Next Thirty Years - Real Estate or Equities?

[valueinvestor]

Feel free to let me know if this has been discussed before, but thought I could get some advice in regards to the Toronto Real Estate market or Real Estate in general. I've provided context, but if you want to skip it, feel free to answer the question below. 

 

I live with my parents, and rent an office. Never really cared about owning a home, and performance has been pretty good, where I was able to edge out Toronto Real Estate prices with stocks even with the recent declines of some growth names. Matter of fact, my parent's stock portfolio that's less "risky" managed to also outperformed their own real estate portfolio that's on the outskirts of Toronto, where houses appreciated higher.

 

If you were a young person (mid-twenties) looking to compound at high rates, what would you do? Divest some of your equities for real estate? Would you dabble in Canadian real estate? Would you look abroad? I was looking at Arizona, Florida, Cleveland, Rochester (NY), Detroit (MI), and more. 

 

I'm slightly interested because with real estate, one has access to tax (depreciation) and low-interest leverage advantages versus equities. However I have a hard time divesting, as I think there is a real opportunity to make money by just holding. As I don't think returns will be as stellar with Toronto real estate and even if I underperform slightly, I rather have that - then spend time maintaining a property or deal with tenants. 

 

My long term goal is to compound at high sustainable rates but so far, my assets are my tiny stock portfolio and tech business. However, my business also has an opportunity to get a 100% LTV through the owner-occupied commercial real estate loan, but I'm not sure if I want to put cash-flow towards real estate versus investing in the business and monetizing sometime later. Commercial rents, as you could imagine has been really dirt cheap at one point, and I was able to lock-in a good lease agreement with very low penalty for breaking it. 

 

My conclusion thus far is if I'm going to purchase a home, it should just be a home rather than an investment. I hear stories with mortgage brokers in Toronto, and the underwriting standards despite the higher "stress-test" for new mortgage applicants, however that's anecdotal. 

 

TLDR. I guess my question is if you just want to compound at high-rates for the next thirty years, where would you be looking? I'm flexible. It can be bonds, currency, art, crypto, NFT, etc. I'm also happy to work with very volatile investments that can produce large mark-to-market declines, as my needs are very little at this point.

[Gregmal]

I think it depends and the largest factor is whether or not you expect to have consistent, investable cash flow from your job/business? If you just have a lump sum type portfolio cash, I dunno. But if you expect to earn decently for the next 5-10 years plus….just do a little bit of everything. 
 

Real estate privately owned is not really comparable to stocks. The financing and optionality IMO make it a different animal. For instance in my mid 20s I got into my first investment property. Bought it for $135k. Rent was $1500 a month. Cash to get in was $35k. 30 year fixed was 4.875%. Tenant sent the check every month. I paid the mortgage. Not a lot to think about or stress about and not having mark to market gives you one less distraction. Today rent is $1900, appraised value is $250k and whenever I want I can either sell or pop out cash with a refi and lower rate mortgage. The only real important action I had to take was writing a check for $35k, once. So it’s a different animal all together. Biggest take away though? I didn’t have to be smart or make savvy moves, but you do have it be in it to win it as they say. Good things happen when you go to the front of the net and the cost of admission was pretty immaterial.
 

With RE too something I’ve found neat is that you can easily pay fair market value or even overpay a little if certain things are working for you. Especially

with rentals super hot right now. Find a property somewhere you may want a vacation home one day, secure it, then rent it off for the time being. If a second home or a retirement home ends up costing you 10% of purchase price plus a few grand a year in write offs, but is fully paid off by your 50s…again, who cares? Well worth it.
 

I’ve also found good opportunity in graded vintage sports cards. A Gretzky OPC, Jordan Fleer, Ruth Goudey, Mantle Bowman or Topps type stuff, pretty solid wagers going forward with long term track records of both demand and appreciation. 
 

Private market equity investments. This too is basically just writing a one time check and then letting the process play out. First one I did was with a bunch of work friends. We made money on a deal and took the proceeds and bought Docusign shares pre IPO. These markets are a lot more liquid than you think and simply

being in pre IPO can get you a good head start on stuff you probably would want to own anyway but would never likely get allocation for. You wanna buy the +40% IPO pop, or be the guy who bought shares with a 6 month lockup 3 years ago?

 

Another thing is, how do you wanna live? Are you a normal dude who wants a decent place, nice car, goes out 3x a week? What’s your monthly figure because if you expect to earn more but wanna live high on the hog, saving and compounding will be a lot harder than if you just live like a normal upper middle class fella. 

 

Otherwise, it’s really just about doing what you’re comfortable with. But give yourself multiple irons in the fire and look for different types of investments because you always kind of wanna have something working for you.

[Spekulatius]

For Canadians, I would stick with stocks or buy real estate in the US. Canada  residential real estate is clearly a bubble and sooner or later, there going to be a price to pay. Compared to Canadian RE, the US is downright cheap.

Edited January 17, 2022 by Spekulatius

[Canalyst]

As Gregmal alluded to, I believe the real attraction to RE is that there are few (maybe none) places where man-off-the-street can get 4x leverage at close to prime rates. This can lead to tremendous compounding, but also occasional disaster. If you are earning and saving, it's hard not to make a case for REITs where you can be buying across a cycle without sacrificing liquidity. You can even simulate the leverage through moderate use of margin or ITM options. Of course, you don't get the tax advantages of direct RE ownership, but I think those are relatively expensive when you consider the headache of being a sub-scale landlord. 

[tay9]

I’m rather new to the investing game, but I imagine that given your age and the number of productive years ahead of you, investing in your career or business will probably be the best payout in the long run.

 

Dabbling in multiple asset classes might be a good learning experience, but I’d argue that finding an area where you can develop an advantage and crushing it would probably give you the best returns.

Opportunistically diversifying into investments outside your core field could also be useful, but I would only target those if you see a fat pitch, or want build competency in that field. Building the muscle to being opportunistic is key here. I think building enough knowledge to being good at spotting opportunities is all you need to make outsized returns.

 

But I guess take everything I say with a grain of salt. This is just what I’ve observed and I’m still trying to get to that point after  a late start in life.

[scorpioncapital]

without hesitation foreign RE. In canada you cannot get a 20-30 year mortgage easily (as far as I know). Yet in many countries a foreigner can get a fixed 20-30 year mortgage and that is a bargain. Especially in Europe for example.

[Gregmal]

I’d also add that at a younger age I would definitely focus more on acquiring good assets than beating the s&p or whatever. Almost everyone fixates, sometimes to a debilitating degree, on what the index is doing. Who cares? If you compound at 50-100% on $50k for a few years in your 20s does it even matter in your 50s when you have $5m? Vs if you have $100k in your 30s but do a mere 10% annually, are you ever really gonna get anywhere? Certainly not fast. 

 

Everyone has a different “number”. If you’re a normal person it’s probably 65. If you’re middle class ish it’s probably a million bucks or two. If you’re coastal blue state it’s like $5m and if you’re finance world it’s “more”. But get yourself figured out with regard to that, and then start building. Once you build your foundation and bridges to get there, you’ll be a lot clearer on what and how you want to invest. 
 

But generally speaking, if you’re normal upper middle class and your goal is to amass $2.5m by 55 and by 30 you have two good properties you put a mere $50k into(each, 10% down), after making the down payment and signing the mortgage you do the landlord thing which on a good property is pretty easy; those half million dollar properties don’t even have to appreciate…..but by mid 50s you’d have 40% of that $2.5, and a nearly paid off mortgage and good source of cash flow. There’s few things that offer the simplicity and assurance of that.
 

People will argue the stock market, and maybe that’s true….but you have to stay on top of the market. Additionally, everyone says we are in a bubble. One thing I love to shit on is when people make future index projections. You just don’t know. And if you’re willing to put the time into the market, why on earth would you buy an index? Of course people will say “it’s easy to invest in a bull market” but I almost always throw that type of thought away because those same people when harping on what s obvious in hindsite(obviously the market went up recently!) are totally befuddled when you then ask them to predict where the market goes from here. You’ll either get a noncommittal type of IDK or some projection about how the market has to produce very low returns from here. So it s like “ok, you shit on people for making money because it’s a bull market although you were probably underweight the whole time yourself but then going forward are underweight because you don’t have the confidence to invest and then two years from now when the market has ripped you’ll again revert back to “easy in a bull market” LOL…make sense? Nope! So I think with the stock market just leave it be, ignore the indexes, and again, just look for good assets and compelling opportunities. If they happen to be in the form of stocks then take a shot. If not, don’t sweat it. 

[Spooky]

4 hours ago, Spekulatius said:

For Canadians, I would stick with stocks or buy real estate in the US. Canada  residential real estate is clearly a bubble and sooner or later, there going to be a price to pay. Compared to Canadian RE, the US is downright cheap.

 

Agree with Spek 100%. I'm in Toronto and have been looking at buying a house and the value proposition just isn't there compared to the US. The dynamics here are that people are just borrowing larger and larger sums to buy houses since there is an attitude that you need to own a house no matter what. It seems like a mania to me. We looked at one semi-detached house that was West of High Park and it had 15 offers and went for nearly $500k over asking. People are just valuing houses based on comparables so if someone overpays that becomes the new comparable. If you buy a house here you are also taking on the interest rate risk because you can only lock in a fixed rate for 5 years. 30 year fixed rate mortgages are not available like they are in the US.

 

Personally, I think stocks are the way to go if you are looking to compound your wealth over a 30 year period. If you look at the historical performance of the TSX with dividends reinvested over the prior 30 year period it has crushed the Toronto housing market by like 4x (it's been a while since I ran this analysis so it might be somewhat different now). If you buy a house you are buying a depreciating asset (other than the slice attributable to land) whose top line revenue (rent) should logically only grow at the rate of inflation. If you buy a good stock, it will reinvest retained earnings into the business and increase its earning power over time at a higher rate than inflation. As others have pointed out the benefit of buying a house is the easy access to leverage but you could always replicate this in a stock portfolio through margin or options.

 

I think the picture changes if you are looking at US real estate since it is actually still pretty cheap compared to Canada / Western Europe and you can lock in the 30 year fixed rate mortgage. This McKinsey study was pretty interesting:

 

https://www.mckinsey.com/industries/financial-services/our-insights/the-rise-and-rise-of-the-global-balance-sheet-how-productively-are-we-using-our-wealth

 

Particularly this chart which has the US at the bottom (they are saying real estate is 2/3rds of net worth):

 

 

 

Edited January 17, 2022 by Spooky
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[Minseok]

Im in the greater toronto area (gta) and I agree with Gregmal that depending on your cashflow situation, you should do both, especially to take advantage of the tax situation.

 

I am sure COBF members need no finanical advice in this matter, but talking to myself out loud, I consider real estate as any other stock ticker. Its got ROE/ROIC ( how much did you put down against expected capital appreciation and income) which varies with leverage and interest. Unless you are investing in debt free companies , companies are highly leveraged these days anyways so compare your Real Estate ROE to your favourite ticker.

 

I like the following aspects to canada’s tax situation with RE. Principal residence is capital gains exempt, and investment property is tax deferred until the day you sell. But the equity can be withdrawn tax free through home equity line of credit. This makes sure your leverage ratio is maintained at 20% for maximum ROE, and the withdrawn equity can be borrowed at 1.5% tax deductable interest rate to invest in canadian blue chip dividend stocks yielding 3-5% which is then taxed at reduced rates due to its eligibility for dividend tax credit.

 

Now about investing in Toronto, i calculate my ROE to be in the tweens assuming a 5% appreciation per year. I dont know if i can beat that easily by investing stocks. The million dollar question here is will real estate appreciate 5% per year.

 

I do think so. Only 25% of homes are mortgaged, (most of my boomer parent genration who are large chunk of home ownershave bought real estate 20 years ago when you could have bout a house with 2-3 year salaries, and their descendants, the millenials are accepting large gifts straight out of the parent’s equity.) Among those mortgages, most of the low rate variant were signed in the last year or two. 
1. if interest rates go up, borrowers are already qualified to pay up to 5.25% due to stress test requirement, and among those who got in more than a years ago are paying 3% anyways so rate hike risk is minimal. There is no credit risk when market is awash in cash and subprime is non existant.

2. There is a signifiant shortage of hosing in toronto. Of the annual 400,000 increase in number of people, construction workers and trades men capacity can build to satisfy something like 100,000 per year. Permit red tape and tax on development only hinders the rate of construction further. Pre construction condo prices in downtown toronto went up from 500,000 to 700,000 in the last 4-5 years but builder profit margins have remained same due to rising cost in labour and development/permit taxes and land prices. The market effect is that new homes/ condos are much more expensive than resale despite having to wait several years for completion

3. Immigration is only going to increase post covid. And canada does not take poor immigrants. I asked an iranian friend how immigrants afford toronto real estate and he says prices back home, you could sell and apartment in Tehran and buy a single detached here easily. Money comes from half corrupt tax free countries in the middle east or China.

4. Toronto has become the educational institution for

rich immigrant families. post secondaries have taken dramatic increase in tuition and enrollmemt and have benefitted greatly. There are families who buy homes in the suburbs here just to send their kids to good highschools. And there are many good highschools here.

 

5. Past trends dont predict the future but compared to the 7% annual increase in last 20 years, 5% annual is conservative considering the unique economic situation today.

Edited January 17, 2022 by Minseok

[Xerxes]

My simplistic view is that you need to own your own real estate. The equity that you built in it is your "central bank reserve". The price will always look expensive, it certainly did to me when I bought my first in 2011. If Toronto or Vancouver look inflated, then you have Montreal, that will always trade at a discount because of the perception that Quebec is about to separate.

 

Now once the first property is bought, anything additional as investment in real estate can be contrasted with other alternative (stocks etc.) and arrayed against the cost of capital. But you need to get that first real-estate as residence, not only for the passive equity that you built but also the steep learning curve that it will make you go through.

 

How could one seriously consider in building real estate as investment, if one never "went through it" with one' own personal experience. This matter because unlike stocks that you can "average in" over many years thereby taking advantage of different prices, real estate's purchase price is a snapshot that once signed, is seared and set in stone forever. Your own lever after that is your mortgage rate.

 

[Minseok]

One aspect that muddies RE and stock comparisons is that stocks dont usually trade at book value. But recent accounting changes to report mark-to-market earnings levels the comparison somewhat.

 

So marking your real estate “book” to market value may have its fair share of counter arguments. Counting market appreciation as “returns” could also be an issue.

[Spekulatius]

I would always run a DCF model when buying RE. That will tell you a lot about the assumptions to make it work. In the past RE has worked even if the DCF didn't because of multiple expansion (lower cap rates) but I think it's an iffy factor to rely on.

[Morgan]

4 hours ago, Canalyst said:

As Gregmal alluded to, I believe the real attraction to RE is that there are few (maybe none) places where man-off-the-street can get 4x leverage at close to prime rates. This can lead to tremendous compounding, but also occasional disaster. If you are earning and saving, it's hard not to make a case for REITs where you can be buying across a cycle without sacrificing liquidity. You can even simulate the leverage through moderate use of margin or ITM options. Of course, you don't get the tax advantages of direct RE ownership, but I think those are relatively expensive when you consider the headache of being a sub-scale landlord. 

 

Agreed, real estate gives a normal person access to (hopefully) safe leverage, and most importantly tons of control. There are so many ways to turn around a failing property. If you own stock, you can buy a good company, the market doesn't like and it crashes. If you add margin or options you can really lose it all real fast. Not to mention you have basically zero control. 

 

That being said, it is time consuming to manage your own properties. 

[maplevalue]

I would agree on the comments of it depending on your expected future cash flow. If you have a stable-ish job, and expect to be paid uninterrupted for a decade or so, and are happy living in the same place it probably makes sense to own real estate. In Canada the first 5 years you will have a mortgage of 2%, and inflation will be 2%, so you are effectively borrowing 'for free'.

 

There would be two other considerations I might point out taking money from equities to real estate.

 

i) Future taxation - In Canada I just cannot see how real estate does not get taxed more heavily in the future, especially at the high end (what could be more politically appealing in a left leaning country like Canada than a mansion tax!). Governments are massively in debt and have to pay for baby boomer healthcare somehow. One of the things higher prices have done is increase the proportion of renters in society, particularly in the GTA, so the political opposition to increased property taxes is probably less than in the past. 

 

ii) Correlation with the 'everything bubble': At least with equities, particularly if you take a value approach, you can construct a portfolio that can perform decently even in adverse market/economic conditions. With real estate you are praying that the QE induced asset price inflation we have seen over the past decade continues into the future. In the event that monetary policy is forced to becomes more significantly more restrictive the value of your real estate will become exceptionally sensitive to the whims of a bunch of PhD bureaucrats at the Fed/BoC. So you want to make a determination how comfortable you are with that.

[Minseok]

1 hour ago, Spekulatius said:

I would always run a DCF model when buying RE. That will tell you a lot about the assumptions to make it work. In the past RE has worked even if the DCF didn't because of multiple expansion (lower cap rates) but I think it's an iffy factor to rely on.

But what if you constantly liquidate your appreciation with a home equity line? It can be considered psudo cash as long as we can assume no long term permanent lost of market value in real estate.

[RichardGibbons]

58 minutes ago, maplevalue said:

i) Future taxation - In Canada I just cannot see how real estate does not get taxed more heavily in the future, especially at the high end (what could be more politically appealing in a left leaning country like Canada than a mansion tax!).

 

I think this is right, and that a pretty significant portion of people think that the way to increase real estate affordability in Canada is through punitive taxes on landlords. The general idea seems to be that greedy landlords are inflating the price of housing by buying homes to rent out. If there weren't any landlords, those homes would be available at a cheaper price to buy. And if you ask, "without landlords, where are the renters supposed to live?" the answer generally seems to be "the government should supply affordable housing."

 

(I think this is one of the biggest problems of the Canadian housing bubble--it makes people start to think about discarding the systems that have made the western world prosperous to replace them with systems that have made parts of the eastern world poverty-stricken.)

 

So, I think you're right that real estate investments in Canada have substantial political risk.

[Spekulatius]

22 minutes ago, RichardGibbons said:

 

I think this is right, and that a pretty significant portion of people think that the way to increase real estate affordability in Canada is through punitive taxes on landlords. The general idea seems to be that greedy landlords are inflating the price of housing by buying homes to rent out. If there weren't any landlords, those homes would be available at a cheaper price to buy. And if you ask, "without landlords, where are the renters supposed to live?" the answer generally seems to be "the government should supply affordable housing."

 

(I think this is one of the biggest problems of the Canadian housing bubble--it makes people start to think about discarding the systems that have made the western world prosperous to replace them with systems that have made parts of the eastern world poverty-stricken.)

 

So, I think you're right that real estate investments in Canada have substantial political risk.

Yes, but a levered recap is not cash flow.

 

If you do live in a non-recourse state in the US, you can do the "levered recap hodl". Load up your property under the roof with debt using conforming mortgage and Heloc and keep it 95% levered by continuously refinancing. If property decreases in value substantially, default and live rent free for at least a year until evicted.

 

you may be laughing but that's what some of our acquaintances ended up doing during 2003-2008 although it wasn't the plan to begin with. they even got a few thousand from the bank upon leaving after eviction for the promise not to wreck the house. Sold washer and dryer on ebay when leaving. It's the ultimate heads I win, tails you lose. It's wasn't possible after the GFC for a while but I think you could do it again, albeit probably not to the 95% level, but I think 90% would work. From 2004-2007 you could lever it to ~100% with eager appraisers trying to meet your target and get the job done.

 

They own already another property again so it's not like default prevents you from starting over.

Edited January 17, 2022 by Spekulatius

[Morgan]

2 hours ago, Minseok said:

But what if you constantly liquidate your appreciation with a home equity line? It can be considered psudo cash as long as we can assume no long term permanent lost of market value in real estate.

 

I suppose it is a balance, but I view that as wildly risky compared to having the mortgages paid off. Once the mortgages are paid off, you have so much freedom and ability to withstand an eventual downturn. Not to mention FCFs are higher with no mortgage payments. 

[Gregmal]

8 minutes ago, Morgan said:

 

I suppose it is a balance, but I view that as wildly risky compared to having the mortgages paid off. Once the mortgages are paid off, you have so much freedom and ability to withstand an eventual downturn. Not to mention FCFs are higher with no mortgage payments. 

Yup there’s just so many different avenues of optionality which is part of the appeal to me. I generally try to stagger it. Have some that are maxed on the LTV and some that are getting paid down. Don’t think I’d ever find an advantage in being fully paid off though. 

[gfp]

22 minutes ago, Gregmal said:

...Don’t think I’d ever find an advantage in being fully paid off though. 

 

Oceanfront property you want to self-insure would be the main one I can think of.  I know a few people in hurricane areas on the Atlantic that have self insured for decades.  Can't do that with a mortgage.

[valueinvestor]

Thanks everyone! I didn't have a chance to go through your post, as I didn't want to skim it and respond, as my usual practice. However, I really do appreciate the support! It means a lot! If I had to say what's my best investment - it's spending $25 to be a member of this board. A huge honour!

[bizaro86]

If you're seriously considering buying real estate outside of the Canadian city where you live I'd consider Calgary. 

 

It's cheap compared to most of the US, and VERY, VERY cheap compared to Toronto/Vancouver. When you add oil at $85 the near term picture looks pretty good.

 

Also, if you ever plan to do the "leveraged recap" plan mentioned above mortgages i  Alberta are non-recourse as long as you don't get mortgage insurance. But 20% down in Alberta is probably the same $ value as 5% down in TO.

 

Since you're still in Canada it'll be easier to get a mortgage with your existing banking/credit info.

 

I'm biased (I own quite a bit of Calgary RE) but I also haven't been this excited about the setup for RE here since 2009. 

[Viking]

Looking 30 years into the future my guess is a stock portfolio will exceed (perhaps greatly) the return of a real estate portfolio in Canada IF NO LEVERAGE IS TAKEN INTO CONSIDERATION. If leverage is included, i think it is close enough that both likely make sense largely to get diversification. Prices in Vancouver and Toronto have increased so much the past 20 years they make Peleton at $80 look cheap…. But perhaps real estate in Canada pulls a Tesla and goes to $1,300. As we keep learning in financial markets… anything is possible. For a while (and real estate cycles last decades).
 

From my perspective the key benefit of real estate is leverage… and this has been mentioned a couple of times already. I also subscribe to the Peter Lynch school of getting wealthy… the first thing you should do is buy a primary residence (but he was talking about something that was your home and not strictly an investment). The problem with real estate in most of Canada today (Alberta and Sask excepted?) is there is no margin of safety; it looks to me like the greater fool theory at play except it is not liquid (tough to exit quickly).

 

What i love about stocks is if you are patient you will get a crazy good entry point every couple of years. Like what is happening right now. I only put my very best ideas in my TFSA. But getting wealthy exclusively with stocks is slow and takes 15-20 years (unless you are a Buffett or Druckenmiller). The key is getting your portfolio to the hockey stick part of the compound interest chart. Most people don’t get there so they don’t understand power of compounding year after year after year. They start too late. Or their rate of return is too low. Or they pull money out to spend it.
 

it also depends on what you love. I love stocks/financial markets/economics/politics… always have. Houses have always been a place to live; put simply, i do not love real estate. Good luck! 
 

My experience is if you think long and hard… learn… your brain will figure things out for you (even when you are sleeping). Eventually, a light bulb will go off in your head and it will be clear what you need to do. The next step in the journey. And a couple of years later you will look back with no regrets. 

—————

Every day a new train stops at everyones door. Whether they realize it or not. It is there waiting for them to get on. Don’t let fear rule your life. Be very rational. And don’t be afraid to get on the train (go after the right opportunities). It is crazy where you can get to 15-20 years later.

[maplevalue]

On 1/17/2022 at 1:20 PM, maplevalue said:

i) Future taxation - In Canada I just cannot see how real estate does not get taxed more heavily in the future, especially at the high end (what could be more politically appealing in a left leaning country like Canada than a mansion tax!). Governments are massively in debt and have to pay for baby boomer healthcare somehow. One of the things higher prices have done is increase the proportion of renters in society, particularly in the GTA, so the political opposition to increased property taxes is probably less than in the past. 

 

Candidate who is likely to become Mayor of Toronto announces an extra 1% land transfer tax on homes over $3mm (https://www.oliviachow.ca/more_support_for_people_who_need_it_most).