This is Number 2 in a Series of Articles that we will be highlighting in the next few months on Investment Property and the strategies to help make you successful at it. Though it is generally aimed at the small investor, a number of the strategies may have an impact on professional investors.

There are a lot of misconceptions circulating about revenue properties and their overall value to you. At the base of these misconceptions is what I like to call the "cash-flow fantasy".

We see a number of TV real estate "experts" tell us about how they made their millions from an easy-to-use system for real estate. However, when's the last time you read the little disclaimers on those infomercials? Ever notice that the disclaimers are rarely positive and that the examples they give are not typical? There's a reason: real estate investing is not a seat-of-your pants proposition. If you understand the risks and make the right decisions you can be successful. Don't, and you could find yourself with some serious problems.

At the heart of every investment decision we make is the underlying return to us. Unfortunately, most inexperienced investors look at these investments based on pre-tax cash flow as opposed to after-tax income. Why is this important? It's simple really. If we don't build our tax liabilities into our investment decisions how can we ultimately decide which investment is better?

With respect to revenue property nothing could be more true. A number of investors have argued that income is only one of the factors in their decision. They also have to weigh the importance of capital gains over time, security of real estate investing, and the value of monthly cash flow in their daily lives. Undoubtedly, each of these is an important factor in making a real estate investment. However, these same issues are valid in any investment decision. Let's deal with each in turn to understand why they are generally overweighted in a real estate investment decision.

Real estate investing for the reason that properties experience capital gains is a somewhat dated concept. What we have seen in the past 3 decades is phenomenal growth in the capital value of real estate. However, this growth is slowing overall. Baby boomers saw huge growth in the overall percentage value of their properties during this time, many properties doubling or tripling in value. What are the chances that this will occur again? Unlikely.

Over that same time period relative incomes (that is incomes adjusted for inflation) have not kept up with the growth of property value meaning that people are becoming less and less able to afford the same relative home that their parents could have. When we factor out the increased use of leveraging (mortgages…remember what your mom said about your huge mortgage!) this fact is easily seen. So, ultimately, prices cannot continue to grow at the same rate.

Want proof? Well, studies have shown that in Canada alone the average house price rose a mere 5.7% during the past decade. Subtracting out the effect of inflation, the average Canadian house price actually fell about 20% over those 10 years! When you factor in the costs of acquiring and selling the property (i.e. legals, transfer fees, lenders fees, etc.) you can see that the potential for capital growth is relatively limited.

This means that capital gains are becoming less and less important over time in the overall real estate decision process. Because of the favorable treatment that most tax jurisdictions give capital gains this is very unfortunate. It also means that this should no longer be the main justification for a real estate transaction unless it is the main reason you are looking at a specific property.

Security of real estate investing is an important issue to take into consideration. A lot of investors ascribe to this theory that real estate provides a high level of security. Why don't I follow this thinking? It's due to an overwhelming factor that is unavoidable… tenant risk! For the average novice real estate investor this is one factor that they severely underestimate.

Tenants can be the greatest thing in the world: they pay your mortgage, they give you income, they sometimes keep your property from being run-down. However, there is a flip side to all good things. A number of investors have encountered the nightmare tenant that destroys property through neglect or wanton disregard for no reason. The result is you, the landlord, trying to collect for damages from people that likely have few assets. The result is the potential loss of a lot of the value that you have built up. If you are aware of that risk that is fantastic. However, don't make the argument that real estate is less risky: when's the last time someone burnt down a T-Bill?

What about the value of monthly cash flow? Undoubtedly, cash flow every month is extremely attractive. I don't need to go into the reasons. However, what happens when tax time rolls around is sometimes traumatic leaving people scrambling to find income to pay the tax bill on their "cash flow". They then depend on their investment property to provide "cash flow" to pay the tax bill on last years "cash flow". This cycle, once started, might be hard to stop and might ultimately lead to serious problems if, for example, your property is suddenly vacant for 3 months or a tenant causes significant damage.

Does this mean that you shouldn't invest? Of course not. What this says is that the overall real estate decision is a complex one needing a full understanding of all the angles. There are huge advantages to real estate including the fact that banks often fall over themselves to lend money for real estate. However, don't fall into trap of the "cash flow fantasy". Ultimately, that cash flow may be a potential tax liability that you should address either at the beginning of your investment as part of your decision and not after the "cash flow" is spent.

Ron Thibeault is a retired real estate lawyer and contributing Editor to ThinkRelo.com. His extensive experience in real estate law gives him valuable insight into the needs of clients, realtors and all other players in real estate transactions.