I know many people considering real estate as an investment. It is a standard ‘go to’ idea for anyone looking to build wealth.
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While you can definitely create wealth with real estate, it certainly isn’t the sure thing many people think. Indeed, real estate investing is high risk (high leverage and high concentration) and a huge pain in the ass (3am clogged toilets, destructive tenants).
To gain perspective, investors need to consider real estate against other investing options.
Toronto real estate is in a bubble. Over the past decade, houses in Toronto have appreciated by over 120%. Many people therefore conclude that a house in Toronto would have been a fantastic – if not the best – investing choice over the past decade.
They are wrong.
The following chart shows 10 year returns for Toronto real estate, stocks, REITs and real estate equities. As you can see, housing price increases lagged.
So how do real estate investors get rich? Leverage. But if you applied the same leverage across the comparison, the relative performance differential would remain.
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To be fair, the return for houses was calculated on a price returns basis whereas the other indices are showing total returns. Total returns include the income earned by holding the asset – dividends for stocks and rent for real property. Incorporating rental income would definitely improve the comprison. But would rent have tripled the return to match that of REITs? Probably not. Especially after considering risk, maintenance expenses, taxes and property management costs.
(Note: in an ideal world, I’d incorporate a $ rent assumption to recalculate Toronto real estate returns as a total return. Unfortunately, I don’t have the base data to recompose the returns.)
Despite the wonky comparison, the chart still disproves the incorrect assumption that owning a home was the easy, low risk way to build wealth – even during the biggest real estate bubble in Canadian history.
During the next decade, it’s not reasonable to expect the pace of Toronto real estate returns to continue at the same pace. A more conservative returns estimate would put Toronto real estate at a further disadvantage to other assets.
Moral of the story: do the math, compare against alternatives and factor in all risks before investing in anything.