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:

  1. Feel you must own a home to be financially successful.
  2. Buy the most expensive home you can afford.
  3. 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.

Growth Comparison Stocks vs Homes 1975-2015 Graph

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.

Growth Comparison Stocks vs Homes 1975-2015 Chart

This difference is more surprising when you consider that:

  1. 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.
  2. 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.

Decline Comparison Stocks vs Homes 1950-2015 Chart

 

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.

Real-US-home-prices-1890-2014

Figure 2: Home Prices after Inflation. http://www.irrationalexuberance.com/

 

What lessons can we learn from this:

  1. Do not expect your home to continue the recent growth rate indefinitely.
  2. 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.
  3. 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).
  4. 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.

 

 

Ed

16 Comments

  1. Al Emid on July 5, 2016 at 11:38 am

    There are a huge number of variables in ths question and your piece is one of the few that I have seen that exhibits many of them.

    Al Emid



  2. Ami Maishlish on July 5, 2016 at 2:14 pm

    Ed, you present an interesting perspective in the comparisons. However, to be more congruent, if I may suggest the following adjustment factors to the figures and graphs:
    a. While the annual cost of renting may be lower than the annual cost (incl. lost opportunity cost on the down-payment) of owning a home, one nevertheless has to live somewhere. One cannot reside in their stocks or MFs, therefore the figures and graphs would be more reflective if the cost of renting the equivalent residence would be adjusted for, such as for example charging the cost of renting against the ROI of the alternative investment in stocks stocks. The counter to this argument is the cost of borrowing, such as the cost of mortgage financing of one’s owned residence’s mortgage, which also should be factored in.
    b. Human nature and human psychology cannot and should not be ignored:
    -there is the known tendency to be spooked by commercial media and its focus on sensationalism. If it is in print in a mainstream paper or broadcast on TV or radio, the tendency is to assume that the information is true and unbiased. That is not so, as disinformation is often disseminated by papers and the electronic media to further their own an/or their advertisers agenda. Personally, I have successfully based my own long-term investment strategy to a large extent on the contrarian approach while keeping my eye on what the large institutions do for themselves rather than what they pitch for in their ads or have their media mercenaries say that one should do. A good example of this is the silly but common “Whole Life vs Term” pitch. While the life insurance companies and media taking heads pitch “term”, the insurance companies are either withdrawing from the market or increasing the premiums on their Whole Life offerings (Of course, term will produce a higher ROI if you plan to die… but that’s another discussion beyond the scope of this topic…).

    The psychological issue with stocks and MFs is that all too often individuals are drawn in by rising values then spooked by market downturns hyped by the media. The consequence is that, unless guided by a consumer interest minded financial advisors, the tendency is to buy high and sell low – the antithesis to sound investing.
    c. Taxation must be taken into account. In Canada, at least presently and before the feds get their fangs into one’s Principal residence appreciation, the increase in value of one’s principal residence is not taxed nor included in one’s taxable income to determine one’s marginal tax bracket, clawback of government benefits, etc. The contrary is true for the increase in value and/or yields on stocks and MFs. Even when sheltered (with the exception of the minuscule sheltering provided by the TFSA) the tax grab and potential negative impact on government benefits is there immediately or imminent. It is therefore wise to compare net of tax results rather than to compare the pre-tax IRR on stocks and MFs against the net of tax IRR on one’s principal residence.

    I could go on for several more paragraphs; however, the bottom line of all this is that reading financial advice articles and books is great for general education or to pass time on a lazy summer weekend afternoon; however, these are not a replacement nor substitute to consultation with consumer interest minded and focused financial advisors. Each person’s financial matters are as unique to the individual as her/his fingerprint and involve more than mere number crunching. The advice of this old grogger is to seek out such a trustworthy and client’s best interest focused financial advisor. Letting a robot or the media be your financial advisor is akin to going out to movie and dinner evening with a mechanical robot instead of with your better half.



  3. Ed Rempel on July 5, 2016 at 8:00 pm

    Thanks for the kind words, Al.

    Ed



  4. Ed Rempel on July 5, 2016 at 8:21 pm

    Hey Ami,

    You put a lot into your reply.

    I tried to keep this clear and simple. I’ve read quite a few articles that try to compare costs of buying and renting. The blog comments tend to focus on debating what typical costs are. Every situation is different.

    That’s why I kept it simple by showing that just the 20% down on a house invested in stocks could be worth more than the entire house. With renting costs being lower, a renter should be able to invest more and be ahead.

    I agree with you about investor behaviour being one of the main risks. Getting the full return of the market (or higher) is not as easy at it sounds, because people tend to invest when the market is strong. They tend to invest in something that has performed well recently (which means they are buying high).

    Tax is not necessarily a big issue here. With tax-efficient equity investments, the taxable income can mostly be capital gains deferred decades into the future. That means probably only 15-20% tax paid 30 or 40 years later.

    My analogy indirectly also shows that the returns of owning a home are primarily from the 5:1 leverage (with 20% down), not because the house itself grows in value quickly.

    Most people seem to think a house is automatically the best investment. Those that cannot afford to buy now, or choose not to, often feel it means they are not successful financially.

    My point here is to put it into perspective and to educate:

    1. I think most people would be shocked to find that returns on stocks have been 5-6 times that or homes the last 40 years.
    2. Renting is a valid option and nothing to feel bad about.
    3. Building a large equity portfolio is the key to financial security and a comfortable retirement.

    Ed



  5. http://www.duanthelegend.info on July 30, 2016 at 2:30 am

    I was wondering if you ever thought of changing the structure of your website?
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  6. Ed Rempel on August 12, 2016 at 7:44 pm

    Hi Duan,

    Thanks for your comments. I’m always open to helpful suggestions.

    I agree that I need to show more graphics. I have some graphics that I think are very interesting and garnered a lot of responses on Facebook and LinkedIn.

    I have made some format changes that should appear shortly. Let me know what you think, Duan.

    Ed



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