Stock Market or the Real Estate Market for Long Term Wealth

The classic debate. Stock market vs real estate market. There are arguments for both and we’ll always have people arguing you’re wrong and I’m right. At the end of the day, there is no right answer and it is different for everyone depending on your situation. As you get more established you’re going to want to have a portfolio consisting of both, however, it most likely won’t start that way. This article is not for day traders but is an article to review if you’re looking for passive investments. If you are a day trader that is your lifeline. Investing is not generally a career that defines your daily source of income but is a mechanism to acquire future wealth, however, over time it can become a career.

When you’re just starting you generally don’t have that much money and when you’re weighing the options of how to strike it rich you will most likely come across the debate of stocks & real estate to get your start. You can’t do both as you’re not rolling in the dough yet so you have to pick. Pick the next google or hottest cryptocurrency and you could be a millionaire in no time. The only problem with that strategy is it isn’t very easy to identify what company that’s going to be so you’re left guessing and listening to Facebook/Instagram “internet geniuses” tell you the next hot thing and hoping that’s the one. People will generally start with stocks or forex because it requires minimal capital to get up and running and can easily be done from the convenience of your home. That’s why I started back in grade 11 at least. It’s not a bad idea and I would say it is a good first place to start as it will teach you some things about business and risk but as you begin to excel in your career then it’s time to start looking at real estate. A big reason real estate is usually the winner is due to the ability to utilize leverage, something you don’t generally have with passive stock investments.

It is the use of leverage that allows for real estate to pay out dividends in the form of monthly cash flow and leverage that allows for a tenant to pay down your loan. Leverage is what allows you to reap the rewards of a 10% lift in a $1M asset with less than $200,000 in the deal in some instances. Leverage is a financial tool unique to real estate and not so much the stock market. You can use leverage in the stock market (not as much as you can in real estate) but there is more risk to it as there’s a risk of hitting margin call and getting stopped out which can happen overnight due to the volatility of the market.

Real Estate Investment Options

When it comes to choosing a real estate asset to focus on there can be a wide variety to choose from but generally, you will be restricted to certain assets based on your experience and access to capital.

Residential

When it comes to residential investment options it will come in the form of either of the following:

• - Condos
• - Townhomes
• - Single-Family

There are a few ways you can invest in either of these property types such as flipping, BRRR, short term/medium term rental, etc but we’re going to focus primarily on buy and hold for this comparative analysis as this article is geared towards individuals looking for passive investments and almost every other form of investing in real estate requires investing a large amount of time.

Commercial

The commercial market can seem like a foreign world to some which is generally why people don’t start their investing career with commercial property. Commercial property can come in the following forms:

• - Retail
• - Office
• - Industrial
• - Mixed-Use
• - Land/Development
• - Multi-Family
• - Storage facility
• - Mobile Home Park

Commercial is a far more dynamic asset class when compared to residential which allows it to be either very straightforward or incredibly complex and technical, however, that is part of the reason why commercial can be a far more lucrative investment opportunity.

Stock Investment Options

There are many different ways someone can invest in the stock market and I’m sure I’ll be forgetting some:

• - Buy Stocks
• - Short Stocks
• - Options Trade
• - Futures Trade
• - ETF’s
• - Index funds
• - Mutual Funds

Out of all the ways one can trade stocks, ETF’s, Index funds and Mutual funds are among the most popular and widely used methods of investing in the stock market.

When it comes to the top four options, one can either day trade or swing trade and either of those methods is how you can earn the highest ROI when compared to almost any other form of investment. The problem with stocks is it allows you to become an overnight millionaire, literally. If you invest the right amount of money in a stock and it shoots up 100’s of percent during a trading session which happens weekly then you could earn an incredible ROI. This is what allures people into the stock market and why it is a far more popular way of investing. It is also the same reason more people go broke in the stock market than the real estate market. The problem is, finding that stock takes hours and hours of research and still, even after you believe you’ve found that one stock you are gambling on an outcome. The reason a stock shoots up so rapidly in price and create millionaires in the blink of an eye is because of news events that are impossible to know the outcome of unless you’re an insider trader and insider traders are not allowed to purchase stock for that specific reason. One advantage with real estate is you are 100% allowed to insider trade. If you know key information because you’re a city planner for example and you know where the next phase of development will be opening up in a 10 year period then you have every right to go and buy land in the path of progress. Fortunately, you don’t need to be a city planner to get insider information, anyone has the potential to find an edge.

Stock Analysis

For this analysis, I chose to use the Vanguard fund (VOO) as it has been a notoriously reliable ETF and consistently performs (Appendix A) providing investors with an average before-tax return of 13.53%/annually which outperforms the real estate in my last example where we looked at the S&P 500 vs buying a principal residence. The investment in my last example was invested by way of a managed account through an individual's bank so incurred fees far above those of someone who simply put their cash in VOO with some of the lowest fees for an ETF. These fees are worked into the daily % change so do not need to be factored into the analysis. This analysis presumes the investor is reinvesting all 39 dividends paid out throughout the duration of the hold so as to take full advantage of compound interest.

For this example, I wanted to give stocks the biggest upper hand I could while keeping it realistic. For this analysis, this individual purchased the ETF on their own through their self-managed account where they incur $0 fees and the only deduction to factor in is tax. For an individual who invested $100,000 into the stock market when VOO opened on September 10, 2010 and held for 10 years until the end of the trading day on September 10, 2020 they would have earned a gross profit of $255,837.38 or 12.41%/year. That is a fantastic return and outperforms the S&P500 which was held in a mutual fund example utilized in my last article where that investor earned a net annual return of only 4.17%.

Dividends

Dividends vary from ETF to ETF and depending on your goals can be a good or bad thing. An ETF/company that pays out dividends can be advantageous if for example someone is retired and has no source of income then those dividend payments could be used for periodic payments. However, if like our investor in the example you are just looking for the best returns over a certain period of time then perhaps an ETF/company that doesn't pay out dividends and instead uses those profits to further reinvest at a greater scale then you could is a more attractive option. Since its inception, VOO has paid dividends every quarter and that has resulted in an additional $36,393.71 for our investor to reinvest every quarter throughout the 10-year hold. Thanks to compound interest, this $36,393.71 reinvestment generated an additional $16,538.80 for our investor in this scenario.

Taxes

In Canada, profit earned on a stock investment is subject to capital gains tax (50% of profit is taxable) unless it is held in a TFSA which has annual contribution limitations. 50% of $255,837.38 is $127,918.69. As of 2020, an income of $127,918.69 is subject to a total tax due of $33,559 on a profit of $255,837.38.

It's important to keep in mind that this $127,918.69 profit is added to the income earned that year when determining the amount of tax. If this stock is sold in a year where you earn $200,000, total income for the year would be $327,918.69 and would be subject to a total tax of $131,534. The inclusion of personal income results in you paying $67,140 on the profit earned from the sale of your stock vs $33,559 when personal income wasn't a factor due to the increase in tax bracket. This stresses the importance of having a good accountant and that tax needs to considered more often than generally is.

Total Return

This investor initially invested $100,000 into the Vanguard fund and 10 years later withdrawals his initial profit and investment resulting in a cheque for $355,837.38 ($100,000 initial investment and $255,837.38 profit). From this $255,837.38 profit, the investor pays a tax of $33,559 bringing his after-tax cheque to $322,278.38 ($100,000 initial investment and $222,278.38 net profit).

The ROI for this 10-year investment is 12.41%/year (Appendix B)

Real Estate Analysis

I chose to scale the time frame back for the real estate acquisition due to the severe increase in pricing that happened in the Vancouver area starting around 2016 (54% in 2 years). I wanted to look at two real properties in two different areas of the Lower Mainland, one property in South Vancouver purchased in September of 2005 and a single-family property bought in September of 2005 in Langley. The chart below has all of the details and the spreadsheet under has the financial details.

Both properties required a downpayment of $100,000 resulting in a $314,000 mortgage amortized over 30 years with a 5-year term. At the 5-year point, the investor has two options. He can either renew his mortgage or refinance his mortgage. If he renews then his new amortization period is 25 years and mortgage payments will be adjusted based on the interest period for that time unless the investor was in a variable loan which is not the case for this analysis. If the investor were to refinance, he would get a new loan on the property and receive a cheque for the difference between the new loan and the balance of the existing loan. If re-amortized over 30 years, the Vancouver property would provide a cheque for $229,099 and $150,459 for the Langley property. There is no tax due on the cash received from the refinance as that money is technically a loan. The ability to pull capital out by way of refinancing is a huge appeal to investors and is a big reason they choose to invest in real estate. This capital can be used for improvements to the property, funding a big purchase or most effectively to fund future acquisitions and get the snowball started for people and their investing journey. This is why just getting the first property is so important so you can start building that pipeline of equity to access in the future. The best part is there is somebody else making the payments towards your equity piggy bank and not you.

Taxes

The amount of tax payable and due is an easier calculation for stocks than it is for real estate. With stocks, there is only one period when you receive cash and that is when you sell which in this case is 10 years after initially purchased. With real estate, you earn returns the month after you purchase which means tax is due throughout the duration of the real estate being held as you receive income for the 10-year duration the property is held. Throughout the hold, you earn taxable income in two ways, principal pay down and cash flow. The third way you earn income, appreciation, isn’t taxable until that profit is realized which is when you sell. Fortunately for the owners in our example, they received minimal cashflows and the principal paydown was small 5 – 10k/year so wouldn’t make too much of a dent in the investor’s pocket when it comes to tax time. This is more so an issue when talking about commercial property and will be discussed in a future article discussing commercial investments.

The owner of the Langley property was left with a cheque for $365,120 ($100,000 initial investment and $265,119 profit) and is responsible for tax in the amount of $35,448 before considering other income leaving them with a net profit of $229,672.

The owner of the Vancouver property is left with a cheque for $899,730 ($100,000 initial investment and $799,730 profit)and is responsible for tax in the amount of $171,021 before considering other income leaving them with a net profit of $628,709.

Total Return

Calculating the total return for a real estate investment can be a bit more tedious than for stocks as income is earned throughout the hold which affects the IRR. Fortunately, I have a few spreadsheets that come in handy for this type of calculation. To see the breakdown of this calculation, review Appendix C for Langley and Appendix D for Vancouver.

The Langley investor invested $100,000 and for the following 5 years had to invest a further $29,175 to cover the negative cash flow that was incurred monthly. After renewing the mortgage in 2010 and getting the rents up to market rates, the investor now earns a positive cash flow of $20,647 which almost makes up for the loss incurred in the previous 5 years. The proceeds from sale resulted in a cheque for $365,120 and tax due in the amount of $35,448 leaving the seller with an after-tax cheque for $329,672.

The ROI for this 10-year investment is 9.75%/year

The Vancouver investor invested $100,000 and for the following 5 years invested a further $41,435 to cover the negative cash flow that was incurred monthly. After renewing the mortgage in 2010 and getting the rents up to market rates, the investor now earns a positive cash flow of $18,579. The proceeds from sale resulted in a cheque for $899,730 and tax due in the amount of $171,021 leaving the seller with an after-tax cheque for $728,709.

The ROI for this 10-year investment is 19.43%/year

Wrapping up

When looking strictly at the returns, investing in the Vanguard fund would have been a better financial investment than buying the Langley property but not the Vancouver property. It is important to remember this is an analysis of history so at the time it would be impossible to gauge which will produce the best financial result. The question also needs to be asked, is this type of investment the best option for me. I am a realtor so I understand how people feel I am going to give a bias to real estate but I do not. I believe in investing, not investing in one asset class and that one asset class is better than the other. Each asset class serves a purpose and you need to educate yourself as to which one is best for you at your point in life. I am writing these articles more so for individuals who have wealth and are contemplating where to invest a large portion of their wealth. When it comes to being worth a healthy sum of money, that money never just sits in the bank, it’s money in the form of assets and that wealthy individual has to choose which assets their wealth should sit in. I believe you should have your money invested in different investment vehicles but I would argue the majority of your portfolio should be in real estate, however, it most likely won’t start that way due to the large amounts of capital required to get started in real estate investing for majority of people.

I could argue that real estate is a better investment because it is physical and everybody needs a physical place for shelter so if all else fails, that real estate will still be in demand and a stock saying you own X% of whatever company could be worth $0 if that company fails for whatever reason out of your control but I don’t think that is the most important point and comes from a mindset of worst-case scenario which isn’t an effective form of debate in my opinion. You need to analyze how this investment benefits you when it performs because that is after all what you are investing in something for right? When stock performs, it adds value to your net worth but none of this can be realized unless you execute a sale that dilutes the absolute value of your holdings. The absolute value is the number of shares you have whereas the absolute value with real estate is one as you are only buying one property (in our example). When it comes to real estate, you don’t need to dilute your position to realize any wealth. These specific examples are not the best examples but generally, when we’re positioning real estate investments for clients there is cash flow paid out every month which for residential is anywhere from $20 – $1,000/month. $1,000/month in extra cash flow can go a long way. That could cover car payments, grocery bills, your own personal mortgage, etc. Furthermore, when it comes to real estate you can refinance to pull out equity that can be used for buying more investments or renovating your own home for example. In my opinion, the ability to refinance is the most attractive aspect of investing in real estate as the goal is to never sell. For those who have built their fortune in real estate, refinancing properties is why as it’s almost impossible to scale without it. For example, the Vancouver property required $100,000 to buy a $500,000 investment property. 5 years in you could refinance and pull out $229,000 which is enough to buy a property for about $1,150,000. That is the beautiful thing about real estate. 5 years later you can buy a property for $1.15M with $0 of your own money.

As mentioned, I do believe you should have some of your wealth in the stock market. I am not a stockbroker and don’t have hours of time to consider which are the best stocks to invest in. I also don’t like the platform my bank (CIBC) and the majority of banks have for setting up a TFSA or casually buying stocks which is why I use Wealthsimple. This is not a sponsored post by Wealthsimple and I have no affiliation with them I just simply like being able to provide value so have no problem sharing the platforms I use to invest. Also, we each get bonuses if you sign up for an account using my referral link. They make it easy to get set up with a simple portfolio managed for you or you can do your own shopping for stocks through their easy-to-use platform, Wealthsimple Trade which I dabble with from time-to-time.

Appendix

Appendix A

Link to spreadsheet analysis for VOO

For the complete historical data, refer to https://www.investing.com/etfs/vanguard-s-p-500-historical-data

Appendix B

Appendix C

Appendix D

Important Points, Disclosures & References

Stocks

The return for this example is based on actual daily price fluctuations that happened for the duration of the hold

VOO data was sourced from https://www.investing.com/etfs...

Real Estate

Presuming subject properties rent is increased by the max allowable starting 2007 and every year after. Property is re-tenanted at the 5-year point with new tenants and rent is increased annually starting 2012

Two rows for the year 2010 is due to the mortgage renewal in September

Mortgage in September, 2005 was calculated as a 30-year loan with a 5-year fixed term at 5%

Mortgage in September, 2010 was calculated as a 25-year loan with a 5-year fixed term at 3.49%

Maintenace was calculated as 10% of gross rent

Property management was calculated as 9% of gross rents

Property tax for Langley is actual figures for the subject property

Property tax for Vancouver was calculated based on actual property tax rates and the benchmark price of homes in South Vancouver for the corresponding year as historical assessed values for the property could not be located

Appreciation is based on the year-over-year increase in the benchmark price for South Vancouver and Langley

General

I am not an accountant and the tax information I have provided is accurate to the best of my knowledge, however, to know how you will personally be affected as everyone’s case is different, please consult with an accountant.

I have used tax figures for 2020 when computing tax payable