Housing

Reasons for Caution in Comparing Real Estate Returns with Stocks

May 22, 2013

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In a recent column in The Financial Post, Garry Marr pointed out that even in hottest bull market in real estate, stocks beat homes as an investment:

By the end of last year real estate prices had climbed about 85% over the previous decade, according to the Teranet/National Composite Bank House Price Index.

Stocks? The TSX/Composite Index has had a total return of about 141% during that period or about 9% annually. Go back 20 years and stocks still return more than 9% annually over the period.

One can sympathize with Mr. Marr’s intention to provide a counterpoint to the constant rah-rahs from the real estate industry (As a matter of fact, many years back, I wrote a very similar post in response to industry claims that real estate beat stocks here). However, Mr. Marr is incorrect in comparing home prices with stocks. Here’s why:

The total return from stocks includes the change in price level of the TSX index from 6,614 in 2003 to 12,433 in 2012. That’s a gain of 88 percent. The rest of the gains came from reinvested dividends (The TSX Composite yields about 3 percent per year). The return from housing was measured solely as the increase in the level of the Teranet – National Bank National Composite House Price Index and does not account for rental income from a property. It is true that owning a home entails expenses such as property taxes and maintenance but even in frothy markets like the present one, housing typically will have a positive yield net of expenses but excluding the cost of financing. Therefore the column presents an incorrect picture by comparing total returns from stocks with just the increase in price level of real estate.

Even if it turns out that stocks beat out real estate over the past decade, it still does not mean anything unless one takes risk into account. After all, if stocks beat bonds in most time periods, investors would hardly express surprise because stocks are riskier than bonds. The TSX Composite annualized returns had a standard deviation (a measure of riskiness of stocks) of 19.53% in the 2003 to 2012 period. The Teranet / National Bank National Housing Price Index, on the other hand, showed a standard deviation of just 2.6% during the same time period (assuming I did the calculations correctly with the information available from housepriceindex.ca). If real estate is less risky than stocks, one would expect real estate to have lower returns as well.

Owning too much real estate may not be prudent

April 17, 2012

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In a recent story that appeared in The Financial Post (See Big debt the downside of loading up on real estate), a tax accountant noted that a much larger proportion of his clientele own rental properties these days compared to a decade ago. It is a trend that I’m noticing in my circle of friends and acquaintances as well (with the caveat that my sample set is likely too small, unrepresentative or both). In the past, young families first purchased a starter home, lived in it for a few years and then sold it and upgraded to a bigger home to accommodate a growing family. These days, many families appear to opt to rent out their starter home when upgrading to a larger property.

There are a couple of factors driving the trend of more homeowners turning into landlords. First, homeowners have built up significant equity in their starter homes due to the decade-long bull market in housing. Second, financial institutions have made it much easier to tap into home equity. For instance, the big banks used to allow lines of credit up to 60 percent of a home’s value less the mortgage balance. Today, the figure is 80 percent.

Consider the following example: Sue purchased a home in 2003 for $200K, which is today valued at $350K. She currently has a $100K balance on her mortgage. Sue is planning on buying a new home for $500K and she has $300K in other financial assets such as stocks and mutual funds. Option 1 for Sue would be to simply sell the current home when purchasing the new one. She would have $500K in housing assets, $300K in financial assets and a mortgage balance of $250K. Option 2 for Sue would be to keep her current home and rent it out. The bank is willing to allow her to tap into her current home equity to the tune of $180K. In this case, she would have $850K in housing assets, $300K in financial assets and a mortgage balance of $600K ($280 on her first house and $320 on her new house).

By dramatically increasing her exposure to the local housing market, Sue has taken on significantly more risk by keeping her starter home. Any downturn in housing prices will result in a much bigger hit to her net worth. Also, any vacancy in her rental property will put a serious crimp in her cash flow (at an interest rate of 4 percent and interest-only payments, Sue needs to net $933 every month just to break even). It may be tempting to chase real estate riches after extrapolating recent housing market returns but putting too many eggs in one basket is hardly ever a good idea.

Competition Bureau versus CREA, Round 3

October 17, 2010

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Recently, the Competition Bureau announced that it has reached an agreement with the Canadian Real Estate Association (CREA) that will ensure that real estate agents to offer a variety of services and prices, including simply posting a property on the Multiple Listing System (MLS). The agreeement, which will remain in force for 10 years, is kept under wraps until the deal is ratified by CREA’s members.

Citing sources familiar with the deal, the Globe and Mail reported on the broad contours of the agreement between the Competition Bureau and CREA:

  • Only licensed agents will be able to post a listing on the MLS. The agent will be responsible for the integrity of the listing.
  • Sellers hiring an agent for simply listing their property will not have their contact information posted directly on Realtor.ca. But the listing can contain links to other sites that provide contact information.
  • FSBO listings will be expected to reveal how much they will pay the buyer’s real estate agent.
  • CREA will eliminate its ability to adopt rules that discriminate against real estate agents who provide listing-only services.

It appears that the Bureau has succeeded in its battle with CREA to (a) allow agents offer a variety of services at different price points and (b) remove CREA’s ability to change to restrict consumer choice. This agreement will allow brokers such as Best Value Real Estate that offers to list a home on the MLS for just $109 (admittedly, as a loss-leader) to continue offering “listing-only” services.