Real Estate Vs. Investing in the market…

Recently I posted an article on Facebook condemning home ownership. Read the original story from my friends at Millennial Revolution HERE

The post on Facebook was hastily titled: This empirically puts to bed the argument “Houses are great investments because they appreciate in value!!”

I was met with the following comment on my Facebook..

Foreword: I am glad I was rebutted since this is a topic I’m extremely interested in. I currently lean toward investing since it makes more sense for my current lifestyle. I responded in the best of my ability based on my experience and research. Please correct if I’ve made any mistake.
Cheers.

The reaction…

“The three year break down of owning a home that this author provides is ridiculous.

First of all, people who purchase a home do not pay their real estate agent anything. The realtor gets paid by the seller.

Second of all, other fees that are listed such as land transfer tax, lawyer fees, and home inspection fees are all one time fees. So that quoted $88,365.46 is quickly cut in half. Not to mention this is based on an over $600,000 house.

Real estate isn’t meant to be a short term investment as this article is making it out to be. If you’re going to buy a house and plan on selling in a few years without doing any upgrades to it then ya that’s not a smart investment because yes there are fees to pay. So in that case stick to renting. Real estate can be a great investment.

Real estate can appreciate as time goes on (realistically more than 3 years) it can appreciate by forced appreciation (updating and doing renovations) or you can buy real estate as rental properties and have someone else build equity for you.

I would also recommend that when you do real estate research to not compare the Winnipeg market to Toronto and Vancouver because they are on a completely different spectrum than us.

One more thing I forgot to mention – is she honestly comparing the fees of an over $600,000 house to a rental that costs $850 dollars a month?? Does she not know Vancouver or Toronto at all?? For $850 per month you would literally be living in a shit hole.

And I can say this because my brother lived in Vancouver and let me tell you it is impossible to find a livable space for that price. So realistically you’re looking at spending $1,100 for a one bedroom apartment which works out to be about $40,000 in 3 years that you have just thrown away on rent that could have been built equity for you.

There’s some number crunching for you.”

My Response…

Anonymous,

Glad you commented. It’s good to hear the other side of the investment & rent vs. owning real estate debate. Currently I lean towards the side of the investing & renting side, though I’m not completely opposed to real estate and may own one day if it makes sense from a financial and lifestyle standpoint.

I should have labelled this post “This puts to bed the argument that Real Estate is a good investment because it ALWAYS appreciates”. Obviously real estate appreciates, but not always. And right you are, short term real estate in most cases is a bad investment (just like the stock market) and can be quite good in the long run (ditto with stocks).

I agree contrasting the purchase of a $600,000 house with renting an $850 apartment isn’t apples to apples.

I am a little confused how you cut the $88,xxx cost in half quickly though? Yes the furniture and cable is something you most likely expend while renting as well. I think it’s a little questionable including all utilities into the rent so excluding from the cost of renting (sometimes you pay, but sometimes you don’t). Realtor and land transfer taxes are listed once as far as I can see and 1% per year towards maintenance doesn’t seem too far off. So that drops things down, but doesn’t cut things in half. Have i missed something/misunderstood your meaning.

Further, they excluded the interest you will pay on your mortgage payments. In today’s crazy low rate environment this might not fudge the numbers. But what if you bought when rates were low, overextended yourself by buying a house or overpaying on that house and rates rise? That can change the numbers quickly. Rates were 18% 30 years ago. That’s drastic but what would happen to someone who is house poor and rates jump from current 2.5% to say even 5%?

When rates rise, your payments rise – save a fixed term period, depending how long you locked yourself in for – and that affects your monthly payment. Rent can rise, but you can quickly up and leave to somewhere cheaper. Real estate can be quite illiquid.

Assuming we are investing the money we save on buying while renting (since thats what this article is about), if a investment portfolio drops its only realized and directly affects you if you sell. Dividends also keep on paying regardless.

Owning rental property is attractive until you consider the tax implications in my mind, then it gets stickier. Again, if financials and lifestyle conditions fit, I might explore rental property.

The issue of comparing TO and BC with Winnipeg is neither apples to apples either. So let’s compare investing and renting vs. home owning in Winnipeg

The Investing/Rental case study…

When I was looking at buying and renting in Winnipeg about 4 months ago I found an average home worth $275,000 to be roughly $1,500 a month to rent (not including utilities).

Let’s keep utilities at a static $200 per month for both cases.

Rent @ $1,500/month over 3 years ($54,000)

Utilities @ $200/month over 3 years ($7,200)

Total: $61,200

Since I am assuming investing the difference let’s look at a few scenarios:

Scenario #1: S&P 500

A benchmark index listed on an American exchange

Let’s say I reinvested the remaining $213,800 in the S&P 500 index at today’s price of $2,186 per share.

Average annual appreciation over the last 3 years has been 8.99% annually
Average dividend distribution has been 11%
97 shares ($212,042) @ $2,186 (compounding @ 8.99%) over 3 years = $274,510

11% dividends reinvested over 3 years = $69,840

Total: $344,350

Minus the interest on my loan of 6% of $275,000 = $33,640

GRAND TOTAL after investing and renting for 3 years: $310,710

Scenario #2: TSX 60 ETF (XIU)

Benchmark Canadian equities market ETF

Let’s say I reinvested the remaining $213,800 in the XIU ETF at today’s price of $21.59 per share.

Average annual appreciation over the last 3 years has been 8.40% annually
Average dividend distribution has been 2.8% annually
9,902 shares ($213,784) @ $21.59 – compounding @ 8.40% over 3 years = $272,309

2.8% dividends reinvested over 3 years = $17,823

Total: $290,132

Minus the interest on my loan of 6% of $275,000 = $33,640

GRAND TOTAL after investing and renting for 3 years: $256,710

The buying Real Estate case study…

Sale price of home: $275,000
7% down (5% for down payment 2% for land transfer and administration) = $19,250

Loan amount: $255,750
**25 year mortgage**

Total annual payment: $13,910 (assuming that includes interest rate of 2.5%)

3 years of mortgage payments: $41,730

3 years of utilities: $7,200

3 years of property tax (I found roughly to be $1,100 a year after rebate, but I consider than number conservative): $3,300

Home insurance (not included in mortgage) roughly $1000 a year, so over 3 years: $3,000

Since I didn’t include any maintenance fees (even though those costs are covered generally in your rent) I will exclude them here. Though can you argue you wouldn’t spend any money on maintenance over 3 years?.. Unlikely.

Total cost of ownership/money spent (unless I’ve missed anything):

Down payment: $19,250
Mortgage: $41,730

Utilities: $7,200

Property tax: 3,300

Insurance: $3,000

Maintenance: $0

Total out of pocket over 3 years of home owning: $74,480 (yes you will get that down payment back as home appreciates – when you sell and realize said gains).

SELLING THE HOUSE…

Houses appreciated in Canada 9% year over year from 2015 to 2016. But it’s well known that TO and BC have greatly affected that number. Excluding those, the national average was actually 3%. (year over year Winnipeg is actually -2%). This is taken from CREA and Global Property Guide. Let’s look at both the Canadian averages before and after BC/TO are accounted for.

Scenario #1: Canadian national average

BC/TO included – 9% appreciation

That $275,000 house is now worth $356,132. And that’s what it sells for.
Sale price: $356,132Realtor fee of 5%: -$17,806Costs of ownership for 3 years: -$74,480

GRAND TOTAL after owning a home for 3 years then selling: $263,845

Scenario #2: Canadian National Average

BC / TO excluded – 3% appreciation

That $275,000 house is now worth $300,499. And that’s what it sells for.
Sale price: $300,500Realtor fee of 5%: -$15,000Costs of ownership for 3 years: -$74,480

GRAND TOTAL after owning a home for 3 years then selling: $211,020

RESULTS…

The best option would have been to rent and invest in the S&P 500.
For a loss of $50,000 you could have bought the average house in Canada and sold, for our 2nd best option
For a close 3rd, by renting and investing in XIU you would have lost out on $57,000 but also avoided the pains of buying, maintaining and selling a house.
Finally, for our worst option, you could have bought a house in Winnipeg. Where the house actually appreciated despite the average house in Winnipeg losing value.

Perspective: The renter didn’t cut grass, shovel snow or spend their weekends doing home repairs (that wouldn’t have cost them anything in this example oddly). And this is a huge fact I want to account for, when you rent, you avoid a lot of home-owner bullshit. Some people enjoy tending their back yard and building decks, I don’t.

Also, the renter can easily up and leave if they lose a job or decide they want to move to say, South Korea?

As well, how long did it take for you to sell that house? How many realtors did you deal with? How many house showings did you have to leave home for? Real estate can be incredibly illiquid as I mentioned.

Over a 3 year period renting and investing took the cake. Subscribe to my blog to see Part 2 where I examine results over a 10 or maybe 15 year period.

Real estate is not always a bad investment, and it can be a very rewarding experience. In our current environment this is how the numbers pan out. In the end, the real answer is there’s no one right way of doing things.

It’s personal preference, but based on these numbers and the work involved compared.. I am currently sticking to the market.

SOURCES:

http://www.calculator.net/loan-calculator.html
http://www.globalpropertyguide.com/North-America/Canada/Price-History

http://www.mortgagecalculator.org/

http://www.free-online-calculator-use.com/stock-calculator.html

https://dqydj.com/sp-500-return-calculator/

http://www.moneychimp.com/calculator/compound_interest_calculator.htm

*****Calculations based on todays numbers, of the average returns of real estate and certain stocks over the previous 3 years.