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Understanding tradeoffs between stock market, real estate is crucial

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The Canadian residential real estate market has enjoyed a prolonged period of strong price appreciation. Understandably, this has inspired debate in recent years as to whether the stock market or real estate has been a better long-term investment. On balance, the historical data paints a more nuanced picture than commonly perceived.

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The persistent strength of many Canadian housing markets over the last decade has left many people with the impression that real estate is a more compelling long-term investment vehicle than other asset classes such as equities. Over the past two decades, however, both the stock market and real estate have delivered attractive long-term returns.  The S&P/TSX Composite has generated annualized total returns since early 1999 that are in line with, or better than, various Canadian real estate markets—including Toronto and Vancouver, which have experienced some of the most robust house price appreciation in recent years.

While it may be tempting to extrapolate from housing’s recent strong run when forming future expectations, it’s important to note that time horizon matters and the TSX Composite has more than kept pace with many local real estate markets as time horizons are lengthened.

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Although the main topic of discussion at many dinner parties in recent years has been how much each person’s home has appreciated in value, most people purchase their homes as primary residences, and thus price appreciation may not be their primary focus. In contrast, investing capital in the stock market is typically done with the goal of having that capital appreciate over the long term to meet the investor’s financial objectives. That said, there are others who look to residential real estate as a potential investment vehicle. While comparing housing and equities may seem reasonable on the surface, there are numerous factors that make a direct comparison difficult, if not outright misleading.

As a start, it is crucial to take the need for liquidity and diversification into account. Real estate can seldom be quickly liquidated for cash. This lack of liquidity compared to other types of assets (such as equities and bonds) makes real estate generally unsuitable for investors with ongoing or expected cash flow requirements. Except for those with sizeable amounts of wealth, it can also be quite challenging for investors to attain an appropriate level of diversification in their real estate holdings. Additionally, real estate comes with potentially onerous barriers to entry, including down payments, access to affordable mortgage financing and insurance coverage, and an array of transaction costs such as agent commissions, legal fees, and land transfer taxes. The long-term cost of home ownership—including, for instance, property taxes as well as repair and maintenance expenses—is another consideration that is often underappreciated, as investors tend to place too much emphasis on the initial purchase price.

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In contrast to real estate, it is typically less arduous for investors to gain exposure to the stock market in terms of initial capital requirements, transaction costs, and achieving a suitable level of diversification across geographies, sectors, and industries.  Some other important considerations, such as the impact of leverage (mortgage) on returns, differences in the taxation of capital gains, and whether a primary residence should be viewed as an investment, must also be considered, but the main takeaway is that any direct comparison between the stock market and residential real estate is likely to be a flawed exercise.

Understanding the tradeoffs and differences between the stock market and real estate is crucial. While the stock market tends to be considerably more volatile, a review of historical performance supports the view that equities have been an equally effective means for investors to build wealth over the long term relative to residential real estate in Canada.

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Most importantly, it is also worth noting that investments in real estate and stocks are not mutually exclusive, and a residential property can certainly play a role in one’s overall investment portfolio. The choice of what assets to invest in and own over the long term ultimately depends on an investor’s financial objectives, time horizon, and risk capacity and tolerance.

Mike Candeloro, Senior Portfolio Manager and Wealth Advisor with RBC Dominion Securities and the head of The Mike Candeloro Wealth Management Group supplied this article. RBC Dominion Securities Inc. and Royal Bank of Canada are separate corporate entities, which are affiliated. Member CIPF. Mike can be reached at [email protected]   You can also visit his website at www.michaelcandeloro.com   To read Mike’s archived articles please visit Mike Candeloro / Special to The Nugget | National Post


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