Mortgage Blog

Real Estate Investing

July 26, 2023 | Posted by: Calum Ross

The Problem

Real estate investors often fail to objectively assess their existing portfolio as a holistic wealth management professional or financial planner would.

Thus, even if they began their investment career following sound investment principles, they stray from these principles when applied to their existing portfolio. This is the eroding effect of inertia. At the same time, high performance of an asset class often leads to irrational exuberance towards an asset class.

This is what’s happening today as:

Yield on Toronto and Vancouver Real Estate Has Diminished: Rising real estate prices in these markets have eroded yields, which means many real estate investors are over-weighted in one asset class and many new real estate investment representative speculative grade real estate investment as they don’t meet the suggested 3% interest rate cushion to sustain cash flow from my book.

To demonstrate this problem, I’ll compare the gross and net cap rate on these properties with dividend paying stocks. 

Investors are Demonstrating Irrational Exuberance and Greed Towards Real Estate: I’m deeply concerned by the number of people who believe real estate values will continue to climb at these uncharacteristically high levels.

There are too many people chasing returns in real estate. There’s an alarmingly high net inflow of money to real estate in overpriced markets. 

These beliefs lead investors make to poor decisions, which means that they are no longer following sound investment principles. To help people make more informed and accurate decision to buy or hold their real estate holdings I will be coming out with a white paper to proactively address key calculation that real estate investors need to understand to determine if they are at risk. 

This Paper’s Solution: Apply Timeless Investment Principles

By assessing market realities and applying timeless principles, investors will conclude that they must adjust their current behavior. The timeless principles outlined will include:

• Highest and Best Use of Capital: If treated as new acquisitions, real estate investors wouldn’t buy many of the properties they currently hold. They would instead favour a blue-chip dividend-paying equity or a different real estate property.  The broader based implication of this is that a huge number of GTA and Vancouver real estate investors would be best served selling their holdings. 
• Greater Due Diligence at Acquisition Stage: A single real estate property often makes up a huge proportion of an investor’s total portfolio value. If they were going to own a comparable amount of a single equity, investors would apply a very high level of due diligence. They do not often do this with a single real estate property. I will argue in this paper that they must as significant due diligence is a non-negotiable part of any substantial investment purchase.
• Stickiness of Real Estate Prices: Real estate is quick to rise but slow to fall, which is unlike equities. Since comparative market data is not as freely available and assets are not as homogenous – fact based evaluation is not as easy. This means prices don’t always reflect value especially when inventory is low. 

Conclusion

Sell Underperforming and Buy Performing Assets: Many, if not most, properties in a typical (Toronto and Vancouver) investor’s portfolio have shifted from investment to speculation grade real estate due to effective yield and opportunity cost of capital. This means investors would be best served to sell and re-weight their portfolio to more diversified assets and/or selling to buy better performing real estate investments.
 

Being overly weighted in one asset class and having investments in that asset class no longer to perform the stated objective of positive cash flow if rates returned to a more normalized five percent range is simply irresponsible. The appreciation has been a great gift, but not re-weighting asset classes and diversifying your overall investment holdings would be an incredibly flawed decision and one which no wealth or portfolio manager who is competent would even encourage or recommend you do in good faith. 

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