When it’s time to invest for retirement or other purposes, many people think of mutual funds first because they are simple and accessible. Some, however, would opt for the real estate sector instead –  or as well –  by investing in one or more income properties.

The table below gives an overview of the main points that differentiate these two options. Read on for a more detailed discussion of each point.

Down payment required

It is usually possible to invest in a mutual fund starting with as little as $500 or $1,000. By contrast, someone wishing to invest in an income property would usually have a down payment equal to at least 20% of the value of the property.

Leverage

On the other hand, the option of using a mortgage to finance a real estate investment can provide significant financial leverage, if the loan is properly managed. In effect, the investor could benefit from the appreciation of the whole property based on a down payment that represents just a percentage of it. It is comparatively rare, however, for an investor to borrow to invest in a mutual fund.

Diversification

A mutual fund provides the investor with instant diversification over one or more asset classes. A rental property concentrates the investment in a single sector – real estate – and a single security. To diversify the risk, the investor might be wise to acquire an inventory of several buildings, or to refrain from placing all of his or her investment eggs in this one basket.

Simplicity and liquidity

It is usually much simpler to find, select, buy and resell a mutual fund than an income property. As well, mutual funds are considered to be a liquid investment since they can usually be disposed of with a simple call to one’s mutual fund representative.

Management

People who invest in mutual funds are usually happy that their investment will be completely taken care of by a team of professionals. On the other hand, people who buy income properties may feel that they are more in control of their investment. This control comes with certain obligations, however: a fund manager would never call you on Saturday night to say that the roof is leaking; a tenant wouldn’t hesitate.

Fees

Every investment involves fees. In the case of mutual funds, these are usually in the form of management fees, and the ratio can vary considerably from fund to fund. These cover all of the services associated with the fund. There are also fees related to real estate investments, which the investor must pay directly: mortgage, taxes, maintenance, repairs, commissions, etc.

Deductibility of expenses

However, many of these fees can be deducted by the real estate investor, thereby reducing the taxable income from the property. Building depreciation may also be a deductible expense.

Income

A mutual fund may generate income from interest, dividends and capital gains. An income property may also generate a capital gain when it is resold, but the main income would be the monthly rent. This could produce a variety of comparative scenarios depending on the investor’s tax strategy and whether the mutual funds are held in a registered plan or not.  

Volatility and returns

Mutual funds and income properties are both forms of investment where the value may fluctuate and the returns are not guaranteed. However, the exact value of a mutual fund can be known on any given day, whereas the value of real estate is not really known until it is sold. According to the latest figures from the Canadian Real Estate Association, the Home Price Index was down very slightly by 0.1% in February 2019, a first since 2009, when it plunged by almost 8%. If we look south of the border, the S&P 500 U.S. stock market index outperformed the S&P real estate index by 6% over the past three years. By contrast, over 10 years, real estate comes out the clear winner by more than 3%.

There are different calculation methods for comparing returns on mutual funds with returns on real estate. Depending on which one you use and the time period in question, one investment or the other will come out ahead. On the whole, however, studies show that over the long term both investments could constitute an appreciable source of wealth.

And if getting a call from a tenant on a Saturday night doesn’t really appeal to you, keep in mind that you can still invest in real estate… through mutual funds that include this asset class. After all, real estate is weighted at about 3.5% of the S&P/TSX Composite Index for the Canadian equity market.