Investing in stock or real estate is a difficult question. Asking the question, “Which is a better investment – real estate or stocks?” is like asking whether chocolate or vanilla is superior or if an Aston Martin is better than a Bentley. There really isn’t an answer because a lot of it comes down to your personality, preferences, and style. It also comes down to the specifics of the individual investment.
The Globe and Mail has suggested that investing can beat real estate in any environment:
Houses are a lovely place to live and raise a family, and they’ve solidly appreciated in price over the past several years. But stocks, even after the mega-crash of five years ago, have been the better long-term investment.
National price data from the Canadian Real Estate Association shows an average annual gain of 5.4 per cent nationally from 2004 through 2013 for resale homes. The comparable average return from stocks was just under 8 per cent. If we go back 20 years, we get an 8.3 per cent gain from Canadian stocks and an increase of 4.5 per cent in the average national house price. Over 30 years, stocks made 8.5 per cent and houses 5.5 per cent.
But this analysis entirely overlooks the power of leverage associated with a typical mortgage. One of the greatest benefits to real estate investing is that it’s probably one of the more accessible ways to invest using borrowed money. At this point, however, it’s worth mentioning that while borrowing to buy an asset can magnify your gains, it can also dramatically accentuate your losses.
To understand how this works, consider what happens if you put 10% down on a property worth $300,000. Your original investment is $30,000. If the house goes up in value by $60,000 and you sell, you’ll make a $30,000 profit (before interest, taxes and expenses). Even though the house went up in value by only 20%, your return on investment is 100%—that’s how leveraging works.
But what if the same $300,000 house drops in value by $60,000, and you sell. You won’t get any of your initial $30,000 deposit back and, worse, you’ll now owe $30,000 to the bank to pay off what you’re short on in the mortgage. While the investment only declined by 20%, you ended up in the red by 100%. Because of leverage you lost more than you initially invested.
The long and short of it is this: real estate, as an investment, really only makes sense when the market is appreciating. Any loss in home value can really put a dent in your overall equity. If, then, you believe that the housing market will drop 20% in value, it would probably be best for you to continue renting and to invest your money in the markets.
In the end, a decision to invest in any product, whether real estate or in the markets, needs to be an educated decision based on a long-term financial strategy. Investing in stock or real estate cannot be an emotional decision based on fear and speculation.