Understanding real estate investments

While real estateEstate The total sum of money and property you leave behind when you die.+ read full definition investments can offer a range of benefits, there is no guarantee that you will earn an income or profit and, like any investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition, there are a number of risks and uncertainties that you need to carefully consider before investing.

5 types of real estate investments

1. Real estate investment trusts

A real estate investment trustTrust An account set up to hold assets for a beneficiary. A trustee manages the assets until the beneficiary reaches legal age.+ read full definition (REIT) invests in income-producing real estate properties, such as shopping malls or multi-unitUnit What you buy when you invest in mutual fund. Similar to a share of a stock. For example, you could buy 100 units in a mutual fund.+ read full definition residential buildings. An investment in a REIT can offer investors income through payouts it receives from the properties it has invested in.

Investors can buy securities in public or private REITs. Public REITs are listed on a stock exchangeStock exchange A market in which securities are bought and sold.+ read full definition and private REITs are traded in the exempt market. Buying and selling public REIT securities through an exchange is relatively straightforward, and its value is easily assessed through publicly- available prices. Private REITs are not listed on an exchange, making their securities more difficult to value and tradeTrade The process where one person or party buys an investment from another.+ read full definition. Investing in a private REIT is different from and generally riskier than investing in a public REIT. There are also certain eligibility requirements that investors must meet before they can buy securities in a private REIT.

Generally, securities sold to the public in Ontario must be offered under a prospectusProspectus A legal document that sets out the full, true and plain facts you need to know about a security. Contains information about the company or mutual fund selling the security, its management, products or services, plans and business risks.+ read full definition (a document that provides detailed information about the security and the company offering it), but there are some exceptions to this rule. For example, in Ontario, if a private REIT is looking to raise money from investors, they may be able to sell under a prospectus exemptionProspectus exemption An exemption that allows a company lawfully to sell securities without providing a prospectus.+ read full definition in the exempt market. Learn more about how the exempt market works.

Some common risks of investing in private REITs

  • Lack of liquidityLiquidity Refers to how easy it is to change an investment or asset into cash, without affecting the price. Liquid assets include most stocks, money market instruments and government bonds. Your home or other property is not very liquid.+ read full definition Since private REITs purchased in the exempt market are not publicly-traded, they may be difficult to value and cannot easily be resold. You may have to hold onto the investment longer than anticipated.
  • Lack of transparency – Since private REITs are not subject to the same disclosure obligations as public REITs, there is less ongoing information available for you on how the REIT is doing, which may make it more difficult for you to assess how your investment is doing.
  • Decline in investment value – The amount of payouts you receive and the value of your investment is affected by the value of the properties that a REIT has invested in and the income it earns. Deteriorating conditions of the properties, higher vacancy rates or tenants that don’t make their rent payments can affect your payouts or investment value.
  • High fees – Private REITs sometimes pay higher management and other fees which can reduce the payout amounts to you and leave the REIT with less money to repair and maintain existing properties or investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition in more properties.
  • Personal liability – You could be held personally liable for paying the obligations of a private REIT if the REIT can’t pay for its obligations. This is commonly known as a “capital call.”

You can face taxTax A fee the government charges on income, property, and sales. The money goes to finance government programs and other costs.+ read full definition consequences if your real estate investment is held in an RRSPRRSP See Registered Retirement Savings Plan.+ read full definition and can’t be sold. Consult a tax advisor for advice.

2. Real estate limited partnerships

A real estate limited partnershipLimited partnership A special type of business partnership. Two or more partners own and manage a business together, along with one or more limited partners who only invest money. The limited partners have limited liability for the company’s debts.+ read full definition (LP) is commonly used to develop a real estate property or to manage completed real estate properties, such as a condominium building. As an investor, you can buy securities in real estate LPs. Real estate LPs are governed by the terms of a limited partnership agreement, which may be complex. The LP is controlled by a general partner who manages the development of a real estate property. For example, the general partner may use money from investors to buy undeveloped land with the expectation of developing it or selling it at a profit. This gives investors the potential for growth if and when the land or development project goes up in value.

Most real estate LPs are private. Their securities are not listed on an exchange, making them difficult to trade and value.

Some common risks of investing in real estate LPs

  • Lack of liquidity – Investments in real estate LPs that develop property are typically long-termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition investments that can extend for the durationDuration Duration is a way to compare bonds with different interest rates and terms. It measures how sensitive a bond’s price is to interest rate changes. It is stated in years.+ read full definition of a development project. You may not be able to resell your investment when you want or at all.
  • No guarantee – There is no guarantee that projects will be sold at a profit because the real estate market fluctuates and development costs can go over budgetBudget A monthly or yearly estimated plan for spending and saving. You work it out based on your income and expenses.+ read full definition. Although not a prediction of future returns on your investment, you may want to ask about past projects that were successfully completed to get a sense of the general partner’s experience. There are many factors that can impact the success of and returns from a development project and past performance is not a prediction of future returns on your investment.
  • Lack of diversificationDiversification A way of spreading investment risk by by choosing a mix of investments. The idea is that some investments will do well at times when others are not.+ read full definition Some real estate LPs develop one specific property or real estate project. If the development project is never completed or sold, you could lose some or all of the money you have invested.
  • Government approvals and market valueMarket value The value of an investment on the statement date. The market value tells you what your investment is worth as at a certain date. Example: If you had 100 units and the price was $2 on the statement date, their market value would be $200.+ read full definition – Some real estate LPs may not have obtained all the required government permits and zoning approvals they need to actually develop the land they own. Delays or denial in obtaining all permits and approvals can significantly impact the value of your investment.
  • Risk of capital call – If a project goes over budget, you could be obligated to contribute more money to cover the extra costs.

If you have been promised a monthly return or payment on an investment in a development project, you should ask where the cash for the payment will be coming from while the project is being developed and is not producing any income.

3. Mortgage investment entity

A mortgageMortgage A loan that you get to pay for a home or other property. Often the loan is for 20 years or more. You make a set number of payments for a set amount each year.+ read full definition investment entity (MIE), also commonly referred to as a mortgage pool or mortgage investment corporation, is a mortgage financing business that pools money raised from investors to lend to borrowers.

MIEs will often provide financing or mortgages to borrowers who may not be able to obtain a loanLoan An agreement to borrow money for a set period of time. You agree to pay back the full amount, plus interest, by a set date.+ read full definition from conventional sources, such as a bank. Borrowers typically use this financing to purchase single-family residences, commercial properties or development projects. A MIE will often hold a number of mortgages in its portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition, reducing the potential risk to investors compared to holding a single mortgage.

As an investor, you purchase a security issued by the MIE (e.g. shares of a corporation, limited partnership units, trust unitsTrust units A way to represent the interests of each member of a trust. Assets often include property (real estate investment trusts), royalties from oil and gas production (royalty trusts) or business income (income trusts).+ read full definition). The security’s value is derived from the value of the underlying pool of mortgages that are typically secured by the real estate properties. Investors have the chance to earn income (such as dividends) from the interest earned by the MIE on its portfolio of mortgages.

Most MIEs are private. Their securities are not listed on an exchange, making them more difficult to trade and value.

Some common risks of investing in MIEs

  • Lack of liquidity – Generally, private MIEs are typically illiquid investments, meaning that you may not be able to sell your investment when you want to or at all.
  • Decline in investment value – Borrowers of an underlying mortgage may default on their mortgages or repay their mortgages sooner than expected, either of which can affect the value of your investment or the amount of income that gets paid out to you.
  • High risk loans – MIEs typically provide mortgages that are higher risk than mortgages made by a conventional lenderLender Any person or organization that lends money.+ read full definition such as a bank. If too many borrowers fail to make their mortgage payments, it can decrease the value of your investment and the MIE may not be able to make any payouts to you.
  • Low priority of rights – MIE mortgages can be second or subsequent to a first mortgage. If a borrower fails to make mortgage payments, and the property is liquidated, the lender that made the first mortgage will be first in line to receive its money back. The MIE that made the second mortgage will only receive its money if and when the first mortgage has been fully paid off.

4. Syndicated mortgage investments

In Ontario, only mortgage brokers and agents licensed with the Financial Services Regulatory Authority of Ontario (FSRA) formerly the Financial Services Commission of Ontario (FSCO) can engage in syndicated mortgage transactions on behalf of a brokerage, and only licensed mortgage brokers (not agents) can sign the required investor/lender disclosure statement forms. You can check that the individual or business is licensed with FSRA on FSRA’s website.

A syndicated mortgage is where two or more individuals invest into a single mortgage against real property. Some syndicated mortgage investments are used to fund large scale real estate development projects. Before investing in a syndicated mortgage, read FSCO’s previous advisory notice warning consumers to be wary of advertisements promoting high returns or “fully secured” investments.

Below are some of the risks that are detailed in FSCO’s advisory notice:

  • No guaranteed high return –Although some companies or individuals offering syndicated mortgage investments may say they offer ‘guaranteed’ high returns, it is actually against the law to do so. In general, the higher the rate of return, the higher the risk of the investment.
  • A lineup for repayment –Often, at minimum, you are second in line to be paid, behind any financial institution(s) that provides a loan for the project. If the project fails, there may not be any money left over to pay you. You may even be further back in line behind other investors.
  • ‘Secured’ does not mean guaranteed – Some advertisements promote SMIs as ‘safe’ or ‘fully secured’. It is true that your investment will be used to create a mortgage that is registered and secured directly with the land or building associated with that mortgage. But remember, if something goes wrong with the project – and the value of the security is limited to the value of the land – you may rank behind other lenders and investors and may not get any or all of your money back. This is because the value of the land may be only enough to pay these prior-ranking lenders.
  • No investor protection insurance – Syndicated mortgage investments are not insured by the Government of Ontario or any other investor protection fund; there is no way to guarantee you will get your money back.
  • Early withdrawals – If you want to withdraw your money before the end of the term, a new investor/lender may be required and there is no assurance that there will be a market for the resale or transfer of the mortgage.

For more information, please contact FSRA at 1-800-668-0128 or contactcentre@fsrao.ca or visit their website at https://www.fsrao.ca/.

5. Real property

You can buy a property as an investment and generate income through rental payments from a tenant, assuming that you charge enough rent to cover all costs associated with ownership, including any mortgages, taxes, utilities and maintenance.

Some common risks of investing in real property

  • Significant expendituresExpenditures A payment or the promise of future payment.+ read full definition and time commitment – Property ownership is an expensive and hands-on type of investment. Be prepared to devote a lot of time to managing the investment, from handling paperwork to finding a tenant and making repairs, regardless of whether the property is producing any income.
  • Tenant risk – You could end up with a tenant who doesn’t pay rent or damages the property. You could also have trouble finding a tenant and not earn any rent for a period of time. In both of these cases, you are still responsible for paying the ongoing mortgage and taxes, and covering the expenses of maintaining the property.
  • Market decline – The value of the property could fall below what you paid for it, and can leave you with a mortgage greater than the property’s worth.
  • Liquidity riskLiquidity risk The risk of being unable to sell your investment at fair price and get your money out when you want to. To sell the investment, you may need to accept a lower price. In some cases it may not be possible to sell the investment at all.+ read full definition You could have difficulty selling the property if your local real estate market is experiencing a period of low sales or declining prices. It also takes time to sell a property and complete the closing.

Take action – check registrationRegistration A requirement for any person or company trading investments or providing advice in Canada. Securities industry professionals are required to register with the securities regulator in each province or territory where they do business.+ read full definition

In Canada, anyone who sells securities or advises other people or businesses on securities must be registered with the securities regulatorSecurities regulator A government agency that enforces the securities act in jurisdiction it has authority over. This act is made up of laws that establish rules for issuing and trading securities. The Ontario Securities Commission is the securities regulator for Ontario.+ read full definition in each province or territory where they do business, unless an exemption applies. Always check the registration of any person or business trying to sell you an investment or give you investment advice at CheckBeforeYouInvest.ca.

Key point

5 types of real estate investments:

  1. Real estate investment trusts
  2. Real estate limited partnerships
  3. Mortgage investment entity
  4. Syndicated mortgage investments
  5. Real property

Take action

In Canada, anyone who sells securities or advises other people or businesses on securities must be registered with the securities regulator in each province or territory where they do business, unless an exemption applies. Always check the registration of any person or business trying to sell you an investment or give you investment advice at CheckBeforeYouInvest.ca.

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