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Friday, April 4. 2008
Real Estate: Bulls VS Bears Pt2
So in my last blog article, I was talking about this blog article from the Royal Bank (RBC) blog entitled, "Just Give Me Four Walls" where they're talking about how students can get a mortgage. The discussion was about what a great investment housing currently is, and how we can take out mortgages with no down payments. One of the RBC bloggers responded by saying how great real estate was because in the last 10 years, housing value has increased by 65% (or 5.3% per year). I responded that it wasn't that great considering the Canadian stock market in the same amount of time had increased by 296% (or 11.1% per year).
A new guy named Scott decided to counter my arguments:
There were several points that are completely untrue:
A new guy named Scott decided to counter my arguments:
Home ownership is with out a doubt one of the best investments you can make. [...] What I present as my argument for the home ownership is this:
1 - Not only do you have the value of your house increasing over time, providing more cash in your pocket when you sell, but you also have to factor in the money that is not going to rent as savings in your pocket. Sure you dont see it until you sell, but future you will be happy.
2- As for Chris' point about a mutual fund being better, I must argue against that. Yes, investment products such as mutual funds are great, and you should have these as well (consult your local RBC banker for your own tailored plan), however the housing market is no where near as volatile as an index linked fund (find me a year in the last 10 where the average home price has dropped in Canada? The same cannot be said for an index fund). And if you can only afford one option, if you take your hard earned money and put it into that fund, you are still needing to pay for somewhere to live (unless you are ok with your parents basement, thought it does make meeting girls harder)so there goes any profits you could have seen in the way of rental payments to a landlord you probably don't even like.
1 - Not only do you have the value of your house increasing over time, providing more cash in your pocket when you sell, but you also have to factor in the money that is not going to rent as savings in your pocket. Sure you dont see it until you sell, but future you will be happy.
2- As for Chris' point about a mutual fund being better, I must argue against that. Yes, investment products such as mutual funds are great, and you should have these as well (consult your local RBC banker for your own tailored plan), however the housing market is no where near as volatile as an index linked fund (find me a year in the last 10 where the average home price has dropped in Canada? The same cannot be said for an index fund). And if you can only afford one option, if you take your hard earned money and put it into that fund, you are still needing to pay for somewhere to live (unless you are ok with your parents basement, thought it does make meeting girls harder)so there goes any profits you could have seen in the way of rental payments to a landlord you probably don't even like.
There were several points that are completely untrue:
- The housing market is no where near as volatile as the stock market.
- Home ownership is the best investment you can make.
- The average home price has not dropped in the last 10 years.
Myron:
Scott, a few points. You're omitting key differences between real estate and other investments: housing is much less liquid than stocks and the people in the real estate market are far more leveraged than those trading stocks, not to mention the emotional investment made in homes. When a slowing of the real estate market occurs, people are typically slow to realize it and once inventory builds up to a certain level, it becomes very difficult to sell very quickly. And having borrowed hundreds of thousands of dollars to "invest" in a house, the losses tend to be severe. You only have to look at past or even current housing crashes to know that.
This just follows intuition. To the vast majority of Canadians, houses are roofs over their heads first, investments second. People often can't pick when they sell. Even you admitted you got lucky because you had to relocate at a time the market was up.
As for the Canadian real estate market being somehow impervious to downturns--are you serious? Real estate is just a slower market, things don't turn on a dime quite like stocks do. It is still a volatile market, though, only on a different scale. Take a look, for example, at Shiller's house price index:
Note the current boom ended not long after this graph was created and so the downward crash in the USA isn't shown here.
Now compare to the DOW.
You tell me which is more volatile.
If you narrow your scope to just the last boom in real estate, then of course housing looks great. But given the long term nature of people's housing investments, this is just blatantly ignorant of past lessons learned.
This just follows intuition. To the vast majority of Canadians, houses are roofs over their heads first, investments second. People often can't pick when they sell. Even you admitted you got lucky because you had to relocate at a time the market was up.
As for the Canadian real estate market being somehow impervious to downturns--are you serious? Real estate is just a slower market, things don't turn on a dime quite like stocks do. It is still a volatile market, though, only on a different scale. Take a look, for example, at Shiller's house price index:
Note the current boom ended not long after this graph was created and so the downward crash in the USA isn't shown here.
Now compare to the DOW.
You tell me which is more volatile.
If you narrow your scope to just the last boom in real estate, then of course housing looks great. But given the long term nature of people's housing investments, this is just blatantly ignorant of past lessons learned.
--Quintus Horatius Flaccus (65BC - 8BC), Roman Poet
As for the "average home price over the last 10 years" statement, the graph holds that statement to be true (unless there's something I'm missing). Of course this generally depends on the market and I'm assuming that for "average", they're looking at national average. In some parts of Canada house price has declined; however, insane markets such as Calgary have more than balanced that out.
I'm not really arguing one way or another, it all depends on the type of investment, or what your goals are. If you're going for locked up and long term, or if you prefer more liquidity and flexibility.
After all that's been said ... I think the best investment you can make is one with the best ROI ...
As for ROI, it's less and less meaningful the more risk you take on in an investment. That people mostly need to leverage huge sums of money to get into the market; that housing is primarily a roof over people's heads rather than an investment they buy and sell; that in past crashes, people couldn't see it coming and got locked into negative equity situations; etc etc. Put it all together and housing as investment just isn't that smart an idea.
Here's another interesting artifact from pre-bubble burst America:
http://www.michael-hudson.com/articles/debt/Hudson,RoadToSerfdom.pdf
(sorry for the pdf)
And this doesn't even get into the fire people have been playing with in the form of 40 year mortgages and zero to five percent downs.
Also notice the graph stops at 2005 and it's a graph of the American market. I leave it up to you to imagine what post 2006 has been like there.
Was just thinking about American vs. Canadian housing ... with the dollar near parity and so many foreclosures south of the border and house prices being what they are, it's quite tempting to snatch up a cheap property and wait for the up-swing that's due to happen eventually ... but that isn't without it's risks, Global TV (I think) had an interesting bit on it, but I can't seem to find it.
Anyway, that "ROI" comment was a bit tongue in cheek as the best investment is dependent on the person's situation. Of course, to cover all bases, one could invest in an Index fund, and simultaneously buy a couple properties and rent them out .... but like you said "people mostly need to leverage huge sums of money to get into the market".
Need money to make money ...
The take away is, whatever goes up can come down. Anything subject to the economic laws of supply and demand means that the value of something cannot keep going up in a straight line.
Don't be duped by real estate agents who claim that housing values will keep going up, and if you don't buy now, you'll be forever priced out of the market. This kind of logic is irrational and ignores all of the housing crashes that we've seen in the past.
Let me also clarify my position that I am not against buying real estate. I just think that currently, it's a bad time to buy as the bottom isn't in yet. It's all about timing. Buy low, sell high. I've just been pounding the table about stocks because I believe the bottom is in, and now it a nice time to get back into the stock market. More on this later.