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Trying to decide between buying a home and investing in stocks? Both types of assets have strengths and weaknesses. Here's what you need to know.

Many Canadians wonder whether it’s best to invest in real estate or stocks right now. The answer depends on your worldview and your appetite for risk.

Residents of Toronto and Vancouver constantly hear about soaring real estate prices, and more than a good investment, simply want to get into the housing market before they’re priced out forever. On the other hand, investing in stocks can be profitable in the long run, but downright scary in the short-term. Look no further than the 30% decline this past March, courtesy of the  COVID-19 pandemic.

But instead of making sweeping generalizations about either asset class, this article will look at the pros and cons of investing in real estate vs. stocks and let you draw your own conclusions.

Is Buying a House a Good Investment in 2021?

Canada’s top mortgage insurer, the Canada Mortgage and Housing Corporation, recently issued its housing market outlook and the results weren’t pretty. In summary, housing prices are expected to decline by between 9% and 18% in the next 12 months before a recovery in 2021.

While that’s bad news for existing homeowners and the equity in their homes, a housing slowdown may actually be good news for potential home buyers. Qualified borrowers with solid incomes and a hefty down payment could find plenty of opportunities to buy a house or invest in an income property in the coming months.

Many Canadian borrowers are leveraged to the max. The ratio of household debt-to-disposable income has reached a high of 176% and more than 1 million homeowners applying for mortgage deferrals during the COVID-19 pandemic.

Again, if you’re well qualified and not in danger of losing your income in a recession caused by the pandemic, buying a house while the real estate market softens could be a very prudent move.

Why Stocks Are Better Investment Than Real Estate

In general, stocks have produced far superior average annual returns than real estate. Using the same 1982 starting point, U.S. stocks have returned an average annual growth rate of 12.11%. Even a balanced portfolio consisting of 50% bonds and 50% stocks (divided between Canada, U.S., and International) returned an average annual growth rate of 10.12% over those 37 years.

Stocks have been the best performing asset class by far over the long term, and despite recent turbulence, there’s no reason for investors to think that outperformance won’t continue into the future.

The biggest advantage of investing in stocks vs real estate is diversification. With real estate, you’re picking one house, on one street, in one city, in one country. That house may or may not be representative of the national average or even the city’s own housing market average.

With stocks, you can invest in a diversified portfolio of companies from Canada, U.S., and abroad using index funds or ETFs. Doing so spreads the risk of any one company, industry, country, or region going through a downturn and instead aims to capture all of the returns from global stock and bond markets.

Investing in Stocks

Thankfully, we have more tools available today that make it easier to buy stocks without needing much knowledge, or even hands-on involvement. I’m talking first about investing with one of the best robo advisors in Canada. These digital platforms allow investors to invest in a low cost, globally diversified portfolio of index ETFs. Your investments are managed, monitored, and rebalanced automatically using algorithms and technology, but there’s also a human element there to guide you and help you make your investment decisions.

When it comes to robo advisors,  Wealthsimple offers a low-cost approach and great user experience. Investors pay a low management fee of 0.40% – 0.50%, plus the cost of the ETFs, in exchange for a hands-off investing experience. If that’s not enticing enough, Wealthsimple is offering an exclusive welcome offer for Young and Thrifty readers. Open and fund your first Wealthsimple Invest account with $1,000, and you’ll get a $100 cash bonus deposited into your account. That alone is a reason to sign up!

And, for those who prefer to take the wheel themselves, there are discount brokers available where you can build your own portfolio of stocks or ETFs. The best choice for ETFs these days is an asset allocation ETF – a single ETF that invests broadly in stocks and bonds from around the world and automatically rebalances daily for the extremely low cost of 0.25%.

Wealthsimple Trade Review

When Buying a House Is a Bad Investment

Now for a sobering reality check. Remember when your parents or grandparents told you that buying a house was the best investment they ever made? The data says that’s probably wrong. Time, leverage, and inflation make housing seem like a great investment.

Let’s say your parents bought a house worth $65,000 in 1975. They sold it for $313,000 in early 2020. The sheer size of the gain – $248,000 – makes this look like a killer investment. But over 45 years that house only appreciated by 3.55% per year – which was the exact rate of inflation over that time period.

Indeed, according to housing price data going back to 1982, Canada’s house prices had an average growth rate of 1.7% per year – a number that actually trailed the inflation rate of 2.46%.

I want to be clear: buying a house is typically a bad investment on its own. You should only buy a house when you’re financially prepared to do so, and only when it suits your lifestyle.

I’ve been over my head as a first-time homebuyer, where I barely had enough income to pay the mortgage, property taxes, insurance, and maintenance. It’s called being “house poor,” and it’s not fun.

Similarly, a home is a bad investment when you buy one without thinking about your medium-to-long-term goals. You should plan to live in your home for 10 years for the “investment” to pay off. Otherwise, all the extra costs that come with homeownership, plus the potential penalties for breaking your mortgage if you sell early, won’t pay off.

Finally, many people look at real estate investing as an alternative to the stock market and want to buy an investment property that they can rent to tenants to generate income. The hope is that you can get someone else to cover the mortgage, taxes, and insurance while you own the home, plus capitalize on the appreciation of the home when you’re ready to sell. A double benefit.

In reality, most rental properties are cash flow negative, meaning the rental income does not cover all of the expenses. Stubborn owners cover the shortfall while still expecting generous gains when they sell the home. But, as you see from the data, the gains might not be as generous as you’d hoped.

Why Real Estate May Be a Better Investment Than Stocks

Up to this point, I’ve argued that buying real estate should be a lifestyle decision rather than an investment-driven one. There’s simply no mistaking that stocks have vastly outperformed real estate over the long term.

But one reason why real estate may be a better investment than stocks has to do with leverage. In Canada, you can buy a home with just a 5% down payment. That means you can use an initial investment of $22,500 to buy a home worth $450,000. You simply cannot obtain that kind of leverage by investing in stocks

Now imagine a $450,000 house that appreciates by 2% per year for 30 years is worth $815,000. That’s a 12.71% return on your initial $22,500 investment. Not bad!

Could you earn an annual average rate of return of 12.71% by investing in stocks? It’s possible, but not likely. The FP Standards Council anticipates future annual returns of 6.1% for Canadian stocks, 6.4% for U.S. stocks, and 7.1% for International stocks.

Of course, this is an oversimplified example that fails to account for other expenses a homeowner incurs, such as property taxes, insurance, and maintenance costs. But it highlights the power of using leverage to invest.

Last Word: Invest in House or Stock Market?

Deciding whether real estate or stocks is a better investment really comes down to your personal situation and preferences.

For one, we’ve already established that buying a home is a personal decision that should be made with lifestyle in mind, first and foremost. And we’ve established the long track record of outperformance for investing in stocks. With COVID-19, now is a great time to invest in the stock market. It’s easy to get started with an online brokerage like Questrade or Wealthsimple Trade, or a robo advisor like Wealthsimple. If you’re a first-time investor, read our guide on How to Start Investing in Canada, and you’ll be a pro before you know it.

With that in mind, investing in stocks seems like the logical answer. But for many Canadians, their home still represents both the single largest purchase they’ve made and the largest asset they own. Many rely on their home for retirement, either by downsizing or eventually tapping into the home equity for living expenses.

Finally, there’s a comfort in investing in real estate and a pride that comes with homeownership and even in being a landlord. Real estate is a tangible asset that you can see with your own eyes, and fix-up with your own sweat equity. It’s not an abstract concept of share ownership in hundreds or thousands of companies around the world. The daily ups and downs of the stock market simply make investors nervous and so many shy away from investing in stocks.

Still undecided? If you’ve got some savings stashed away, take a look at Saving vs Investing: Finding the Perfect Balance. It will help you figure out the right strategy for you.

Evidence-Based Guide to Successful Investing

Article comments

Seamus O'Rooney says:

This is a thought-provoking article, albeit with a few flaws. I’m a fan of both passive index investing and real estate, and agree that there are pros and cons to real estate. However the examples and figures you use are not totally accurate. Chances are, someone who purchased a home for $65,000 in 1975 is going to sell for a lot more than $313,000, unless they’re in the middle of nowhere. For example, homes in Southern Ontario that sold for $20,000 in the mid-seventies are now going for over 900k, and were still north of 700k before Covid craziness swept the real estate market.
Also, it is inaccurate to state that most rental properties are cash negative. While it’s true that skyrocketing prices have impacted CAP rates in major urban markets, there are still tremendous opportunities for those who can manage the 20% down payment hurdle to get into the investment property market. I would argue that it’s never a good idea to purchase a rental property that is cash flow negative, and if it is, there’s a problem with the sale price, the rental rates, or both.
Anyhow, thanks for a decent article overall, as usual.

Potato says:

Now imagine a $450,000 house that appreciates by 2% per year for 30 years is worth $815,000. That’s a 12.71% return on your initial $22,500 investment. Not bad!

Leverage cuts both ways. Importantly, you forgot about the interest in this over-simplified example. If you’re not adding more principal (to compare to the “return on initial investment” framing), then your investment loan is growing too. So at a 3% interest rate, that hypothetical negative-amortizing 30-year loan means you’ll face a $1,037,655 loan to pay off at the end, putting you significantly underwater on your now $815,000 house.

Leverage can work to enhance your returns to crazy levels, but only when the return on the underlying investment beats the cost of the interest on the loan. Just like you wouldn’t borrow at 5% to invest in a stock portfolio that you only expect to return 3% — it makes no sense. So people who bought in Toronto or Vancouver and saw big price increases, way above the mortgage interest costs, experienced even better returns on their equity because of the leverage. But anyone paying 3% on their mortgage in a flat or falling housing market had that leverage work against them.

Robb Engen says:

Hi John, you’re right about also having to include the cost of borrowing in this example. The point was to show how investors can use up to 20:1 leverage to invest in real estate – which CAN amplify returns (or magnify losses).

Most people couldn’t fathom using any amount of leverage to invest in stocks.

Jack says:

This is the place where the dialogue needs to be taking place. The inclusion of the borrowing cost averages and inflation over spans of times in specific markets. Everyone has read the plethora of superficial explanations… the comment is more insightful than the article.. Robb, you should write bro!

Pop says:

He is the author!