Why I prefer Real Estate Over Equities (PSA: I invest in both)
From my experience, investing in real estate the right way can easily yield double digit returns even without the power of appreciation. The return on investment from investing in real estate outweighs the stock market if you can partner with an expert or build expertise in the asset class. Here are some of the key benefits of why I personally think real estate serves as a superior investment versus equities over the long-term.
Before getting defensive, I completely understand that this is only one side of the story and a whole argument can be made to support equities investing (E.g. liquidity, passive, diversification, low barrier to entry, dividends, easier to invest in etc.). A great portfolio will consist of a mix of several asset classes which include equities, bonds, and real estate to name a few.
Without further ado, here are the reasons why I love investing in real estate:
1) Leverage:
The power of real estate returns come from leveraging, or in other words, using debt to invest. In Canada, the average residential real estate investment allows investors to leverage 5 to 1. This means that for every $1 of down payment the investor puts in the property, the bank will loan the investor $4 as a mortgage.
What this does is it amplifies your return on investment. Let’s say you purchase a $100,000 property. The down payment required will be 20% of the property value- in this case, $20,000. Let’s say property prices increase by 3%, which is very conservative as it is slightly above the Bank of Canada’s target inflation rate of 2%.
Assuming we do not leverage, or in other words, we do not borrow any money from the bank and purchase the property for $100,000 cash, our return on investment would be:
ROI = ($100,000 x 3%) / Initial Investment
= $3,000 / $100,000
= 3%
Now let’s assume that we leverage money from the bank and the purchase of the property requires only 20% down payment. Our return on investment would be:
ROI= $3,000 / $20,000
= 15%
The argument of leverage works both way. If property prices drop, then an investor’s return on investment will decrease significantly as well. However, it is safe to assume that in the long-term property prices will increase by at least 3% if you are investing in a city with strong population growth and decent economic fundamentals.
While you can also leverage in stocks, real estate allows investors to leverage 5 to 1, significantly more than what an average investor can leverage with equities.
2) Cheap Debt
When borrowing money, mortgage interest rates are among the lowest interest rates you will receive since it is backed against a tangible/hard asset. If banks are loaning out money at low interest rates for real estate, this indicates that banks assesses real estate as a low risk asset.
The average credit card in Ontario has close to a 20% interest rate. Student debt fluctuates between 5% to 7% interest rates. Unsecured line of credits range from 4% to double digit interest rates. Typical interest rates for leveraging on stocks is around 6% or higher. Real estate interest rates are generally below 2.5%.
When you borrow debt, in order to break-even your investment must provide you a return on investment at least equal to that of the interest rate. Let’s say your stock return is 6% (after-leveraging) and your cost of debt is 6%. You are breaking-even since your Return on Investment is the exact same percentage as your cost of debt.
Since real estate has low interest rates, it is fairly easy to achieve returns that are greater than the cost of borrowing by considering just mortgage pay down alone. Adding the effects of cash-flow and appreciation will allow you to achieve even higher returns.
3) Inefficient Market
An inefficient market says that an asset’s market prices does not always accurately reflect its true value. Real estate is undoubtedly inefficient in nature. As I discussed in a previous article, 10 people can walk through a single property and each person will come up with a different value of what the property is worth. In the case of fixer-upper properties, this allows investors to purchase properties below its true market value. Investors can then complete cosmetic renovations and as a result, this brings the value of the property up to its true market value. Opportunities like this exist everywhere in real estate, and are almost exclusively available to savvy investors who keep an eye out for under-valued properties.
As a result, this leads to instant equity. There were times where I purchased a property, and the bank appraised the property at a significantly higher value than my purchase price. I was able to create 5-figures of equity in less than 24 hours.
4) Tangible Asset
Real estate is a hard asset, which essentially means that real estate is tangible and has fundamental value. You can actually see and touch a property and thus it is easier to put a value to real estate.
Having a safe place to live is an essential human right and people will always need a place to live regardless of a bear or bull market. Real estate is also a great hedge against inflation. As cost of living increases, so does the acquisition of land. As a tangible asset, real estate preserves and creates wealth over time.
5) Land Scarcity
Moreover, land is scarce. There is a limited amount of land to develop in Ontario. With an extremely high projected population growth in the upcoming decade, high immigration rates, a strong international presence, strong future development plan, etc. this means that there will be more housing development required to meet the expected demand by population growth. Over the next 25 or 30 years, land will continue to become more scarce and as a result, this will drive real estate prices up. South of Ontario is bordered by Lake Ontario which limits further development south. Moreover, the Ontario Greenbelt, which is a permanently protected area of green space in Northern Ontario, creates further scarcity of land.
6) Controllable
Lastly, real estate is controllable. Individuals can manipulate and change the functionality of their property to drive prices up. Investors can Airbnb their property to get a higher yield. Investors can choose to turn their property to a student rental, or rent their property by the bedroom to maximize revenues. To take a more passive approach, investors may simply rent their property out to a family who pays steady rent every month. If an investor wants to add an extra bedroom to a property to increase revenues, they can simply get a contractor to redesign the property’s layout. If an investor wants to create a secondary unit by completing the basement, they can work with the city to create a legal secondary suite. As an owner of a property, you have direct control to increase the value of the property by completing strategic renovations. You have control of increasing revenues by changing the strategy you look to deploy in the property. You have control of minimizing expenses by including more efficient electrical appliances and heating.
Control gives investors a sense of safety as they are directly responsible for the decision making process of their investment and make adjustments to their property as necessary.
Originally posted to Facebook by Austin Yeh