While the term real estate is familiar to most people, understanding the intricacies of what the term encompasses might be a different matter. Real estate is a type of property that can include land, buildings, or both. It is a tangible asset that is owned or leased, and depending on the nature of your lease or ownership, you’ll have certain rights to use and enjoy the land and its buildings.
People purchase or lease real estate for different purposes, including as a principal place of residence, a vacation home, an investment, commercial purposes, and a rental property. Here, we dive a little deeper into what real estate is, the different types of real estate and the benefits it offers.
Types of Real Estate in Canada
In general, there are three categories of real estate:
- Residential real estate can be single-family or multi-family dwellings owned or rented by individuals, including undeveloped land, houses, condominiums, and townhouses. Their sole intent is to provide a home.
- Commercial real estate includes nonresidential structures intended for business use, such as a single-use property such as a small shop, restaurant or doctor’s office, or a multi-purpose structure such as shopping centres or office towers. Properties include office buildings, warehouses, and retail buildings.
- Industrial real estate includes factories, business parks, mines, and farms.
So basically, the type of real estate is based on the purpose it serves, whether that is a home, to generate revenue or to produce a product.
Residential Real Estate Ownership
Residential property provides the opportunity for homeownership. When buying a home to live in, your property is considered owner-occupied. Residential properties allow you to build equity and gain wealth. That’s always a good thing. Most homeowners acquire their homes through a mortgage, a loan specific to real estate. Residential properties can also be purchased as rental properties to earn income.
Unlike renting, where you pay a landlord for the use of a living space, owning residential real estate means you hold the title to the property, giving you the rights to use, rent out, or sell it. In financial terms, it’s often considered a long-term investment, offering tangible and monetary returns over time. The concrete nature of real estate makes it a preferred choice for many investors, serving both functional and investment purposes.
Commercial Real Estate
Commercial real estate is used for business purposes, from shopping malls to skyscrapers and freestanding shops to houses converted for business use. The difference between commercial and industrial properties is that it is intended for “commerce,” while industrial space is used for manufacturing products. Although multi-family buildings such as high-rise apartments generate money for their owners, they aren’t considered commercial properties.
Unlike residential property, the value of commercial real estate is closely tied to its useable square footage and the income it generates, commonly referred to as the capitalization rate or “cap rate.” These properties often require a substantial upfront investment but can offer stable, long-term financial rewards. One of the appealing aspects of commercial property ownership is the possibility of entering into triple net leases, where the tenant is responsible for property taxes, insurance, and maintenance costs in addition to rent. This arrangement can reduce the financial burden on the owner.
Industrial Real Estate
Industrial real estate ownership refers to acquiring and managing properties used for industrial activities, such as manufacturing, warehousing, research and development, and logistics. These properties are generally located in industrial districts or on the outskirts of cities, away from residential areas. Industrial real estate tends to differ from other types of commercial real estate in terms of its physical characteristics, operational needs, and the types of leases standard in the industry.
Leases are often long-term, sometimes spanning several years, providing a consistent and reliable income stream. In addition, tenants in industrial spaces are generally less transient than those in retail or office spaces, adding an extra layer of stability to the investment. Ownership also involves understanding complex zoning laws, environmental regulations, and possibly dealing with labour unions.
Real Estate Investment
Investing in real estate can prove very lucrative, as almost all properties appreciate over time. When purchasing properties for lease, you can often regain the money you pay for the property from rent and continue to generate gains as the property appreciates in value. There are several ways you can invest in real estate, including:
- Buying tracts of land
- Buying structures
- Buying shares in real estate through publicly traded real estate investment trusts (REITs)
- Buying mortgage-backed securities (MBS)
The benefit of real estate investment is that it takes severe market issues, such as a major recession, for properties to depreciate. There can also be other unexpected factors, such as investing in “swamp” land, which would greatly reduce your odds of reselling the land for profit.
Land is not likely to make any gains if it lacks purpose or is not located in an area where demand is expected to increase. Both at the time of buying and the time of selling, investment value is dictated by several factors, including the local economy, employment rates, local transportation, the availability and quality of municipal services, property taxes and even the quality of schools if investing in residential properties.
Benefits of Owning Property
The main benefit of owning property is that, in most cases, your property will appreciate if you buy at the right price. The trick is to ensure you never pay more for a property than the fair market value, which is the average price properties are selling for in the area. This price can vary greatly, even for neighbourhoods a few kilometres away. So, working with a real estate agent who understands property values in a specific area is very important as they will guide you on true values and negotiate a price that makes sense.
For example, if you had purchased a home in Toronto or Vancouver around 2015 in a high-demand downtown neighbourhood, chances are you overpaid for your home at the time. However, if you held onto the home until early 2022, you would feel like you got yourself a bargain!
Real estate often serves as an effective hedge against inflation. As inflation rises, so typically do property values and the rent you can charge, making real estate a safer long-term investment than certain other assets like cash or bonds. Plus, if you rent out the property, you can enjoy the security of your property paying for itself.
Pros and Cons of Real Estate Investment
The pros of owning investment properties include:
- If you find and maintain steady tenants, it will generate steady income
- In most cases, you enjoy capital appreciation
- It is an excellent way to diversify your portfolio
- It can be bought with leverage
- It can pay for itself and then become strictly profit-generating
- If rented, your tenants pay for the property, eventually making the property strictly an income generator
There are also cons to property investment, including:
- It is not liquid
- There can be influences that will significantly reduce its value, making it difficult to sell
- It does require larger upfront capital unless you choose REITs or MBSs
- Requires management of some type, even if just basic maintenance, unless REITs or MBSs
Of course, the type of real estate you buy impacts the pros and cons.
Understanding Real Estate Appreciation
Appreciation in real estate builds over time, starting from the time of your purchase. For example, if you buy a home in Toronto for up to $500,000 (very unlikely, but this is for simple math purposes) in value, all you need for a down payment is five per cent. So, your down payment for your personal property is considered equity because you own that part of the property out and out. The average increase in home prices in Toronto rose 4.6 per cent from July 2022 to July 2023. So, in a year, if you sold your home, you would have gained $50,000, which includes the $25,000 for your down payment plus the $25,000 roughly gained in appreciation. Factors such as interest rates determine how quickly equity builds.
The best way to see gains in real estate is to find a neighbourhood in the “gentrification” stage where homes are still selling at lower prices in a less trendy or developed area. As people see that the neighbourhood has potential, they begin to buy homes in the area that attracts trendier cafés, restaurants, shops, and services. This increases the value of your property.
For commercial properties like vacant land, prices can skyrocket if a natural resource like oil is discovered. Office space can rise in price as a city begins to attract a particular industry, such as tech companies, that increases the demand for office space.
Regardless of the type of real estate, appreciation also rises based on basic rules of supply and demand, so the lower the inventory available in the real estate market, the higher the prices.
If you are shopping for real estate, whether it is commercial or residential, a RE/MAX professional can help.