there's no way to be sure whether real estate will be a better investment in the future than a privately-held business, for example, or a portfolio of publicly traded stocks.

Your attitude toward real estate is often influenced by the performance of real estate in your home market. The performance of residential real estate in Vancouver has been exceptional. This is no doubt one of the reasons - even if it's unacknowledged - why the family believes real estate will be a good investment in the future.

But I asked the McKenzies, what would their opinion on real estate be if they lived in Winnipeg, for example? Or St. John? Or Thunder Bay? Would we even be having this discussion?

The point hit home for Mr. McKenzie senior. As it turns out, one of his cousins had emigrated to Canada at around the same time he had. But instead of going out West, the cousin had settled in Hamilton, where he had established a successful welding business.

I asked Mr. McKenzie what his cousin's perspective on real estate investing was. Mr. McKenzie thought for a moment, then answered: "I don't think he likes it much at all."

And that was my point. Before increasing their real estate holdings, the McKenzies need to ask themselves whether their hometown bias is interfering with an objective determination of portfolio needs. They should also ask themselves:

How concentrated is the portfolio?

Concentrating assets, whether in real estate or in a single stock, can be an excellent way to create wealth. But it is a risky way to preserve wealth.

Now that the primary goal of the McKenzie family has shifted from wealth creation to wealth preservation, diversification might make more sense than in did in the past.

Even if the family wants to keep its real estate exposure, they can still diversify: by balancing the portfolio between residential, commercial, and industrial real estate; by investing in markets outside the Lower Mainland, such as significantly depressed areas in the U.S.; or by investing through a pooled structure such as a limited partnership, a private equity fund, or even a publicly-traded REIT.

Can you align business and real estate interests?

If there is, real estate can be an excellent investment. This is what kick-started the McKenzies' real estate portfolio: their operating business bought the buildings where it conducted business. The tax advantages of such a move can be significant, and can easily enhance both capital gains and after-tax cash flow.

Own or loan?

The McKenzies had always been owners of real estate. But as I pointed out, there are also opportunities for those who can provide real estate financing and mortgages as well.

This can be an excellent way for high-net-worth families to maintain some exposure to the real estate market, but move up the capital structure into an income-oriented investment that generally provides more security.

Opportunity or core holding?

Over the past few months, many wealthy individuals have taken advantage of economic turmoil and the strong loonie to buy bargain-priced real estate in the U.S., where opportunities in multi-family dwellings and offices in select markets have been very attractive, and will likely continue to be for the next one to three years.

As I told the McKenzies, seizing opportunity is smart. But a decision about making real estate a core holding deserves much greater consideration, as part of an overall wealth management plan.