As advisors who take all of a client’s assets and liabilities into consideration, it is without question that real estate and property have grown to a meaningful share of one’s net worth. Our team’s approach holds diversification as a key tenet and this means we believe both asset classes of real estate and stocks deserve to be held. Ultimately, the important question to ask oneself is to what proportion these should make of our net worth. One of the factors that is often considered is long term return potential; However, there are a host of other factors that should be considered when determining whether one needs to adjust any proportions. We will review these factors later in this blog.
Even with most generally aware of real estate’s strong returns, investors may have guessed that a growth engine like the US stock market would have outperformed over the last decade. Afterall, the S&P500 has earned a 10 Year Return of 162% even after taking into account the dismal performance of 2022. However, it may come as a surprise that for the past two decades, even the TSX has kept up or beat various real estate markets – including the very robust Toronto and Vancouver markets.
As humans, we tend to have recency bias – favoring recent data and extrapolating that into the future and deemphasizing older data. Therefore, it is important to look at longer term horizons to see the full picture. We also feel the only fair way to make comparisons is by looking at national and regional averages. Similar to how there have been specific companies that have outperformed the stock market index, there will undoubtedly be specific neighborhoods that outperform the regional averages. The key takeaway from the data is that both the stock market and real estate have been rewarding investors with attractive returns.
As alluded to in the introduction, beyond the investment returns, investors should also acknowledge other considerations that make the comparison of real estate and stocks difficult. The variables below will rank at different levels of importance at different stages of one's life. For this reason, the ratio between real estate and a 'stock & bond' portfolio is truly personal and may dynamically change.
Liquidity: Real Estate is an asset that is not as easily liquidated for cash compared to equities and bonds. Therefore, this type of investment may not be suitable for individuals that have ongoing or future expectations of cash flow needs.
Tangible Asset: Real estate is an asset that has a physical component that you can see and touch, giving a sense of security. On the other hand, share ownership in the stock market is intangible. The tangibility of real estate is a key feature that many investors hold dear. Being able to understand and feel comfortable with one’s investment is valuable.
Volatility: The stock market may appear to be more volatile as it is literally valued every second of every day. The frequency of valuing real estate is generally less and therefore the price movement may appear to be smoother. Although every asset class follows a cycle, new investors generally have to learn to accept daily pricing and the emotions that come with it.
Diversification: To attain a diversified real estate portfolio, an individual needs a sizeable amount of wealth. Whereas diversification in the stock market can be easily achieved through ETFs, Mutual Funds or Separately Managed Accounts.
Leverage: Most real estate investors seek some type of mortgage financing to fund the purchase of a property. When the real estate market is doing well, leverage can amplify the returns. However, losses can be magnified when the real estate market is heading the other direction. The degree of leverage that one can accept is personal. For some, an investment property that has depreciated in value can put extra stress on an owner if they are unable to find renters to help pay down the cost of the mortgage.
Ease of Entry: Purchasing real estate has more requirements making it more difficult to make an investment in property. Some of these barriers include down payment, approval for mortgage financing, legal fees, property taxes and etc. To participate in the stock market, the requirement to start investing is less burdensome as the initial capital requirement is significantly less.
Taxation: It is easier to control the tax implications of a stock market portfolio versus a real estate portfolio. Investors can sell portions of their portfolio, thereby, triggering a portion of the portfolio for taxes as required. Real estate is not afforded the same luxury as it is not usually possible to sell a portion of property. Therefore, the tax consequences tend compound greater as it is not possible to smooth out the tax liabilities over multiple years.
It is important to understand the difference between the two asset classes to decide what type of investments is most suitable for you. With all investments, it should not be seen as mutually exclusive. Real estate and a stock portfolio should both play a role in one’s person wealth. The key is determining the right proportions based on financial goals, time horizon, and risk tolerance.