Investing in U.S. real estate from Canada can pay off for some, but it’s riskier than many investors think and riskier than quality REITs in Canada

Investing in U.S. real estate from Canada is not without risks, and, unlike quality REITs in Canada represent a poor place for any significant portion of your retirement savings. Buying a second home in the U.S. may be a good personal lifestyle choice, but it’s not necessarily a great investment choice like, say, investing in a well-diversified Canadian REIT.

However, if you do want to invest in U.S. real estate, you should look at multiple-unit rental housing or commercial properties, especially those with big parking lots or extra land. Investments like these can give you current income, like quality REITs in Canada, plus long-term development possibilities. That’s a potent combination for patient investors. High-quality REITs with some exposure to the U.S. are also worth investigating when investing in American real estate.

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Investing in U.S. real estate from Canada: Even the Sunbelt has unique drawbacks

We all know how long winter lasts, and following COVID-19 lockdowns, many Canadians are once again spending part or all of the winter in Florida or other Sunbelt locales.

Despite now-higher home prices in key U.S. markets, many of us are buying second homes with the belief that even further price increases are inevitable and will make those winter havens good investments that somehow rival the returns of quality REITs in Canada when investing in American real estate.

However, costs may be higher than you think. Beyond the purchase price, you’ll also have to pay real estate taxes and condo fees, if that’s your choice of a dwelling. (That’s one of the reason, we recommend REITs as an alternative for real estate exposure.)

On top of that, there’s insurance and maintenance. In addition, due to the heat and humidity, you have to run the air conditioning year-round to avoid mould. New condos will come on the market and compete against decades-old units. As well, when you do decide to sell, you’ll pay a 5% or so real estate commission.

If you make any money on the real estate sale, you’ll be liable for capital gains taxes, unlike the tax-free capital gains you can earn on your Canadian home.

Directly investing in U.S. real estate from Canada entails more work than you might think

You have to recognize that there is no such thing as a simple direct investment in real estate (outside of REITs in Canada, for example). It’s more likely that you’ll have a part-time job running a house that you own, renting it out and being responsible for calling the plumber and chasing down tenants that don’t pay and so on. There’s a lot more to that than many people realize.

Large property companies, like REITs in Canada, own hundreds of properties and the gains and losses on individual properties average out. But if you have a single property and you get into litigation with the tenant or into major repairs and so on, there’s a lot of cash flow that you’re going to miss out on.

We think you need to go into a real estate investment with a lot of knowledge about how wide the variation is—don’t look at the average price increase in your home market in the past 20 years. Look at the worst case scenario: what if you have to hire a lawyer to deal with an unruly tenant?

Having said that, many people do make great fortunes by buying real estate, using a lot of leverage, and sticking with it for 10, 20 or 30 years. But don’t kid yourself into thinking it’s the same as buying a stock like Canadian Pacific, or quality REITs, because there’s a lot more to it when investing in American real estate.

Investing in U.S. real estate from Canada: rising interest rates could ruin your plans

If interest rates continue to move up in the long-term, which is possible, it may force even more buyers out of the market, and lead others to lower the price they are able or willing to pay. Fewer houses will change hands in that case. House prices may hold steady, but they could also move down.

If interest rates shoot up in the midst of an economic setback and rising unemployment, it forces a lot more buyers out of the market, while forcing many more others to cut their house-buying budget. In addition, some of the newly unemployed might dump their houses on the market because they won’t be able to keep up their current mortgage payments, let alone refinance when their current low-interest mortgages come due. In that case, there could be a deeper slump in house prices.

Bonus tip: We believe you should have foreign exposure in the U.S., but for most investors, stocks, including quality REITs in Canada, are a better bet than real estate

Our view on foreign investing is that U.S. stocks can provide all the foreign exposure most investors need. We also feel that virtually all Canadian investors should have, say, 20% to 30% of their portfolios in the U.S. stocks we recommend in Wall Street Stock Forecaster.

If you do want to add more foreign content, you could buy individual stocks from other countries. But for most investors, directly investing in foreign stocks can add an extra layer of risk and expense. As well, timely and accurate information about overseas companies is not always available, and securities regulations vary widely between countries. It can also be hard for your broker to buy shares on foreign markets without paying a premium. Tax rules and restrictions on transferring funds between nations add further uncertainty and cost.

In summary, while investing in American real estate may seem appealing to Canadians, especially those looking to purchase a winter home in the Sunbelt, it comes with significant risks and challenges. Directly owning U.S. properties involves managing tenants, dealing with repairs and maintenance, and potential legal issues. Additionally, rising interest rates could negatively impact property values and demand. In contrast, investing in high-quality Canadian REITs offers a more diversified and hands-off approach to real estate investing, with the potential for steady income and long-term growth. For most Canadian investors, allocating a portion of their portfolio to U.S. stocks and quality Canadian REITs is likely a better strategy than directly investing in American real estate. It’s essential to carefully consider the risks and responsibilities associated with owning foreign properties before making any investment decisions.

For investors seeking real estate investment, we continue to recommend high-quality REITs in Canada with diversified holdings, including residential buildings.

What are your thoughts on investing in the U.S. real estate market as opposed to REITs in Canada? Do you think it’s a smart move long term?

This article was originally published in January 2006 and is regularly updated.