Investing in Real Estate vs. Stocks

Investing

First off, I launched my new blog on March 1st. And these are the 5 most popular posts so far.. have a look if you’re interested:

Also, on March 1st, my friend Sean Cooper released his first book – Burn Your Mortgage. Maybe you’ve heard of Sean. He was all over the news because he paid off his mortgage…at… 30! In his book, Sean chronicles how he did it. Not everyone will have the motivation to pay their mortgage off so quickly but it’s an interesting read nonetheless. I endorsed Burn Your Mortgage, and had actually inspired Sean to write the book in the first place, walking him through the publishing process.

We all invest in stocks and are obviously passionate about the markets. And some of you may also invest in real estate too. So, I asked Sean to write a blurb on investing in real estate vs. stocks.

This is what Sean had to say:

A common argument is that it doesn’t make sense to buy a home in a big city. That renting is a lot less expensive and the way to go. As real estate blogger Garth Turner so bluntly put it, “Why would any person want to buy a condo in Toronto or Calgary or Vancouver and actually pay twice the monthly cost than it would take to rent the same unit?” Kevin O’Leary of ABC’s Shark Tank shares a similar view. Mr. Wonderful has gone on record saying you’d be an “idiot” to buy a home (I guess I’m king of the idiots, since I not only bought a house in a big city, I paid it off). We’re told we’d be better off renting and investing.

When it comes to the performance of real estate versus the stock market, the findings seem to back this up. The average price of a resale home in Canada was up 5.4% from 2004 to 2013. Over the same time, the S&P/TSX Composite Index posted a 7.97% return. It seems pretty clear: you’re better off renting and investing than you are buying.

So why isn’t the debate over? Because it’s flawed. It ignores the power of leverage. Leverage is a fancy way of saying you’re borrowing the bank’s money to invest in something that’s expected to go up in value. You’re leveraging when the bank lets you borrow up to 95% of a home’s value. The bank doesn’t let you borrow this much money for stocks. Why not? Because real estate is seen as a safe, long-term investment. (It’s also because of collateral. If you lose all your money in the stock market, the bank has nothing, but if you default on your mortgage, the bank can sell your home to recover some or all of its money.) Here’s an example that shows the power of leverage: Let’s say you bought a home a decade ago for $250,000, with only 10% down ($25,000). You later sold it for $400,000, making $125,000 in profit (for simplicity’s sake, we’ll ignore associated costs such as mortgage interest, mortgage insurance, property taxes and closing costs). Even though your home only went up in value by 60%, that’s a 500% return on your initial investment (down payment) of $25,000. Try finding that kind of return in the stock market!

MarketMasters

Robin Speziale is the national bestselling author of Market Masters, which is available at Chapters, Indigo, and Coles as well as Costco and Amazon.ca. He lives in Toronto, Ontario. Learn more about Market Masters.

Advertisements

3 thoughts on “Investing in Real Estate vs. Stocks

  1. ” Here’s an example that shows the power of leverage: Let’s say you bought a home a decade ago for $250,000, with only 10% down ($25,000). You later sold it for $400,000, making $125,000 in profit (for simplicity’s sake, we’ll ignore associated costs such as mortgage interest, mortgage insurance, property taxes and closing costs). ”

    I think you are missing the opportunity cost with this sort of analysis. All those costs mentioned which you chose to ignore are every bit real as the trade commissions you pay when buying stocks. The biggest thing you have overlooked it the time-frame that dollar value was gained. Using your example of 125k profit, it was only an 5% per annum return. That’s below the market on just about every long term average you can find.

    The second aspect that was ignored was that well leverage comes with a downside too. Leverage doesn’t make your investment decision better or worse it just magnifies the outcome. So in this case sure you made more money but what if home prices fell 5% in the next 5 years. I doubt people buying today would really be making the same claims about how good of an benefit owing an home is.

    Alex Avery an Research Analyst at CIBC World Markets has recently written a book about this particular topic. Called “The Wealthy Renter” It may debunk some of the conclusions you made above.

  2. Good book, Robin. You have met some great fund managers. Francis Chou and Martin Ferguson are clearly way ahead of most of the rest.

    Leverage is a huge factor, but you can leverage similarly into stocks. 100% “No margin call” loans are available with no legal fees, appraisal fees or CMHC fee. 3:1 loans are easier to qualify for and are the same as 25% down. Again, no legal or appraisal fees.

    The Toronto Stock Market has had 6 times the growth of Toronto Real Estate in the last 40 years. This period was the best ever for real estate and a bit below average for stocks. The 20% down alone invested into stocks would be worth more than the leveraged house.

    I get asked often: “Should I invest $100,000 into a mutual fund or put it down on a $400,000 rental property?” Comparing $400,000 in real estate to $100,000 in stocks would put the real estate ahead for the first 30 years or so. However, pledging the $100,000 for $400,000 into mutual funds is an apples-to-apples comparison, in which stocks should have 6 times the growth over the next 40 years.

    Ed

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s