Retail Investor .org


#1 Everyone Loves Real Estate

#2 You Should Buy Real Estate Because Rent $ Is Just Thrown Away ... FALSE

#3 Factors Affecting Returns

#4 Calculate the Return Before You Buy

#5 Spreadsheets

#6 Co-ops

#7 How To Value Leasehold Property

#8 Investment Possibilities

#9 More on Capital Gains Appreciation


Many people buy Real Estate (RE) because everyone, even their in-laws, will lend them money, will tell them it is a 'great investment'...'the best decision I ever made', etc. (This page was written long before the United States R/E implosion). Yet how many of those people ever kept track of what their investment rate of return was?

A real benefit from RE comes from the savings behavior 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. Slightly contradicting that POV is a study of Germans found that the more real estate people owned, the less they saved. Included in the measure of savings was the principle portion of the mortgage payments. It is not clear which way the cause and effect flows, but regardless, it is a warning.

Everyone, but EVERYONE, has a vested interest in promoting real-estate. Just think about it. Can you name any sector of society that doesn't want you to buy RE?

  • 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. RE 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 RE 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.

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 subsidizing home-ownership."

Of course, you are less interested in the social value of home ownership, 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 RE 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 of interest - 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 Time-Value-of-Money Problem #3).

When you add the extra costs for

  • property taxes,
  • property insurance,
  • condo fees,
  • mortgage fees and insurance,
  • regular and lumpy maintenance,
  • sporadic upgrades,
  • higher utilities, and
  • 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 RE have been only slightly above inflation. Properties on the coasts return slightly more, those inland slightly less. Graphs of real and nominal gains from many sources are shown at the bottom of this page. Don't be mislead by people quoting cumulative returns. E.g. "Mr A realized a 50% return." If that took 10 years it is only 4% annually. The longer the holding period the lower the yearly return. (See Problem #6 in calculating returns.)

There are many problems with trying to measure statistical prices over time.

  • The real estate market is very cyclical. Do you measure the annual gains from peak to peak, or from trough to trough?
  • The results may have a smoothing bias because artificial appraisals are done only once or twice a year, while actual market transactions may be more volatile.
  • There may be a selection bias if only those properties sold are included. They may not represent the entire stock, especially when the housing stock is being rapidly changed.
  • Data coming from REIT stocks will reflect the leverage these businesses use, while your own residence may be leveraged more or less.
  • The idiosyncratic risk will be large when you own only one property. Your one property may have problems not faced by any index of properties.
  • Averages include properties of all ages. If you buy a new property, it will start at the top of the range. 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.
  • A boom in new construction will distort some averages. Newer, expensive units will more heavily weight the average.
  • Averages include properties of all values, but higher value properties tend to increase in value at higher rates. The difference in rates of 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.
  • Averages include properties of all sizes. The size of your home may no longer be 'average' when you sell it. The average price in the 1970s bought a house of 1,500 square fee. In 2010 new houses average 2,500 square feet. Values are most heavily determined by square feet (other than land).


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 only because it looks dated. 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 commuting, you will be paying higher auto costs and gas costs, etc. There is also the unquantifiable cost of your decision to NOT live in your first choice of area (where you were renting).

Strata fees are too easily dismissed when pricing a property. 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.

Look at this offering document for a Vancouver residential apartment block for sale in 2008. It gives good details on the normalized costs for a detailed list of items.


The change in the home's price is just one part of the capital gain. The transaction costs relating to buying and sell real estate are high. These are not recouped on the eventual sale, so you need some gain in the home's price just to compensate for those transaction costs. For a rough example, on purchase you face ...

  • 2% provincial property transfer tax,
  • 1% legal fees and title insurance,
  • 1% mortgage insurance,
  • 0.5% life or disability insurance,
  • 0.5% moving costs.
  • 5% Total
  • Don't Forget - everyone immediately wants to personalize their purchase as 'theirs'. Renovations are necessary to update to an open-plan, new furniture will be needed to fill the space or match your new affluence, etc

On sale you face other transaction costs of ...

  • 5% broker fees,
  • 0.5% legal fees,
  • 1% mortgage discharge fees,
  • 0.5% duplication of accommodation costs between sale and move to the final destination address.
  • 7% Total

Since these are one-time costs, the longer you live in the home the smaller their yearly amortization - the smaller their drag on your calculated yearly total rate of return. This is why the Buy-Rent calculators on many websites show graphs the change over time. The average length of ownership is becoming shorter and shorter. About a third of properties are sold within five years. The average is less than 10 years. Using the example above with a total of 12% transactions costs. Assuming an 8 year ownership there would need to be 1.5% capital gains each year just to compensate for the transaction costs (12% divided by 8).

Do you think that you won't need to sell when your life changes because "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. You should expect multiple transactions in a lifetime.


The returns from RE 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 RE 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 an income property, the income is the actual rent you charge. Factor 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.

But commercial rents most often require the tenant to pay all the actual costs even as they increase with inflation. There may also be another clause stipulating a rent increase to equal inflation. In these circumstances the owner's income would be highly hedged against inflation.


For owner occupied investments the Principal Residence protection from capital gains is a huge benefit. It is of greater benefit to those in the 45% tax bracket, than those at 25%. Tax savings apply also to the net rent saved (your operating return). Rents would have been paid out of after-tax earnings. Divide the net-rent-saved by (1-tax%). E.g. at 25% tax bracket the savings on $750 rent would be $750 / (1-.25) = $1,000 per month before taxes equivalent income.


Statistical RE price increases are often reported in 'real' terms, i.e. with inflation removed. The implication becomes that real estate is a hedge for inflation, that during high inflation returns will be higher. This is debatable. There is much disagreement. Capital gains and income from property can react differently to inflation. The impact on rents was discussed above. For capital gains look at the very last graphs at the bottom of this page. Prices during the high inflation of the 1970s and 1980s largely under-performed inflation. High interest rates often come with high inflation, so the cost of servicing a mortgage increases, and buyers are less willing to pay high prices.

The question whether RE hedges inflation can be looked at over a short or longer time horizon. Most agree that there is little correlation (even negative) in the short run but increasing to about 30% correlation over 3 years. Some research has found that office properties are the best inflation hedges, and retail properties the worst.

Instead of inflation, the drivers of real estate prices are interest rates, economic growth, market fundamentals, and other risk premiums.




There are three steps to analyzing real estate.

  1. The operating return is measured, without any reference to 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 operating costs that include an allocation for lumpy purchases that don't occur each year. This gives you a normalized operating cash flow.
  3. Divide the net yearly income by the total property cost (including the original legal and transaction costs and personalization). This gives you the operating return percentage.

The dollar value of the normalized operating cash flow will increase over time as rents increase - roughly in line with increases in the market value of property. You should not factor the increase into your calculated operating return %. Consider this like the stable 4% dividend paid by banks on their stock. As the bank grows, the value of its stock grows, and the dividend also grows, but remains at 4% of the stock price. The owners realizes 4% + capital gains over time.

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 vice 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.

2. Leverage

will amplify the asset's return. Obviously there will be no effect if the RE is paid for with cash and no mortgage. Otherwise, compare the operating return calculated above, with mortgage interest rates. Review your understanding of leverage. If the debt% is higher than the operating return% (which is frequently the case), your net 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% * neg2%) = 0.5% loss yearly. That net loss will only be recovered from the eventual capital gains on sale.

3. Capital Gains

are only realized when RE is sold. They will not be there to tide you through any low return calculated in (2.). When RE is booming, all attention is on capital gains, 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 publish articles relating all the facts of a supposedly normal situation. They always 'prove' how great an investment the RE 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 % is greater or equal to the debt's interest rate. In real life the opposite is most often true.

Real estate agents have a sales pitch 'proof' that purchasing 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 down payment. Their argument can be made to support any priced property, by increasing the cash paid and decreasing the mortgage. But all investors should require a return on any investment, including the real estate down payment.




Rate of Return from Ownership

  • 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. Download

Canadian Mortgage calculators

  • Karl has a very good Canadian mortgage calculator that permits you to input changing rates as you expect your variable mortgage to change. It also allows for pre-payments. Another good Canadian site is at
  • For Monthly payments mortgage, create an amortization table. See the effect of changing a payment. Download
  • For Weekly payments mortgage, create an amortization table. See the effect of changing a payment. Download
  • For Bi-Weekly payments mortgage, create an amortization table. See the effect of changing a payment. Download
  • 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. Download
  • Compare different possible mortgages with different fees and different interest rates. This calculates the APR percent that factors all fees into one metric. Download

Beware of mortgage calculators on the web. The Canadian calculations for quoted interest rates are different from the US rates. Also do not use the NY Times or Gummy's calculator for the rent vs buy decision. Gummy's is simply wrong, and the NY Times includes a lot of preset variables they don't readily disclose. It's inclusion of a 'lost opportunity cost' for BOTH options is wrong. To compare apples to apples you must include the income that would have been earned by the cash used for a purchase. But this difference should be added or subtracted from ONE option only.




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 holds a mortgage on the property.

Co-ops come in all shapes and sizes. The major distinction you should recognize is between privately-held co-ops and government-sponsored co-ops whose purpose is to provide rent subsidies. These latter can be structured as a Co-Op or as a a Life-Lease. 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. He may have little say over the management of the property or its upgrades and maintenance - although he will be billed the costs. The property can be an apartment building or a single home - no difference.

Leaseholds are valued less than fee-simple property for two reasons. First, the lease payments will increase the ongoing costs. Second, at the end of the lease your rights come to an end. You may walk away with nothing, or you enter a new contract at the up-to-date market values. Buyers deal with the second problem by making different assumptions.

  1. They assume that governments will intervene at the lease's end, forcing a renewal at low cost. And assume that when they sell, the next buyer will believe the same. In other words the second issue does not exist. If you believe this then you treat the lease as if it continues forever. The leasehold's discount to a fee-simple property equals the capitalized cost of the extra lease payments. E.g. When a leasehold's ongoing costs are $4,000 per year higher than for a fee-simple property, and you want a 4% return, the discount will be $4,000 / 4% = $100,000.
    So you are willing to pay $100,000 less than for a similar free-simple property.

  2. They assume that they will die before the lease's end without having to sell it to finance long-term-care. And assume that they don't care about the value of any estate left to heirs. In this case too the second problem is treated as if it does not exist. You need only consider the additional lease costs over your remaining lifetime (say 20 yrs). (PVA pmt=4,000 i=4% n=20) You would use a $54,361 discount.

  3. They assume that they walk away with nothing at the end of the lease. Or, that the new lease's terms effectively zero out all ownership's value. This buyer values the net rent saved for the remaining term of the lease. Instead of deriving the value from the value of fee-simple (owned) properties, he derives the value directly from rental rates.

    Considers the leasehold interest as prepaid partial rent over the lease term (say 50 years). Find out the total costs of renting the equivalent property. Subtract the total ongoing costs of the lease. Calculate the Present Value of the difference. If the ongoing lease costs are $8,000 less than market rents, then the Present Value of Annuity = $171,857. ( PVA pmt=8,000, i%=4%, n=50). You would value the leasehold at $171,857.

    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.

Interesting Reading

In the United Kingdom there is a formal body for negotiating lease extensions. A 2014 paper by Badarinza and Ramadoai reviews the discount rates used for the lease valuations. The authors found that land owners believed they could generate higher returns on lump-sum lease pre-payments for very long-term leases, than for shorter-term leases. I.e. the discount rate they used increased with the length of the lease. The last chart may be helpful. It shows the discounted present value of a property, as a percent of its current value.




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, second home or for rental. It is legally called 'fee-simple' or 'freehold' when you own registered title to all the land and buildings. It is called 'strata' or 'condominium' when your title is restricted to only a part of the property, with the common areas shared.
    • Leaseholds have no ownership rights. In exchange for an occupancy lease, you assume responsibility for costs during a specified period of time.
    • Mobile Homes 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. These are usually sold to renters without a downpayment, or who cannot get a mortgage. It is easiest to say what they are not. They are not a seller providing the buyer with a mortgage, and the buyer making mortgage payments that include accumulating equity. In these contracts the property title never passes to the buyer until the end of the contract. There are no laws about what these should be called. You see also Rent to Own, Agreement for Deed, Installment Contract, Lease Puchase Agreement, etc.

      Most contracts are only for the option to purchase, not an actual forced purchase transaction. Most involve rents that are higher than normal - supposedly to build up equity. But many contracts have terms that near- guarantee the buyer walks away with nothing. Some presume that the buyer will be able to arrange his own mortgage once he has enough equity built up - but that presumption may prove false. There may be terms forcing the buyer to effect repairs - termination if not done. Some '$rents' are structured with interest rates far above normal.

  • Group Ownership
    • Residential Property can be shared. A private agreement can be written for joint tenants or tenants in common. This is common for single family homes that have been 'unofficially' subdivided. Co-ops are shared ownership with the same rights and obligations as condos, but without individual titles for each unit. All are owned by a corporation, itself jointly owned, and tenancy rights exist as a lease attached to the share ownership in the corporation. Fractional ownerships have more complicated legal properties.
    • Limited Partnership Units with a group of investors may be either private or public. They may invest in bare land, or development projects, etc. There is usually a foreseeable 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 the public by private businesses that group public investor's capital.
    • Mutual Funds and ETFs holding mortgages.
  • Derivatives
    • Futures Contracts at one time were based on the Case-Shiller Housing Price index. Now they reflect the equity index that includes REITS and real estate corporations trading in the US.




A picture is worth a thousand words, so here are some graphs. Watch out which are 'real' returns (i.e. after inflation has been subtracted). 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. The statistics are difficult to accumulate and averages deceive. 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.

published GMO