BAD INVESTMENT
With housing’s historical record, you’d be crazy to buy real estate.
According to data from the TD Bank, housing prices in Canada from 1980 to 2012 increased at an annual rate of 5.4 per cent, Toronto and Vancouver a full point higher.
The Dow Jones Industrial Average calculates its average annual return for the same time period was 8.9 per cent.
The Toronto Real Estate Board says the average price of a house in 2014 was $566,726, an 8.4 per cent increase from 2013. It adds that “we should not expect current price increases to continue.”
TD concurs, forecasting that over the next couple of decades, real estate should grow three per cent annually, while stocks will grow seven per cent. What should you invest in? Duh. THE END That should be enough, but come to think of it, 10 lines of common sense arithmetic is not likely to come close to dispelling the most indestructible urban myth of all time.
Robert Shiller, Nobel Laureate and author of the classic analysis of behavioural economics, Irrational Exuberance, has determined that going back to 1890, U.S. housing prices have risen faster than inflation only twice. Once in the generational boom after the Second World War and again only in the runup to the sub-prime mortgage crisis of 2008. To which we may now add, price levels in Toronto and Vancouver the last few years.
Otherwise, the rate of return, in real dollars adjusted for inflation is with extremely rare exceptions, zero.
On the other hand, in The Apprenticeship of Duddy Kravitz, Duddy’s grandfather advises, “A man without land is nothing.”
As Canadians pile up record debt levels to get into the housing market, they are apparently subscribing to Zayde’s Nineteenth Century Shtetl School Investment Strategy. Shiller, and others are working to figure out why the bias to ownership persists in the face of a growing body of overwhelming evidence. “Irrational exuberance” is how former Federal Reserve Chair Alan Greenspan described the stock market’s self-destructive, lemming-like behaviour in the dot-com bubble at the turn of the century. Shiller applies it to the real estate market driven by cultural and psychic motivations that transcend traditional economic explanation.
He uses the simple example of a house sold in 2005 for 10 times its 1945 purchase price as a symptom of so-called “recency bias.”
“Simple return from such a transaction is 900 per cent. In addition, the claim of selling for 10 times more appears impressive. However, this transaction yields a real annualized return of less than one per cent, before factoring in operating costs.” Those operating costs, such as taxes, maintenance, repairs, and in Canada’s case, mortgage interest, can add up to hundreds of thousands of dollars, leaving the Canadian dream home a money-losing proposition, painted in several coats of red ink.
Yet, as Shiller notes, “the widely held impression that single family homes have historically shown high real capital gains, when in fact, over the last century, the gains overall have been only nominal and hence illusory (and) can only be explained by using other social sciences like psychology.”
With data like that, why are people incurring Franken-mortgages and crawling over broken glass to buy? Shiller’s answer, simply put, is that they’re crazy. Whether it’s tulip bulbs in Holland in 1637, dotcom stocks in Silicon Valley in 2000 or homes in Toronto in 2015, people are terrified of not having one, whether they need it or not.
Homeowners angrily deny this. “It’s a good place to park your money,” is one comeback. “Better than throwing money away on rent.” Both seem wise observations. Except if they ever actually sat down and did the math, they would choke. And they never have. They just repeat the accepted wisdom.
Just take a look. As simple as possible, leaving out details such as reinvesting dividends, estimates of growth in property taxes or even having a mortgage subject to rate hikes (which frankly only make the case for owning look even worse).
This is not the work of a Nobel laureate but of a freelance writer on Moneychimp. com, so if he can figure it out …
Put $400,000 each into A) a house and B) a stock portfolio while renting.
TD forecasts an annual growth rate of three per cent for housing, well above the historic rate. So after 25 years, it’s worth $837,511. More than double, congrats. But the Bank of Canada forecasts inflation at two per cent, so in real dollars, it’s down to $656,242, a net ROI of 2.6 per cent. Not great. But wait. Assume operating costs even at estimates ridiculously low by Toronto or Vancouver standards. Fees and taxes of $5,000 per year, as well as maintenance and repairs of $7,000 and the net worth becomes $356,242, a net loss of almost $44,000.
As a columnist at The Week recently observed: “If medianincome people borrowed hundreds of thousands of dollars to speculate on the price 30 years hence of a single, highly illiquid asset that wasn’t a house, they would be called financially insane.”
As for throwing it away on rent, your down payment invested in the market (at a conservative five per cent return) gets you about $1.34 million, call it $1.25 million after fees. Another $181,000 is eaten by inflation. Even at an average rent of $2,000 per month, the cost over 25 years would be $600,000 leaving $469,000. You do the math.
Shiller does concede there are “implicit dividends” to ownership that can’t be measured. “There is no way to put a dollar figure on the psychic benefit one gets by owning and living in one’s own home.” But then, he argues, it becomes not an investment or even a good place to park your dough, but the consumption of a luxury good, which should be left to those who can afford it.
But recent research in British Columbia and elsewhere has found there are diminishing returns to those psychic benefits as prices mount and the lifestyle sacrifices necessary to meet mortgage and other costs keep mounting.
“People are making so many trade-offs in order to have that home,” according to, associate professor of psychology at the University of British Columbia, Elizabeth Dunn, who studies consumerism and happiness. She finds that people are highly unlikely to admit any fault in past decisions. They are, in fact, even more convinced buying a house is the only way to go. Like a reformed smoker, they are militantly evangelical.
It could well be that people are happier spending on vacations and lifestyle than being house-rich, cash-poor. Or worse still, they could further erode their dismal rates of return by taking on lines of credit to try to have their cake and eat it, too.
The important thing is not to be critical of people for their investment decisions but rather to correct a dangerous economic distortion. Real estate is a huge business, bigger even than oil and gas. Do we want a significant portion of our GDP dependent on fundamentals that a Nobel laureate has called “illusory?”
Have you ever heard a bank manager or real estate agent say, “You know, at these prices, you may want to hold off and rent till you grow your down payment?” Not bloody likely. They make billions selling people mortgages and products they would be better off without. They are no better than Big Pharma or Big Tobacco. Call them Big Mortgage. They are enabling addictions that, left uncorrected, are well known for leading to catastrophic outcomes.
Operating costs alone can add up to hundreds of thousands of dollars, leaving the Canadian dream home a money-losing proposition