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The stock market soars to new heights. Real estate rises to unforeseen valuations.
Which is a better investment? Real estate or the stock market? An in-depth long term analysis might surprise you. Why is real estate often seen as the stronger investment?
Three major reasons
1. Stocks and the stock market are quoted on a daily and/or weekly basis – The TSX Composite or Dow Jones is up (or down) 6.7 per cent this week, month, etc. This gives the perception of volatility (like the weather). And since our memory is not usually programmed to look at the markets over a longer time period we often remember only infrequent details.
In order for stocks to seem a better investment, house prices would need to decline for 12-18 months and the media would have to step up and trumpet declining house prices. Declining prices and sales numbers over the last several months have yet to reach the front pages of the newspapers.
2. The second reason is that because real estate is usually a long term hold (years rather than months or weeks) the perception is that the absolute value of real estate doesn’t seem to go down.
When was the last time that home values decreased in Canada? Probably not in the last 10 or 15 years. Aside from a few troughs that may have lasted several months (like late 2008), prices have been stable or have increased.
And yet the real data is different.
The Teranet /National Composite index showed that real estate prices in Canada climbed 85% over the past decade. In contrast, the TSX Composite had a return of 141.18%. And the Dow Jones Index? A 191% increase.
The US data is significantly different. Because of the mortgage crisis and the subsequent housing collapse, trillions of dollars of equity were erased and home values across the country dropped over 20% since 2007. Home prices increased about 10% over the last decade compared to the 191% for the Dow Jones.
3 .The third major reason is that in many cases the comparison between stocks and home ownership is an apples vs. oranges comparison. Because only the sales value of a home is quoted in most price comparisons, the true cost of owning a home is rarely calculated.
Let’s look at the numbers. In order to offer a true comparison (we are using unleveraged real estate numbers):
- An investment of $500,000 in the TSX Composite (which returned 141.18% over the last ten years) would have yielded $1,205,900 with reinvestment of dividends over that ten year period.
- Buying a $500,000 home for cash in 2003 in Toronto or Vancouver would have seen a possible appreciation to $925,000 (if it could be sold today).
The costs of owning that home for ten years and selling it today:
- Initial purchase closing costs $8,000. Taxes over 10 years $52,000. Maintenance $50,000 Closing sales costs $35,000 for a total of $145,000.
- Final price of $925,000 minus costs of $145,000 show a net return of $780,000 – an appreciation of $280,000 or a net return of 56%.
- It seems then that over the last ten years, the stock market has outperformed real estate appreciation even in overheated regions like Vancouver and Toronto.
However buying a home has rarely been just about the return on investment.
It’s often been an unrequited love affair with the idea of an ivy covered cottage or a huge McMansion in the suburbs. Having a piece of land to weed and mow and lounge on this weekend trumps renting.
What do we know about real estate in Canada?
More than 70% of Canadian households now own their own homes. And the costs? Owning an average two story home will absorb 48% of a household’s gross income. Much more than the 32% recommended by the banks and CMHC.
The national savings rate is 3.8% with a third of all Canadians having “no wealth.”
Why? So busy buying that big home at inflated prices with the idea that real estate will continue to grow at same rate over the next ten years as it has over the past ten that they have no money left to save.
And yet all indications from the banking economists is that the market will stay flat or grow at about 2% (less than inflation) over the next ten years.
If you own now, you may want to re-examine your financial situation. Are you saving for retirement? Can you? Should you cash out now and take your profits?
But the prices are rising you say!
That’s right. But sales are decreasing and the number of available buyers is dropping – dramatically. It’s only a matter of time before prices decline.
And if you are willing and successful at selling your home?
Should you invest in the stock market? Blue Chip stocks like the big five banks? Buy government bonds? Even diversify into real gold and silver?
What should a wise person do? Your decision must be specific to your own circumstances.
You might hire a portfolio manager who can build you a globally diversified, tax efficient portfolio of securities. Securities that offer maximum return with minimal volatility and fit within your comfort zone.
Another choice is to talk to a fee-for-service financial planner who has an advisory team who can present you with a long-term plan. The plan would take into account all aspects of your wealth – your home, your life insurance, and your investments.
Because you pay for the portfolio manager and the fee-for-service financial planner, you can be assured that you will receive excellent advice. They won’t be loading up your portfolio with products that pay them a maximum commission.
Use their plan to grow your investment and then preserve your wealth in the best possible way in order to minimize taxes and pass it on when you pass on.