Many people buy Real Estate (R/E) because they are told by everyone (even their in-laws who will lend them money) that it is a ‘great investment’…’the best decision I ever made’, etc. Yet how many of those people ever kept track of what their investment return was? Can you find even one?

A real benefit from R/E comes from the savings being forced, and enforced, by the very structure of a mortgage. Let’s face it – most people can’t save. Without the bank demanding payments they would NEVER build up equity. That is real-life practical, but this website is for people who have a choice, who can save by themselves, and can invest by themselves.

Everyone, but EVERYONE, has a vested interest in promoting real-estate.

  • The newspapers publish whole sections, with 90% advertising, at least every week.
  • Real estate agents are ubiquitous. The revenue they keep and the advertising dollars they spend are huge.
  • The construction industry uses huge swaths of unskilled labour. R/E is the training ground for skilled journeymen.
  • Home furnishing stores are on every local business street.
  • Repair stores and repairmen are another set of beneficiaries.
  • Cities depend on the growing R/E values for a tax base.
  • Banks and mortgage brokers depend on your borrowing.
  • Pension funds depend on the return from buying those mortgages to fund pensions.
  • Just think about it. Can you name ANY sector of society that doesn’t want you to buy R/E?

One voice of concern was reported in The Economist after the US housing crash of 2008. “A decade ago Andrew Owald of the University of Warwick in Britain argued that excessive home-ownership kills jobs. He observed that, in Europe, nations with high rates of home-ownership, such as Spain, had much higher unemployment rates than those where more people rented, such as Switzerland. He found this effect was stronger than tax rates or employment law.

If there are few homes to rent, he argued, jobless youngsters living with their parents find it harder to move out and get work. Immobile workers become stuck in jobs for which they are ill-suited, which is inefficient: it raises prices, reduces incomes and makes some jobs uneconomic. Areas with high home-ownership often have a strong “not-in-my-backyard” ethos, with residents objecting to new development. Homeowners commute farther than renters, which causes congestion and makes getting to work more time-consuming and costly for everyone. Mr Oswald urged governments to stop subsidising home-ownership.”

Another Economist article there demolishes the myth governments use to justify subsidizing home ownership. It it interests you, this section (Everyone Loves …) was written well before the R/E crash.

Of course, you are less interested in the social value of homeownership, and more interested in whether R/E is a good investment for you. You must be super careful of financial decisions made from one-sided advice. Below, the problems and realities of R/E as an investment are discussed.



You Should Buy Real Estate Because Rent $ Is Just Thrown Away … FALSE

Most homes are financed with debt so the sad truth is that most of the monthly payment goes down a black-hole – just like rent. It would be nice if all of the mortgage payment grew your equity – but not so. Even at low interest rates a 20-year 4% mortgage payment is 55% interest. (see Problem #3).

When you add the extra costs for:

  • Property taxes
  • Property insurance
  • Condo fees
  • Mortgage fees and insurance
  • Regular maintenance and sporadic upgrades
  • Higher utilities
  • Higher commuting costs from living farther from work

you may well find that the dollars disappearing down the drain are no different from your rent.





In the long term, capital gains on R/E are only slightly above inflation. Properties on the coasts return slightly more, those inland slightly less. The media frequently states that historical gains have been about 4%. There are problems with this figure so many graphs from many sources are shown at the bottom of this page.

Part of the measurement problem comes from the cyclicality of the realestate market. Do you measure the annual gains from peak to peak, or from trough to trough? Academics mostly measure from an average of a cycle to the next cycle’s average. A second problem comes from the media quoting cumulative returns. E.g. “Mr ‘A’ realized a 50% return.” That is really 4.14% for 10 years. See Problem #6.

A third problem comes from measuring the returns in ‘real’ terms, i.e. with inflation removed. The implication becomes that realestate is a hedge for inflation, that during high inflation returns will be higher. This is not so. Look at the very last graph – Montreal’s prices during the high inflation of the 1970’s. Real returns were hugely negative.

More discussion below.


These are most often totally ignored. Not only are there property taxes and insurance, your utility costs may double, and there are the never-ending repairs to the roof, siding and windows. You need to purchase ladders and shovels and lawnmowers. You will spend tens of thousands of $ buying furniture to fill the house. And just when you think you’re ahead of the game, you pull out equity to update the bathroom. These costs increase the cost of your investment and decrease your return.

Many people who live close to work while renting, find they cannot afford any homes in the area. In order to enter the housing market, they move farther into the suburbs. There is an increased cost to that decision. Even ignoring the cost of your time, you will be paying higher auto costs and gas costs, etc. These are a cost of ownership, and eat into your ownership profit.

Strata fees are too easily dismissed when pricing a property. When purchasing, you must determine if the strata board assesses low regular fees because it keeps costs down, or because it assesses large lumpy payments for big ticket items as they are needed (instead of saving for them beforehand). Determine a ‘normalized’ cost to compare between properties. You should be willing to pay $13,764 more for a property that runs $1200/year cheaper (assuming you expect a 6 percent total return on your RE investment. See Problem #7.

The same math should be used to put a value on (eg) extra insulation or (eg) geothermal heating. Monthly savings for the life of the building are worth paying a premium today. But no premium should be more than the actual cost to install the same features yourself.

The strata’s bank balance is also wrongly ignored. Your portion of it is no different from money in your own bank account. If a 10-unit property has $100,000 more than another, you should be willing to pay $10,000 more.

The costs of a residential apartment block may not be anticipated. See this offering document for a Vancouver property for sale in 2008. It gives good details on the normalized costs for a detailed list of items.


What other investment has 5%-7% transaction costs? Not to mention the legal fees and title insurance and transfer taxes, and the months and months to close the deal. Do you really think “I’ll just rent it out if my job moves (or we have kids, or I meet a partner with a house)”? Think that through again. Being a landlord is no fun, even when you live next door. A ten-year turnover is now ‘normal’. You should expect multiple transactions in a lifetime.


The return on R/E comes mostly from your rent saved. This is an application of the ‘opportunity cost’ concept. There are two approaches here. One argues that you save the rent on the property you WOULD BE living in if you did not purchase. The other argues that you save the rent equivalent of the property you buy. Since most people buy more R/E than they would be willing to pay for as a renter, this second argument is a little self-justifying.

Of course if this will be a rental property, the income is the actual rent expected factoring in the expected vacancy rate. Don’t anticipate that market rents will keep up with inflation, making this investment inflation-proof. Research into Canadian markets shows that rents have not kept up with inflation in the long run. And more importantly, have lagged (along with property prices) in times of high inflation.


For owner occupied investments this is a huge benefit. But of greater benefit to those in the 45% tax bracket, than those at 25%. The tax saved is not only on the eventual capital gain. It also applies to the rent saved, which would have been paid out of after-tax earnings. Divide the rent by (1-tax%). E.g. at 25%tax bracket the savings on $750 rent would be $750/(1-.25)=750/.75 = $1,000

Offsetting the benefits from your income tax, are the payments of property tax. Historically property taxes were roughly 1% of the market value. After the doubling in values after 2000, they lag at (eg. Toronto) 0.85%. That is the same as a 28% tax on a yearly capital gain of 3%.

You may also consider the R/E transaction costs as a ‘tax’. Eg.(1) assume your house has doubled in value, when you sell it. Half the proceeds will be gains. If you pay R/E commissions of 7% on the full price, then you are paying 14% on the gains. Eg.(2) assume your house has appreciated 50%. One third of the proceeds will be gains. A 5% R/E commission on the full price equals 15% on the gains.

The point here is not that this is the way you should do your analysis. The point is that the transaction and carrying costs of real estate are higher than other investments. They cannot be ignored. All the cash flows must be considered.




Beware of mortgage calculators from the web. The Canadian calculations for quoted interest rates are different from the US rates. An explaination of the difference is available from here.

  • Calculate the rate of return you actually realized from a property. The default example shows a typical condo with predicted 4% operating returns and a 20% realized capital gain. But when all the cash flows are included, the return actually realized was NEGATIVE.
  • For Monthly payments mortgage, create an amortization table. See the effect of changing a payment.
  • For Weekly payments mortgage, create an amortization table. See the effect of changing a payment.
  • For Bi-Weekly payments mortgage, create an amortization table. See the effect of changing a payment.
  • Decide whether it is better to invest your savings elsewhere, or pay down your mortgage. This calculates the rate of return you earn from paying down the mortgage.
  • Compare different possible mortgages with different fees and different interest rates. This calculates the APR percent that factors all fees into one metric.



There are three steps to analysing real estate.

  1. The asset itself is considered, without any reference to the financing.
  2. The effects of financing and leverage are added.
  3. The expected capital gain over the life of the deal is added.

1. Calculate the Operating Return

  1. Start with the rent saved (or earned, if this is an investment property).
  2. Subtract the ongoing costs.
  3. Divide the net yearly income by the total property cost (including legal and transaction costs).

The dollar value of the operating return will increase over time as rents increase – roughly in line with increases in the market value of property. You should not add this to your calculated operating return %. Consider this like the stable 4% dividend paid by banks on their stock. As the company grows, the value of its stock grows, and the dividend also grows, but remains at 4% of the stock price. The owner realizes 4% + capital gains. This is the same conceptual argument used in the discussion of dividends.

This operating return may be over 8%, or it may be as low as 2.5%. It may be that in areas of the country that experience higher increases in house prices, the operating return is lower. And vica versa. Investors looking to buy rental properties look outside the major cities where the rents are higher compared to the selling prices. But in these areas the capital appreciation will be lower. If anyone has seen research that looks at this, please e-mail this site with the reference.

2. Leverage

will amplify the asset’s return. Obviously there will be no effect if the R/E is paid for with cash and no mortgage. Otherwise, compare the %return calculated in 1. with the %cost of any debt. Review your understanding of leverage. If the debt% is higher than the operating return% (which is frequently the case), your operating returns will be NEGATIVE for the portion financed by debt.

Calculate your weighted average return and be comfortable with the reduced return. It is at this point that many people should walk away. E.g. if your Operating Return is 4%, mortgage rate is 6% and you finance 75% of the purchase: 25%(4%) + 75%(-2%) = 1%-1.5% = 0.5% loss yearly. A loss that will only be recovered from the eventual capital gains on sale.

3. Capital Gains

are only realized when the R/E is sold. They will not be there to tide you through any low return calculated in (2.). When R/E is booming, the name of the game is the capital gain, but most of the time the benefits come from the operating return. The gain at the end is just icing on the cake. It has no nutrition.

The media sometimes publishes articles relating all the facts of a supposedly normal situation. They always ‘prove’ how great an investment the R/E was. Now that you know how to calculate the return, reverse engineer their example. Every time, you will find that the example’s operating return percent is greater or equal to the debt’s interest rate. In real life the opposite is most frequent. Their examples are fraudulent.

Real estate agents have a sales pitch ‘proof’ that purchase will cost you less than renting. They take the cash flow to cover the mortgage, and compare it to your current rent. This argument is wrong. First: it does not include the extra ongoing costs of owning property. Second: it presumes a 0% return on the cash portion of the purchase price. The argument can be made to support any priced property, by increasing the deposit and decreasing the mortgage. But all investors should require a return on any investment, including the real estate downpayment.




While most buyers understand condominiums, few understand either co-ops or leaseholds. Instead of making the effort to learn, many simply walk away without even considering the option. The problem starts with the real-estate agents themselves. THEY don’t understand the differences. Even when the agent himself lives in a co-op, he can be completely ignorant (and in denial) about the simple fact regarding whether the co-op corporation hold a mortgage on the property.

Like leaseholds, co-ops come in all shapes and sizes. The major distinction you should recognize is between privately-held co-ops and the government sponsored/financed co-ops whose purpose is to provide rent subsidies. Here, we are talking about only private co-ops.

There is an excellent paper written in 2006 for the New York University. It details the differences between a condo and a co-op, and presents a model for apartment valuations showing the impact on price from different attributes of the property. These are interesting for any purchaser.




A leasehold property has two owners. One owns the land and all residual rights to the property at the lease’s end. The lease holder has only a temporary right to use the property and a responsibility for all costs. The property can be an apartment building or a single home – no difference.

Leaseholds cost less than fee-simple property (say $100,000 today) for two reasons. First, the additional lease payments will increase the ongoing costs. Second, at the end of the lease you either walk away with nothing, or enter a new contract in which you will pay roughly market rent less the ongoing costs you assume. Buyers deal with the second problem by making different assumptions.

  1. Assume that governments will intervene at the lease’s end, forcing a renewal at low cost. And assume that when you sell, the next buyer will believe the same. In other words the second issue does not exist. If you believe this then the leasehold’s discount to a fee-simple property equals the present value of the additional lease payments: the additional yearly costs divided by the operating return you want.
    (e.g.) An additional $1,000 per year when you want a 4% operating return equals 1000/0.04 = $25,000.
    So you are willing to pay $25,000 less than a similar free-hold property.
  2. Assume that you will die before the lease’s end without having to sell it to finance long-term-care. And assume that you don’t care about the value of any estate left to your heirs. You need only consider the increased lease costs over your remaining lifetime (say 20 yrs), discounted at the operating return %. (Problem #4 but use your lifespan instead of the the lease term.) You would discount the leasehold by $13,590.
  3. Assume that you walk away with nothing at the end of the lease. Or, that the new lease’s terms effectively zero out your ownership’s value. This buyer will discount the purchase price by the sum of two factors: the PV of the excess operating costs over the term (say 50 yrs) of the lease ($21,482 from Problem #4 ), plus the amount that must be invested today to buy a replacement property at the end of the lease. ($22,811 from Problem #8). You would discount the leasehold by $44,293.An alternate calculation considers the leasehold as only prepaid partial rent over the lease term. If the net operating costs were $3,000 less than market rents, then the Present Value of Annuity = $64,446. ( Pmt=$3,000, i%=4%, n=50). The discount to a free-hold property would be $35,554 (100,000 less 64,446).It could be argued that instead of the “present value of an annuity” calculation, the “present value of a growing annuity” should be used. This would be because both the market rents and operating costs would be increasing each year: the difference along with them. Using “a growing annuity” results in a value for the property that can be 30% higher. The argument against presuming the annuity will grow rests on the fact that as real estate ages, the costs for upkeep rise at a faster rate than just inflation.



There are many different ways to invest in real estate. It is probably the most common progression beyond savings products. RE offers a higher return without assuming as much risk as the stock market.

  • Individual Ownership
    • Residential Property for a principal residence or for rental. It is legally called ‘fee-simple’ or ‘freehold’ when you own registered title to all the land and buildings.
    • Mobile Home on either leased land or owned strata titled land.
    • Industrial and Commercial property can be bought individually by investors or professionals for their own use or for rental.
    • Multi-units Buildings to be leased out as residential, industrial or commercial.
    • Agreement For Sale. The investor retains title to a property occupied by someone without the necessary downpayment to purchase. The rent charged includes an additional amount for the tenant’s option and right to purchase after (say) five years. The extra rent gets considered as partial payment of the purchase price, or forfeited if there is no purchase.
  • Group Ownership
    • Residential Property can be shared. A private agreement can be as joint tenants or tenants in common. Leaseholds, condominiums (strata), co-ops and fractional ownership provide personal ownership of shares in a partnership, company, trust, or non-profit that in turns owns the property. Tenancy rights may have a registered title (condominiums) or exist as a lease attached to the share ownership in the corporation/etc.
    • Industrial and Commercial Strata works the same way as residential properties.
    • Limited Partnership Units with a group of investors which may be either private or public. They may invest in bare land, or development projects, etc. There is usually a forseeable end date.
    • Time Shares sell occupancy rights for only a limited period of time each year. You may remain exposed to common costs without participating in possible upside appreciation of the property in total.
    • Real Estate Investment Trust (REIT) units that are usually publicly traded on stock exchanges.
  • Debt Products
    • Canadian Mortgage and Housing (CMHC) Bonds available from full-service stock brokers.
    • Personal Mortgages extended to family and friends, or offered as a sweetener on property you sell to a stranger.
    • Second Mortgages offered to retail investors by special businesses who group investor’s capital.
    • Mutual Funds holding mortgages.
    • Rent To Own. The investor retains title to the property, but no cash flow risk and only a slightly reduced ability to realize capital gains. The tenant pays monthly rents to cover ALL expenses: mortgage payments, property tax, utilities, maintenance, etc. At a specified time (say 5 years) the tenant has the option to buy the property at a price determined by an appraised value, less the normal agents’ commission, less (say) 25 percent of any capital gains since the start of the agreement (or plus 25 percent of an losses in value).
  • Derivatives
    • Futures Contracts on US real estate prices based on the Case-Shiller Housing Price index.
    • ETF’s from MacroShares allow you to bet on the upside (N-UMM) or downside (N-DMM) of the Case-Shiller index.



These graphs below (except the first) show the REAL increase in house prices (after inflation is taken out). They support the idea that owners should not expect price appreciation to be more than about one or two percent greater than the rate of inflation. This historical trend has been broken since 2000. At that time, instead of correcting, the real return continued to soar. The question investors must ask: “Will this abnormality be corrected?”

Your anticipation of capital gains is based on the tracking of average/median prices, but statistics can be misleading:

  1. If you buy a new property, it will start at the top of the range resulting in the average. After 25 years, it will sit at the bottom of the range. Your personal return will be less than the average because you must subtract both the premium to the average on purchase and the discount to the average on sale.
  2. The difference in yearly capital appreciation between the top decile of home sales, and bottom decile, was about 20%/yr in the 1970s and 1980s. In the 1990s it narrowed to about 10% but has widened again this century.
  3. A boom in new construction will distort averages. New and expensive units will more heavily weight the average.
  4. Remember to not compare apples to oranges. The average price 25 years ago bought a normal house of 1500 (est.) square feet. Today’s average house is (est.) 3000 square feet. Values are most heavily determined by square feet: building and land.

The point here is that statistics must be fully understood. Don’t accept them at face value. Don’t think they will guarantee you make a fortune. These graphs show that returns vary geographically and over different time frames. It is just like the stock market.


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