The purchase of a primary residence, rental property, or any property type, is something we will all most likely experience throughout our lifetime. Many of us will own multiple properties in addition to our primary residence as investments or further diversification of one’s own net worth.
To get a better sense of owning real estate, let’s look at a high level picture of what real estate is all about.
There are many different types of real estate across the globe pertaining to usage, property interest, and ownership. First off, let’s look at usage.
Usage
Real estate can be used as a commercial property, industrial, residential, retail, hotel, leisure, or some combination of these usage types. Since the majority of us will only own residential real estate, let’s break down the residential category a little bit. This can include multifamily properties such as townhouses, low and high rise buildings, or single family homes such as existing houses, infills, redevelopment, or new suburban or subdivision development.
Property Interest
Real estate interest of owners or prospective buyers can be broken down into 5 categories. The first type of interest is referred as Fee Simple. This essentially means that one has full ownership or full interest over a property. This can also be referred to as Freehold Estate Ownership, where there is a indefinite period of time in which an estate is owned. This could include both property that are passed down to heirs once the original owner has passed away, or property who’s ownership period lasts as long as the owner’s life.
The second type of interest is referred to as a Possessory Estate, where an agreement between a tenant and a landlord has been arranged for the tenant to reside at an estate for a predetermined amount of time. This is also referred to as a “Non Freehold Estate”, or “Leasehold Estate”. Technically the tenant will have ownership of the property, but the property rights are split between the tenant and the landlord. Such is the case with someone who is renting a place to live.
The third type of interest is where the original owner of interest is no longer in possession of the property. This is the case where a “reversion” of ownership takes place when a tenant’s lease has elapsed and the landlord takes back full possession and property rights to the property.
The fourth category is referred to as Non-Possessor, where an easement exists on the property. An easement essentially gives someone the right to use land that is currently owned or leased by a different party.
Lastly, the fifth category is Security Interest. This refers to a party having legal interest in a property but cannot transfer into possession unless default happens. This “party” will typically be a bank that has issued a mortgage to someone for example. The bank can claim possession only in the instance of default by the owner.
Ownership
There are various forms of ownership of real estate. The most common forms are singular tenancy, joint tenancy (common law or married couple), or what is referred to as a tenancy in common (two friends renting a place together). Less common forms of ownership include partnership agreements, limited partnership (one person has more property rights and more liability than the other), Real Estate Investment Trusts (REITS), corporations, and condos (we are used to seeing these as low or high rise buildings where ownership is defined by space, but condos can also be defined by lot as in the case of bare land condominiums).
Moving along on the topic of property ownership, while owning equity in real estate can be a great investment through natural price appreciation and cash flow through rental income (also additional income tax benefits when using a HELOC through writing off interest expenses.; see Lesson 21 for more details on HELOCs), there is an argument to be said about owning too much real estate, as being overweight in any one investment type or sector specific entity is never a good way to diversify one’s assets.
Careful consideration of one’s total debt to equity is important, as it gives a good measure of how leveraged one person is with their current assets or investments. Owning a Real Estate Investment Trust, or REIT, may be a better alternative to “owning” real estate. Not only are REITs readily available and can be traded like stocks, but this function makes them extremely liquid, and a REIT can offer instant geographical diversification of real estate, as well as diversification of the type of properties in the portfolio. REITs are also required to pay out 90% of its net income in the form of a dividend to its shareholders, so the underlying function of a REIT is to provide an investor with a constant stream of income, or cash flow.
Choosing to invest in real estate will be unique for each individual, and specific to one’s investment strategy, leverage or risk tolerance, and affordability. Real estate does involve a lot of upfront capital, and these funds will not be as liquid as stock equity investments. One needs to decide what “proper property” ownership means to them and how it can be beneficial to one’s quality of life and financial freedom in the short and long term.