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expert's podium

I was catching up on a backlog of reading last weekend when I came across an interesting, if worrisome, article in The Economist. In it, the British newsmagazine suggested the Canadian real estate market is overvalued by 25 per cent or more, and is now "frothier" than the U.S. market was at its peak in 2008.

A provocative suggestion, one sure to make millions of Canadian homeowners a little concerned. For better or worse, real estate remains a significant asset for most Canadian families. If our real estate market is in bubble territory, the financial implications would be serious.

Now, by no means am I an expert real estate investor. I've owned each of the principal residences I've lived in over the past 25 years, and they've all done reasonably well for me. But real estate is not the focus of my portfolio, and beyond the old adage about "location, location, location," I have little in the way of secret wisdom or guru-like tips to pass on to real estate investors.

The wealthy people I know, however, are quite another story. Many of the smartest, wealthiest people I have ever met have made millions in real estate. These people are shrewd investors. Real estate is something they talk about often, and when they do, I listen.

Based on these conversations, I would say high net worth (HNW) investors seem to be pulling back from the Canadian real estate market. Not exiting altogether, mind you. But instead of allocating new money by buying Canadian residential property, they've decided to invest in real estate in a different way.

The following four "profiles" describe some of the different approaches HNW individuals are currently using to invest in real estate. I offer them as a jumping off point for how you might allocate your own real estate assets, no matter what your net worth.

The developer Many HNW real estate investors are in fact real estate businesspeople. They tend to be highly experienced investors with detailed knowledge of a particular market, along with a vision for what a particular piece of property could be (as opposed to what it is now). They are prepared to take big risks. But they can reap equally big rewards.

Playing the development game requires a strong stomach and deep pockets. It also requires a somewhat paradoxical mindset. On one hand, bringing a property from raw land to completion can take years, so patience is a necessity. On the other hand, once a site is built, cash return becomes a priority, so quick-flipping is standard.

Investors with neither the mindset nor the capital for development can still invest like a developer by putting money behind publicly listed companies in this line of work. Firms related to development (engineering firms, for example) are another possibility.

The income investor Real estate has always been an attractive asset for income-oriented investors. With the current low interest rate environment, that interest has only grown. More and more HNW investors I talk to are taking a look at apartments, office buildings, malls, and warehouses, where there's potential for capital gains, but the primary goal is income.

Like the developer, the income investor takes a businesslike approach to real estate. But the business is more conservative, with less focus on vision and more focus on balance sheets, cash flow, and cap rate. These investors seem to be in it for the long haul, and many times, with the intention of handing down through multiple generations.

Investors of more modest means can easily take the same approach. There are several REITs that focus on apartments and long-term tenants, both in Canada and the U.S.

A diversified portfolio of them could make an intriguing income investment. Accredited investors can also consider investing via Limited Partnership structures.

The opportunist Legendary value investor Benjamin Graham talked about putting his money into "cigar butts": companies that had been beaten up and discarded but still have a "few good puffs" in them. That's a good analogy to what many HNW investors are doing with real estate. The opportunist sees real estate as a contrarian play—potentially the greatest of the past 50 years—but not necessarily a long-term hold.

Since 2008, the prime target for this type of real estate investing has been U.S. housing. With prices down 50 per cent or more from their all-time-highs in sun belt states such as California, Arizona, and Florida, dozens of HNW investors I know have bought condos, houses, and also apartment buildings and commercial property. A strong Canadian dollar doesn't hurt, either.

There is nothing to stop investors of more modest means of doing the same, either through direct purchase (condos in many Snowbird destinations can be had for $150,000 or less), or a U.S.-focused REIT.

The loaner Some HNW investors have decided to invest in real estate not by owning, but by loaning. Instead of buying property, they're funding mortgages, investing in private real estate financing pools, or by backing companies that do the same.

Such an approach has several advantages over owning. It's a good way to diversify, for one. It's also a good way to move up the capital structure: mortgage holders generally take precedent over equity holders if a project goes sour. And of course, mortgages and real estate debt can be good income generators, too.

There are several publicly traded securities that offer exposure to mortgages and other financing pools. Many Canadian mutual fund companies offer mortgage loan funds. They're more expensive than publicly traded securities , but active management may arguably offer additional risk control. Limited Partnerships are also an option for Accredited Investors.