My January 8, 2019, column titled, “Re-think what you thought, Part 2” contained a statement that a common misperception is that a house is one’s most important investment. For farmers, a house often comes with the farm, which is clearly an investment. Does this apply to those who don’t farm? I wish to clarify that statement, and weave in some thoughts regarding farmland.
While the overriding purpose of this column is to discuss stocks as an off-farm investing avenue, I also have extensive real estate experience. That experience includes all types of real estate including houses for rental, multi-family, commercial, farmland, recreational and hotel-condos. I have sold all my real estate with the exception of the hotel-condos, and the farmland housing my seed business.
What has always baffled me is the belief that a house is the best and most important investment a person can make, the value of which never goes down. But is a house for personal use really an investment? Here are three simple qualifications for an investment:
- Interest paid to finance the purchase must be tax deductible (if financing isn’t used, it would be tax-deductible if used);
- The purchase provides, or has the potential to provide, a steady stream of cash flow; and,
- The asset has the potential to change in value.
An owner-occupied dwelling only meets one of these criteria. Interest in Canada isn’t generally tax-deductible (although it can be), and it will only ever have negative cash flows. In many cases renting is cheaper than owning when all costs are considered. My position is that a house purchase decision is a lifestyle decision, not an investment decision. I’m not suggesting buying a home is a poor decision, simply attempting to re-position the decision, stepping away from conventional wisdom.
Real estate values
The second part of the misperception is that house values never go down. Real estate values are based on local market conditions and often go down. The home we own in Calgary is worth about 15 per cent less than it was a dozen years ago. From a bigger picture perspective, Canadian house values peaked about 1990, declined for a number of years, then took until 2002-04 to recover. While most areas in Canada have gone up for the past two decades, it doesn’t mean they will continue doing so.
Many also believe that farmland values can’t go down. They certainly can. Those of us with some grey in our hair will recall farmland dropping in half between about 1980 and 1990. While it has been trending upwards for the past three decades this trend is not guaranteed.
Land, housing and stocks have a couple things in common. First, they tend to take the stairs up and the elevator down. Second, prices recover after declines. Stocks exhibit more rapid decline and recovery; real estate cycles are longer.
Now for some data that will blow your mind. From 1900 to 2017, U.S. equities provided 6.5 per cent annualized after inflation returns, whereas U.S. housing returned a paltry 0.3 per cent. Canadian stocks returned 5.8 per cent, but unfortunately Canadian housing wasn’t included in the report. The best housing market in the world was Australia with 2.2 per cent annualized after-inflation returns. Those are huge differences. One reason real estate is favoured is that large amounts of leverage are allowed. However, leverage is a two-way street that can cause serious financial stress in down markets.
Why did I turn my back on real estate? While generally deriving good returns, real estate entails a lot of work, and I was absolutely nuts taking care of real estate investments. I was delighted to say good-bye to my tenant and toilet days. A well-selected stock portfolio is much easier to manage, significantly less stressful and delivers better returns.