How to start an instant argument: Question whether homes are an investment.
That's what last week's column did, and the response was intense. It shows how deeply people believe that, more than a place to live, a house is an investment that builds wealth. Further discussion is definitely required.
The point of last week's Portfolio Strategy column was to make a case that while houses may be a wonderful place to live and raise a family, they're not a home-run investment. Supporting this argument were data showing that the Canadian stock market has delivered better returns over the past 10, 20 and 30 years than housing.
Readers raised several points about these numbers that are worth exploring:
1. The impact of taxes
Provided your home is your principal residence, you'll pay no taxes on your gains when you sell. The only other investment vehicle shielded permanently from income tax is the tax-free savings account. Wouldn't houses enjoy a big advantage over investing, then?
Over the long term, possibly. But last week's column threw out the idea of young prospective home buyers sitting out the next five years, a period in which some experts see house prices declining. The plan: Rent and invest the money saved by not owning a home. A case was presented where, if we assume investment gains of 6 per cent annually, the five years of renting and investing would build more wealth than a housing market that moves up or down slightly or remains flat.
Here's why taxes are not much of a factor over this five-year period. For one thing, a couple would have $62,000 in combined cumulative contribution room in tax-free savings accounts, provided they hadn't yet used TFSAs (annual contribution amounts were $5,000 for 2009-12 and $5,500 for 2013 and 2014). Also, they could shelter even more money from taxes by contributing to registered retirement savings plans and then withdrawing up to $25,000 each from the federal Home Buyers' Plan. Taxes must be paid on regular RRSP withdrawals, but not money taken out through the HBP (it has to be repaid to the RRSP over time).
Long term, taxes must come into play in any comparison of stocks versus homes. But what a lot of people forget is that the cost of maintaining and improving a home undercuts your wealth gains in a way that's similar to taxes (and fees) on investments.
2. Some housing markets are hotter than others.
Resale homes across the country averaged gains of 5.4 per cent annually over the past 10 years, while the total return on stocks (share price gains plus dividends) averaged 8 per cent. A couple of Toronto readers said these numbers underplayed the gains they've had in their homes.
Below, you'll find numbers showing that Toronto has in fact trailed the average marginally over the past decade. Vancouver and Calgary are the outperformers. Joining Toronto with below-average gains were Halifax and Montreal.
The word "leverage" is an investing term that refers to borrowed money and its ability to magnify gains and losses. Some readers thought the gains from housing in last week's column were underplayed because leverage wasn't considered.
Here's a simple example of how leverage works: You buy a $400,000 house with 5 per cent down and the price increases by 10 per cent. In other words, you've put down $20,000 to buy a house that you can sell at $440,000. Even after paying off your mortgage, you've dramatically increased your investment thanks to leverage.
Mortgage interest, real estate fees and other costs associated with both buying and selling the house would reduce this leveraged gain considerably, but you get the point. Borrowing to buy a house that goes up in value boosts your gains a lot.
Just the opposite is true, of course. If the $400,000 house you bought with a 5-per-cent down payment falls by 10 per cent in price to $360,000, you'd be in a tough spot if forced to sell. Your down payment money would be gone and, depending on how much principal you've paid down, you might have to come up with some extra cash to pay off your mortgage.
4. Human frailty vs. the forced savings plan
Some people doubt that renters would have the discipline to invest the considerable amount of money they save by not owning a house. Home ownership, they say, is a forced savings plan.
In fact, the financially irresponsible behaviour people attribute to renters is endemic among homeowners. Financially handcuffed by their homes, owners may dip into their home equity lines of credit to supplement their salaries and neglect their retirement savings.
Blame our expensive housing market for this, not the concept of home ownership. Unless they're big earners, today's first-time buyers will have trouble balancing home and savings obligations. The struggle only gets worse when cars and kids are added to the mix. Bottom line, the financial well-being of homeowners is a serious concern.
5. Stocks may beat houses, but how relevant is that to real-world investors?
Quite correctly, some readers said it's common for investment returns in the real world to fall below what the stock markets make. Fees and commissions cut into returns, as do bad decisions on when to buy and sell.
Still, there are many widely available balanced mutual funds that have surpassed the housing market on a long-term basis, even after fees. I offered to list a few of them last week, and a few people asked me to follow up.
To give housing an extra fair shake, funds were benchmarked against the full 10-year average price gain of 5.4 per cent. A case could be made for reducing this gain by roughly two percentage points to reflect the average annual cost of owning and maintaining a house over the years (including utilities).
Check out the accompanying chart – plenty of choices from all corners of the fund world have beat housing in the past decade.
Housing: A National Perspective
Nationally, resale housing prices averaged a gain of 5.4 per cent over the past 10 years. Here's how selected cities across the country did. Percentages are 10-year annualized gain.
The stock market (S&P/TSX composite total return): 8%
Source: Canadian Real Estate Association
Editor's note: In an earlier version of this article, an incorrect figure was given for a couple's combined cumulative contribution room in tax-free savings accounts, provided they had not yet used TFSAs. The correct figure is $62,000.
Globe app users view the table of balanced funds that beat the housing market.