“Buy a house. It’s the best investment”. “The banks are crooks, they only benefit the rich”. Common words spoken by common people. Those are the popular phrases that have been drilled into our heads for as long as I can remember. It’s also been reiterated by man real estate agents and moms across the world that owning a home is the way to go. Make no mistake owning a home has become the North American dream and for some people, the only purpose in life.
The only question that comes to my mind when I think about these words after so many years is this: Why are normal everyday Canadians struggling, while the bankers are making billions of dollars? If buying a home is indeed the best investment, why aren’t all Canadians doing better than the bankers?
This has led me in an investigation into the real life historical numbers of investing. Is a house actually the better investment? Or is it actually better to buy the bank? The argument comes down to this. Should you rent money to buy your home? Or should you rent your home and collect the interest instead?
Debunking The Myth
Mom always told me her home was her best investment. That’s because she didn’t invest in anything else other than a GIC or high cost mutual funds. I get it, she’s very conservative and she wasn’t a personal finance nerd like me. I like to run spreadsheets and do historical analysis on financial matters. In some sense, I’m a rare breed.
What I wanted to do is figure out what the better investment is after 25 years. A house or the bank. For this exercise, I arbitrarily took TD bank as my bank and the average Toronto home as my comparison. I know you might be reading this and think that’s it’s unfair to pick Toronto because the market is so hot right now, while other parts of Canada are not, but Toronto is the center of the universe so get over it.
With a little bit of research it was easy to find the average price of a home 25 years ago. In 1993, the average home price was recorded as $206,480 in Toronto. That number seems outrageously cheap when compared to 2018 average price numbers in Toronto which was reported as $796,786. That’s over 3x the price increase in 25 years which is phenomenal!
Figuring out how much an investment in TD bank is a lot harder to calculate, but thankfully the bank itself has it’s own calculator. So assuming someone had $206,480 dollars in 1993, would buying the home be better or buying TD bank stock?
I need to warn you before reading any further. I do not make up these numbers and this calculation is entirely done on the TD investment calculator from the link above. It’s also close to Halloween and I’m not out to scare you. I also want to send out a grave warning that before you read any further, you might need to make sure that your mom is not in the room.
Holy FUCK! $6.6M dollars! What has mom been doing the last 25 years? I could be driving a Bentley by now if she didn’t buy that house in Toronto. No wonder the rich get richer. They didn’t buy houses like my mom. They bought the stock of the company that everyone borrowed money from to buy houses. Yet again, we got conned by the crooks at the bank.
Before I get flamed by every reader of my blog that I’m skewing the numbers by providing fake numbers and flawed analysis, I took another approach to figuring out how well an investment in a house would fare versus buying TD bank stocks.
First off, it’s an unrealistic assumption to look at the absolute cost of the house in 1993 to 2018. That’s because no one really had $206,480 just sitting around to invest. Like many homeowners today, mom needed to get a mortgage. That means it’s impossible for her to just drop $206,480 on a house or TD stocks.
In a more realistic scenario, mom probably had a 20% down payment, but she also needed somewhere to live. If she didn’t buy that house, she would have had to rent at market prices in a very expensive Toronto city.
Thankfully all of these numbers can be obtained. In a popular city like Toronto, historical statistics are very easy to obtain. Average rent prices for a 3 bedroom place in Toronto for the last 25 years in Toronto can be found at the CMHC website.
Interest rates for mortgages can also be easily obtained thanks to the folks at RateHub. For the purposes of my analysis I took the standard 5 year fixed rate mortgage that is preferred by most Canadians.
In my very complicated scenario, I had to make a few assumptions:
- Mom can always make the more expensive payment of renting or the mortgage
- Any difference between renting and the mortgage payment would be invested into TD stock. Even if she owns the house.
If mom invests in TD stock
- Mom would invest the entire down payment on TD stock and reinvest the dividends
- Mom needs to rent at average Toronto 3 bedroom prices
- Mom never sells her investments
- Mom doesn’t pay taxes in her investments because she can defer dividends into her RRSP.
If mom buys a house
- Mom always gets a 5 year fixed rate mortgage
- Mom doesn’t pay off the house faster than the 25 year amortization period
- Mom always gets a mortgage rate of posted – 1.42% or the discounted RateHub rate
- Mom sells house for $1M instead of $796,786 because she always gets over asking
In this controlled environment, just what are the results?
You might want to cover mom’s eyes for this one too. From a pure wealth generation perspective, the house, even when sold at $1M still lags behind investing in TD stock. Damn those bankers! Mom’s been tricked for over two decades.
This was one of the most interesting analysis that I’ve done with renting versus buying. For one, renting is not always cheaper than buying. That’s because rent prices always go up, but mortgage rates can fluctuate all the time. With that in mind, a homeowner can definitely start getting into the stock market once their cash flow is better than the renter, and in this case it happens in only year 6.
What is amazing in this analysis is just how powerful compounding growth is over a long period of time. The fact that a renter can just invest 5 years and end up more financially well of than a home owner is just unfathomable.
What makes this even more amazing for the investor is that during the last 25 years, stock markets haven’t just gone up. In fact, there are 3 well known periods where large corrections occurred. The first was the dot-com bubble bursting in 2000 that took down the markets and valuations of many stocks. That was followed by the events of 9/11 which took stock markets down even further after the dot-com crash. Finally, everyone remembers the greatest financial crisis of all time in 2008 when all financial companies took a major tumble. With 3 such large corrections, it would be assumed that owning the house was the better way to invest, but that just didn’t end up to be correct.
The reason why bank stocks in Canada have fared very well over the last two decades is the insatiable appetite of Canadians for houses. In fact, the performance of Canadian bank stocks have a strong correlation to the housing market in Canada. Let’s face it, most home buyers need a mortgage to buy a house. The interest payments that Canadians make on a monthly basis continue to pad the bottom line for banks. This isn’t going to stop being true as interest rates rise. Expect bank profits to continue to soar as the cost of borrowing rises over the next few years.
With this kind of past performance does it make sense to continue just buying TD bank stock? I’m never the one to try to pick stocks. I’m an index investment type of guy, but if I had to bank on picking either a house or a bank stock to outperform over the next 2 decades, I’m pretty sure I know what I would take.