Real estate can be a safe harbor for your RRSPsJanuary 9, 2020
Planning for your retirement can be overwhelming. The average Canadian investor is now enjoying a longer life and volatile equity markets and low interest rates may render their traditional investment choices (i.e. stocks and bonds) inapt at helping them achieve their retirement goals.
RRSPs continue to be one of the most significant tax saving opportunities available to individual Canadians – and one of the most effective ways of saving for retirement.
You may have a rough idea of how RRSPs work, but do you have a grasp on how these investments fit into your overall financial plan?
Get to know your retirement investment options
Think of your RRSP like a big basket. Essentially, you can determine what goes in it. Many investors are under the impression that the traditional RRSP is limited to investments like mutual funds, GICs, stocks and bonds. However, there are other options available that could potentially enhance your RRSP.
If you have been losing sleep worrying about how the next public markets crises will impact your retirement savings, maybe it’s time you consider a more stable alternative like real estate investments.
Traditionally, in order to invest in real estate, you basically had to buy a property, rent it out, collect the rent, attempt to increase the value through renovations, and then sell it for a tidy profit. A very time-consuming proposition and hard to diversify your risk since the more properties you buy, the greater your financial and time commitment become.
A more efficient option would be to invest in Real Estate Investment Trusts (REITs). This would give you the benefits of diversifying your portfolio into real estate without having to become a ‘landlord.’
Public REITS vs. Private REITS
Real Estate Investment Trusts (REITs) are like mutual funds in that they pool investors’ funds and use it to purchase an underlying asset. REIT funds are used to purchase and hold properties that produce income. REITs can be private or public. Publicly-traded REITs are traded like stocks on the stock exchange and therefore their value is tied to the price that its shares trade on an exchange. This makes them more susceptible to being influenced by emotions (such as fear and greed) that often drive public markets. On the other hand, unitholders of private REITs are largely insulated from broader market fluctuations, as their net asset value, not market sentiment, drives pricing and valuation.
To illustrate this meaningful difference let’s consider the 2008 financial crisis. During this time, the TSX fell approximately 33% and the public REIT index fell approximately 38%. That year, the private apartment index experienced positive returns of 6.5%. The impact on your RRSP would have been significant if your real estate investments were tied up in publicly-traded REITS.
The graph below reveals that the returns on public REITs are more correlated to the returns of the broader equity market than they are to private real estate. Therefore, adding private REITS to your RRSP should help to add stability to your RRSP by providing better diversification in comparison to public REITS.
Diversifying your portfolio with private income producing real estate investments
Canadian income-producing real estate (office, industrial, retail, multi-residential, etc.) has historically displayed low correlations to many of the traditional major asset classes, thereby providing investors with potentially valuable diversification benefits, such as improving both the efficiency of their investment portfolio and their risk-adjusted returns. In other words, when portfolio investments are efficient, investors may achieve higher levels of return for the same level of risk.
As well, using commercial real estate to diversify a portfolio may potentially generate more consistent returns. Commercial real estate has historically generated favourable absolute and relative total returns. Over the past 31 years, multi-residential properties, the best performing of the primary real estate classes, outperformed Canadian Bonds by over 60% and Canadian Equities by 13%. The lowest annual return for multi-residential properties was a positive 1.7% return versus -0.17% for Canadian Bonds, -31.4% for Canadian Equities, and -41.4% for Emerging Market Equities.
The size of the bars in the graph above represents the range of annual returns recorded by each of the asset classes over the last 30 years. The larger the bar, the larger the disparity was between the highest return and lowest returns achieved by the asset class.
In a volatile stock market, real estate can be a safe harbor. An investor with long-term goals should keep risk diversification and strategic asset allocation top of mind. As an alternative investment with limited volatility, private equity real estate can help preserve retirement savings when financial markets come under stress.