Everyone and their uncle seem to have a strong but differing opinion on whether it’s worth investing in real estate or the stock market. With each person comes a different view on which “hot” market will win big and be the catalyst of your financial future. Although everyone has their own opinion, it’s important to base your decisions on facts and not personal experience. 

I recently got into a conversation with a family member in the real estate business who was considering getting out of the stock market entirely due to their perceived notion that they were getting a lesser rate of return. Through my financial knowledge and work in the industry, I had opposing views; however, I knew that they were incomplete and potentially biased. 

I knew that my parents’ generation had done tremendously well investing in real estate in Canada; however, were previous generations so lucky? What is the outlook for the future? Surely, we can’t keep seeing the same returns, given that my whole generation is getting priced out of the market. 

After this conversation, I decided to seek answers to the question myself – is one market better than the other? And when is either one more appropriate? 

First, I felt it was important to look at a historical breakdown of the returns going back several generations. 

What is the historical rate of return in the stock market?

Although there is an infinite amount of financial investment tools to analyze, to get a picture of the overall market performance, I looked at the annual returns of the S&P 500. The S&P 500 incorporates 500 of the US’s largest companies – and has since 1926. It represents a comprehensive picture of the stock market and the overall economy. Since formation, it has returned 7% (adjusted for inflation) on average annually, and over the last ten years, it has returned 13.5% annually (including dividends, but not accounting for inflation). 

Since no investor can hold stock in the S&P 500, to realize these returns, you need to invest in an exchange-traded fund (ETF) mirroring the S&P 500. These ETFs track the holdings of the S&P 500 and try to mimic their returns. If investors want their money to perform at the same rate as the market, they can invest in these ETFs for a fee called the ‘Management Expense Ratio’ (MER). An example of such an ETF is the SPDR S&P 500 (ticker SPY) with a MER of 0.09% annually. You deduct this cost from the overall returns.

Although these average returns represent a favourable picture for the stock market, it is essential to note that most investors don’t realize these returns in full due to volatility, fees, and inadequate due diligence when selecting investments. 

What is the historical rate of return in the Canadian real estate market? 

It is no hidden secret that Canadian housing prices have soared in the last 20 years. To buy a home in the Greater Toronto Area in 2019 would cost you roughly $850,000, up 140% from approximately $350,000 in 2000. This example is similar to my parents’ situation who purchased our semi-detached family home in central Toronto a little over twenty years ago for $200,000. Its current value is now over $1.2M. On the one hand, I’m happy that they were able to realize these returns, but on the other, I’m sad knowing that I will likely not be able to raise a family in the city I grew up in. 

Across the country, appreciating real estate values were seen over the same period, though to a lesser extent, with National housing prices rising 87% in real terms between 2005 and 2016. That is an increase of 7.25% annually. These returns are slightly above the 7% average annual return since inception of the S&P 500, but less than the performance seen over the last ten years. 

These crazy real estate prices were not always the case in Canada. As  ‘Figure 1 – Canadian Residential Real Estate Prices’ shows, prices grew steadily between 1980 to 2000 with two lengthy plateaus during the ’80s and ‘90s with housing prices averaging $75,000 and $150,000. Although that is a 100% increase over the 20 years, it is still very little compared to the 333% increase over the last 20 years, with an average home price now sitting at $500,000.

What does this data mean to us today?

From this data, we can conclude that both have done similarly very well over the last ten years, but I think it would shock people to know that Canadian real estate returns have underperformed the S&P 500. 

Psychologically, people remember negative events more than positive ones. In other words, losing $100 generates more powerful emotions than gaining $100. Real estate may be viewed more favourably due to this phenomenon since, unlike the stock market, you are unable to see the value of your home go up and down every day. 

I believe that both the stock market and real estate market serve a purpose; however, as a millennial dealing with unrealistic housing prices, it’s nice to know that I’m not jeopardizing my financial future by continuing to rent and investing my savings in the stock market. 

What are the pros and cons of each investment opportunity?

Before you invest, it’s important to evaluate more than just historical returns. As I mentioned before, both markets serve a purpose and help you reach your financial goals. 

Where you choose to invest your money depends on the amount you have, your risk tolerance, whether you need quick access to the money, and the amount of time and energy you are willing to put in.

For a breakdown of these differences, here are the pros and cons to both options: 

Investing in the Stock Market
PROS
Capital Requirements:	A significant benefit to investing in the stock market is how little money you need to get started. If you have a brokerage account, you can invest in the stock market with as little as $1.00. This is not, however, considering potential commission fees and administrative fees of holding the account.
Low Maintenance:	If you plan to invest long-term with a passive approach, meaning that you aren’t trying to outperform the market, you can park your money and not touch it for years until you are ready to use it. In addition to being the easiest approach, data shows that a “buy-and-hold” strategy is the most favourable for returns.
Strong Historical Performance:	Throughout the ups and downs in history, the stock market was still able to rebound and provide favourable average returns for investors. Even with the craziness of 2020, the S&P 500 is miraculously only down 0.47% year-to-date. Although historical performance does not equal future performance, you can feel confident knowing that volatility is only temporary.
Liquidity (Money Accessibility):	You can’t predict the volatility that may be present at the time of withdrawal, but investing in the stock market guarantees your money can be made readily available. For most financial instruments such as stocks, bonds, mutual funds, and ETFs, you can convert your investments into cash in two business days.
CONS
Volatility & Risk:	The stock market has provided favourable average returns; however, year-over-year gains can be highly volatile. For example, the 2008 financial crisis caused returns to be -37.22% for the year. Although the markets have rebounded significantly, earlier this year, we regularly had double-digit drops daily. Due to this volatility, investors need to assess whether they can handle the higher risk and stress compared to other investments.
Taxes:	Although capital gains (the money made from selling a stock higher than the purchase price) are taxed the most favourably compared to other forms of investment income such as dividends and interest, there are still tax implications. Unless your hold your investments within a Tax-Free Savings Account (TFSA), the capital gains on your stock investments are taxed at 50%.

Investing in the Real Estate Market
PROS
Stability:	As you can tell by the chart, with the small exception of the 2008 financial crisis, the Canadian real estate market hasn’t seen a significant drop in decades. When it comes to movements in the stock market and economy, the real estate market is normally the last to be affected, if at all.
Canadian Real Estate Trends:	The upward trends in the real estate market continue to shock investors. No one can know for certain if these trends will continue, but recent history is certainly on their side.
Accommodation:	A fair argument for investing in real estate is the fact that everyone needs accommodation. Unless you live with your parents, you will be paying for it in some form, either through rental payments or mortgage payments. Making monthly payments towards an asset in your name sounds better than paying down your landlords’ mortgage.
Taxes:	Compared to the taxes on capital gains, the gains you make from selling your principal residence are tax-free. Canada has a ‘principal residence tax exemption’ that permits this if the property was your primary residence for every year you owned it.
CONS
Capital Requirements:	Unlike investing in the stock market with as little or as much as you can, investing in real estate is costly, and many Canadians may never have the financial means to enter the market. According to a 2019 KPMG study, nearly half of millennials feel that owning a home is a “pipedream”.
High Maintenance:	Maintaining property as a landlord or as a resident is costly and time-consuming. According to real estate company UpNest, property owners should expect to pay 4% of the value of their home annually on maintenance costs. If you own a $500k home, that’s $20k every year.
Liquidity (Money Accessibility):	Real estate is highly illiquid as an asset, meaning that it’s much harder to convert the value into cash, should you ever need it for emergencies. For this reason, it’s important to leave some of your money in other, more easily accessible forms of investment.

What about Real Estate Investment Trusts (REITs)?

I feel that this article wouldn’t be complete without touching on the investment tool called a REIT. You can view this tool as a combination of the two types of investments. Like any other stock, REITs are listed on a stock exchange for a per-unit purchase price. They grant individuals the ability to invest in real estate by pooling people’s money to buy a wide selection of assets. 

There are different REITs for different real estate properties, such as long-term care facilities, commercial properties, and healthcare facilities, to name a few. Investors of REITs generate income through the scheduled distributions. These distributions include money earned from capital gains, rent, and other income streams that would be involved if you purchased property yourself. They are similar to dividends in that they are scheduled on a monthly or quarterly basis but are taxed differently depending on the breakdown of how the income was earned. 

PROS.

• You are still invested in the real estate market

• Requires little capital to invest

• Low maintenance as you are not a landlord

• Stable cash flows through the distributions

• Liquidity or easy access to money 

CONS.

• Low growth or capital gains opportunity compared to regular stocks

• Distributions are taxed at a higher rate

• Potential for volatility

• Higher management fees 

So, is one truly better than the other? No. Both have different characteristics and can be used simultaneously to meet your financial goals. Real estate should not replace your other investments. They cannot offer the liquidity, retirement savings opportunities, and tax benefits (if you are investing in multiple properties) that financial investment tools can. Also, contrary to popular belief, they have returned more on an average annualized basis. 

This is an important point to make as millennials may feel discouraged or pressured to enter the real estate market too soon. The psychological burden of having a mortgage you can’t afford is not worth the perceived benefits. The stock market can seem daunting, especially given this year, but know that with every downturn in history, the stock market has rebounded and returned more for investors. Continuing to rent until you are ready while investing your savings in the stock market, is one of the best financial decisions you can make.