Many people believe that growth of the value of their home has been phenomenal over the last few decades. The common belief is that growth is similar to the stock market and much less risky. Is this actually true?
This is important, because believing a home is the best investment leads you to:
- Feel you must own a home to be financially successful.
- Buy the most expensive home you can afford.
- Spend a lot of money improving your home to maximize its value.
To find out, I graphed the actual values of the average home price in Toronto against the Toronto stock market (and a few others) since January 1975.
One quick glance at the historical growth chart below shows that growth of houses is nowhere close to the growth in the stock market. It is not even in the same category as stocks. The growth is close to GICs and inflation.
Figure 1: Morningstar & Toronto Real Estate Board January 1975 to December 2015 – CPI, 5-year GICs, Global stocks MSCI World index (US$, U.S. stocks S&P500 (US$), Canadian stocks TSX60.
Seeing your home grow in value from $53,000 to $613,000 sounds like a lot, but it is actually only 6.2% per year.
Here are the surprising facts:
- Canadian stocks have had 5.2 times the growth of Toronto real estate.
- You can easily invest in stocks globally, not just in your home town. Global stocks have had 6.3 times the growth of Toronto real estate.
- If you had invested the price of the average house into stocks in 1975, you could now have between $2.9 and $5.4 million.
- Even lowly GICs have grown faster than houses.
This difference is more surprising when you consider that:
- The last 40 years have been roughly average for stocks, while being (to my knowledge) the best ever for real estate. This period includes the biggest real estate boom in the 1980s.
- The size of the average home today is far larger than it was in 1975.
What about risk? Owning a home is much safer than stocks, right? The largest declines since 1950 show that the downside risk historically for homes has been nearly 2/3 as much as for stocks.
What is going on here? Why is this so different from what you may have thought?
A big reason is that we humans tend to focus on recent events. Toronto real estate has had strong growth the last few years. It has grown consistently the last 20 years, since the bottom of the 1990s real estate crash. Stocks had a big crash just 8 years ago.
It is useful to look at long term growth. It gives you a proper perspective.
Studies by Robert Shiller are quite insightful here. The Case Shiller National Home Price Index shows that real estate in the US since 1890 has grown only slightly above inflation. This makes perfect sense, since real estate growth is linked to our ability to make mortgage payments.
This also partly explains why growth has been strong recently. With interest rates so low, we are able to afford more expensive homes.
Figure 2: Home Prices after Inflation. http://www.irrationalexuberance.com/
What lessons can we learn from this:
- Do not expect your home to continue the recent growth rate indefinitely.
- Far higher growth is why stock market investments, such as mutual funds and ETFs, are usually recommended for our long term retirement investments. They consist of businesses that grow their profits over time.
- Your home is still a decent investment. The growth is tax-free, the payments are a forced savings, and people tend to buy with 5:1 leverage (20% down).
- Renting is reasonable option:
- Note that just the 20% down payment on a house invested in stocks would have grown to a higher value than the house. Growth of stocks over 40 years has been 5-6 times higher, so you would have only needed to invest 1/5 as much to end with the same value.
- The cost of renting is usually less than owning. If you rent and invest the savings effectively, you would likely eventually be better off than owning.
- Renting may improve your career by allowing you to easily move to a better job.