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 different 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 general, there are three categories of real estate:
- Residential real estate can be single-family or multi-family dwellings that are owned or rented by individuals and include undeveloped land, houses, condominiums, and townhouses. Their sole intent is providing a home.
- Commercial real estate includes nonresidential structures intended for business use which can be a single-use property such as a small shop, restaurant or doctor’s office, or a multi-purpose structure such as shopping centers 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 to be 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.
Commercial Real Estate Ownership
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 multifamily buildings such as high-rise apartments do generate money for their owners, they aren’t considered commercial properties.
Real Estate Investment
Investing in real estate can prove to be very lucrative, as almost all properties tend to appreciate over time. As well when purchasing properties for lease you can often not only regain the money you pay for the property from rent but also 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 is lacking purpose or is not located in an area where demand is likely to increase. Both at the time of buying and the time of selling, investment value is dictated by a number of 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 the fact that in most cases, if you buy at the right price, your property will tend to appreciate. The trick is to ensure you never pay more for a property than the fair market value, the average price properties are selling for in the area. This price can vary greatly, even for neighbourhoods a few kilometers 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.
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
- 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 greatly reduce 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 5%. So, your down payment amount 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 12.3% from January 2019 to January 2020. So, in a year, if you sold your home, you would have gained $150,000, which includes the $25,000 for your down payment, plus the $125,000 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 catch on 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 such as vacant land, prices can skyrocket if a natural resource is discovered such as oil. Office space can rise in price as a city begins to attract a certain 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, the experts at RE/Max can help.