As a curious investment adviser, I’m always looking for assets that will provide long-term rates of return that get my clients from A to B without exposing them to excessive risk. That doesn’t mean we chase the asset class that did the best last year. In fact, quite the contrary. But when comparing the relative performance of your investments, making sure you do so on a level playing field is crucial to getting the real information you may be looking for.
I frequently hear about how owning direct real estate, especially in Metro Vancouver, is a "no brainer" investment, for even the least-sophisticated investor. But despite an incredible environment for real estate over the last 10 years, it has actually underperformed highly liquid U.S. stocks. And, when you consider the true costs of ownership, onerous tenant needs and potential for illiquidity, you may think twice about an over-concentration in this class.
One difference between stocks and real estate is that stock prices are readily observable, and as a result we are often tempted into being more transactional.
But what if we treated our public securities as longer-term assets – specifically, how might the performance of owning Metro Vancouver real estate compare with that of the S&P 500 over the last 10 years?
Before we get into this, let me be clear on a few points:
1. I am a believer in diversifying your investible asset base across a number of asset classes, including real estate. So far, it’s one of the few asset classes I have found where tenants spend their own money to improve your asset and then agree to rent it back from you (wow!)
2. Complexity makes comparing returns tricky. Assumptions from credible sources are needed to reach a fair comparison.
3. Past performance does not guarantee future returns. It has been an exceptional time for both U.S. stocks and Metro Vancouver real estate, and a degree of caution is warranted.
We have used the S&P 500 Total Return Index (in U.S. dollars) as a proxy for U.S. stocks. “Total return” means the index assumes your dividends are reinvested back into the companies you invested in. This index has returned an impressive 15.9 per cent compounded annually from March of 2009 to March of 2019. That’s like turning $1 million into $4.4 million over 10 years!
In comparison, the price of a typical Metro Vancouver apartment has grown from $326,200 to $656,900 over 10 years. Accounting for average rental incomes of $1,348 per month, average property taxes of $1,500 per year, average maintenance fees of $340 per month, compound annual returns would have been 9.8 per cent over the same period. Similarly, the price of a single-family property in Metro Vancouver has increased from $692,400 to $1,441,000. Accounting for average rental incomes of $3,370 per month, average property taxes of $3,241 per year and average maintenance fees of $850 per month, compound annual returns would have been 10.5 per cent.
These returns also assume an investor reinvested their pre-tax free cash flow from excess rent at a healthy 10 per cent compounded annually.
For simplicity's sake, I ignored transaction costs, investment advisory fees, property management fees, property sales commissions and personal or corporate taxes. Note that these returns are historical and future returns, of course, cannot be guaranteed.
Now I can’t think of a better 10-year period for U.S. stocks, so I am not surprised by these results. But I also recognize that March 2009 just happened to be the end of the financial crisis and public markets were depressed – perhaps overly so.
To be fair, I also calculated the results as of January 2005 before the U.S. market corrected (just over 14 years ago), which is as far back as far as the Canadian Real Estate Association real estate data would allow. In that instance, real estate did outperform the S&P 500, but only marginally.
It’s been a remarkable time for both of these asset classes and I would caution you if you are expecting these returns to continue. However, I am confident you are now armed with the facts the next time your sister-in-law is boasting about how much she made in Metro Vancouver real estate.
Jeff Boomer is an investment adviser with RBC Dominion Securities Inc. (a member of the Canadian Investor Protection Fund). The information in this article is not investment advice and should only be used in conjunction with a discussion with a qualified investment adviser. This will ensure that your own circumstances have been properly considered and that any action that is taken is upon the latest available information.