Portfolio manager, analyst and author Mebane Faber recently made a statement that is sure to strike fear into the hearts of Canadian homeowners. "The biggest surprise to individual investors I chat with is that historically, and broadly, after inflation, housing appreciation is zero."
How can this be? Canadian gross domestic product growth has been tepid in recent years while low interest rates sent home prices skyrocketing.
Mr. Faber's theory only holds in an "all things being equal" sense and, for Canadians, a rising population and gross domestic product growth are factors that create housing price appreciation.
But the charts, with help from Ben Rabidoux of North Cove Advisors, highlight the importance of inflation in determining the relative merits of housing versus equity market investment.
Since June 1998, the average annual growth in domestic home prices has averaged 6.1 per cent, if inflation is not considered. Adjusted for inflation, the growth rate is 4 per cent annually.
1983-1998: Equities outperform home prices
SOURCE: Scott Barlow/Bloomberg
The 2 percentage point difference between the two growth rates doesn't sound like a lot but, it has a massive effect when we start talking dollar amounts over time. The average $300,000 home bought in 1998 would be worth $733,800 now. But, once inflation is taken into account, the same home is worth about $541,400. In other words, inflation accounted for over $190,000 of the dollar appreciation in the example.
The success of real estate versus equity investing is cyclical. The period from 1998 to the present included two huge blow-ups in equity markets – the tech bubble and the financial crisis – and real estate handily outperformed equities. It's completely understandable that Canadians have increasingly allocated assets into the rising real estate market.
But it wasn't always that way. In the 15 years prior to 1998, housing prices barely moved in inflation-adjusted terms. Equities, despite the crash of 1987 and North American recession conditions in the early 1990s, generated far better returns for the period.
1998 to 2014: Home prices outperform equities
SOURCE: Scott Barlow/Bloomberg
From 1983 to 1998, the average after-inflation appreciation of a Canadian home was 1.6 per cent per year. For equity markets, the annual inflation-adjusted return was 4.4 per cent. For a $100,000 investment, the dollar difference was just under $65,000 for the period.
The rally in Canadian home prices may end next month, or three years from now. But after 15 years of steady outperformance driven by declining interest rates, it likely won't be long until equities will retake the performance leadership after inflation is taken into account.
Follow Scott Barlow on Twitter @SBarlow_ROB.