Everyone knows real estate rocks
By John Caspar - Sympatico/MSN Finance
Real estate is like the equity investment of the people. Everyone has heard about the enduring bull market in Canadian real estate, and most everyone has an opinion about it. It’s easy to find folks who will humbly admit that they don’t really understand the finer points of stock market investing. But, at least in Canada’s hottest real estate markets, it’s tough to find anyone who isn’t an expert.
Consider Toronto, for example. It’s a crazy hot real estate market here, and it has been for several years. Anyone who has owned property here for any length of time has seen the value of that property rise, perhaps dramatically. And it’s been going on for long enough that Toronto real estate as an investment has fallen into the “Everybody Knows…” category. You know: “Everybody knows that Toronto real estate is a safe investment”, or “Everybody knows that Toronto real estate outperforms stocks”, or “Everybody knows that you can’t get hurt in Toronto real estate.” Like that.
Now, I guess I tend to be a contrarian, so when Everybody is quoted as an information source (”How do I know that? Well, Everybody knows that.”), I get interested in knowing more about the whole story. And as it turns out, the whole story about real estate as an investment isn’t quite the same story that Everybody knows.
Take the idea that Toronto real estate is a “safe” investment. Real estate certainly can be a brilliantly rewarding investment, for all the same reasons that being an equity investor of great businesses is so smart. You can get long-term capital appreciation as well as income in the form of dividends or rent (or imputed rent). Hey, it’s good to be an owner! But if your idea of safety is consistent appreciation or stability of capital in the short run, well, real estate actually doesn’t provide that any better than stocks.
According to data from the Toronto Real Estate Board, in the last thirty years the average price for a detached home had three bear market periods where it took at least two years for prices to recover to their previous high. After prices topped out and corrected in 1981, it took seven years to get back to those 1981 prices.
Real estate investors were just getting back to “knowing” how great Toronto real estate was when prices peaked and corrected again in early 1990. It was 1992 before prices climbed back to where they were. And then, in early 1995, prices once again started downward. This time, it wasn’t until 2003 until the market saw those 1995 prices again. That’s right… in very recent history, it took the investment that Everybody believes in eight years to recover from a downturn.
Now, that’s not to say that stocks don’t turn down too. They do. Everybody knows that. So, to be fair, I pulled out chart data on the S&P/TSX Composite Index (and its predecessor, the TSE 300) for the same period, and had a look-see. Like the price chart for the average price of homes in Toronto, it’s a plenty squiggly line, and reflects a lot of volatility. But as with the Toronto real estate data, we’ll concern ourselves with just those periods since 1977 that involve at least two years to recover.
For Canadian stocks represented by the S&P/TSX (TSE 300), there were four such periods. In 1981, the Toronto real estate market fell and took two years to get back to its high. Then there was the famous correction in 1987, which also took two years to right itself. Less dramatically, the market head south in the early moments of 1990 and took a couple of years to come back. And lastly - and certainly freshest in our minds – the Canadian stock market turned bearish in 2000 and took five years to recover.
So there it is. Three bears for real estate, with durations of 7, 2 and 8 years. Four bears for Canadian stocks, with durations of 2, 2, 2 and 5 years.
Hmmm. Interesting. So what were the comparative returns for those two asset classes over those 30 years? Well, based on the data mentioned above, the average detached home in Greater Vancouver went from $80,000 in 1977 to $785,234 in (April) 2007. Wow. Can you believe the average Greater Vancouver home once cost 80 grand? And can you believe it’s now nearly 10 times that?! That’s a total return of about 882 percent, or an average annual return of nearly 8 percent. Nice!
As for the S&P/TSX Composite Total Return, well, if you had invested $80,000 in the index in 1977, it would be worth over $2.5 million in April 2007. That’s more than 3,000 percent return, or an average of over 12 percent per year. Very handsome. And by the way, if you’d invested the same amount in the U.S. S&P 500 index, you’d have over $3.1 million in Canadian dollars today – a 3,825 percent return, or an average of 13 percent a year.
So, as it turns out, over the long run stocks do rather well compared to real estate. Of course, on an intuitive basis, you’d figure this out anyway, right? Because if Everybody knew they could make more money in the long run by simply owning real estate rather than owning resources companies and financial institutions and industrial firms and telecom companies, they’d never start, run or buy a company. And Everybody knows that’s just silly.
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