The theoretical principles of real estate investments and market-traded financial assets are extremely similar, yet they seem to attract fundamentally different investors. Real estate arguably attracts a pragmatic and entrepreneurial investor, while stock market investors seem to be more theoretical and managerial.
Having received a formal education in Finance, I was once a believer in the almighty stock market; I am now somewhat of an apostate. My general skepticism of investments in the stock market has been ridiculed by friends in the financial industry. I am called neurotic because I find it difficult to invest my hard-earned money in assets which are sometimes intangible, complex and managed by people I don't know -- and a simpleton for preferring plain ol' real estate to any sophisticated Wall Street concoction. However, as will be demonstrated in the following comparison of the Toronto Stock Exchange and the Montreal real estate market, there is something to be said for this simple, yet timeless investment.
Comparing real estate returns with market returns poses certain challenges. Total returns of a financial asset are comprised of capital gains and dividends, but the latter is difficult to estimate in the real estate market. Dividends of a stock are analogous to the Net Operating Income (NOI) of a property (after reserves). Unfortunately, the rental market is quite opaque and the average "dividend rates" of residential real estate have not been recorded throughout the years.
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The most expensive house for sale in Quebec is located in the suburb of Laval, on the shores of the river separating it from the island of Montreal. The house has six bedrooms and eight baths on 9,800 square feet of land.
The house features a heated inground pool.
A very ornate living room.
The dining hall.
Twin staircases flank the lobby.
The kitchen features a large island.
A spacious bathroom.
The media room.
The wine cellar.
A custom-built, 8,300-square foot home with four bedrooms on three acres of land in Shediac Cape. The house features its own elevator.
A fully equipped gourmet kitchen with large centre island opens to breakfast room.
Vaulted ceiling adorn the main room, and the entrance foyer features inset ceiling lights and a chandelier.
The second floor offers magnificent master suite with sitting area adorned by propane fireplace, access to balcony, dressing room, luxurious ensuite and guest room/bedroom with ensuite.
This two-year-old property on Ketch Harbour near Halifax has three bedrooms and four baths, made from high-grade Italian limestone. But the property doesn't seem to be selling; it was the most expensive property for sale in Nova Scotia the previous time HuffPost compiled this list, in October, 2012.
A slick, modernist bedroom with stunning views.
Stunning views of the ocean.
Located above the bluffs of P.E.I.'s stunning North Coast, this house features six bedrooms and nine baths, and clocks in at a stunning 13,360 square feet.
The kitchen is a blend of rustic and modern.
A bedroom with fireplace.
Upper levels open on to the great room.
A spiral, three-story staircase.
A snug bedroom with fireplace.
Take the virtual tour.
This lime green, six-bedroom, nine-bath house just outside of Corner Brook is the most expensive property for sale in Newfoundland. The two-story, 6,000-square-foot house features a walkout basement that offers access to the back yard.
The main floor has a floor-to-ceiling fireplace.
The realtor describes the gourmet kitchen as a "chef's dream."
"Cathedral ceilings" top the second floor.
The back yard.
The most expensive house for sale in Ontario is a condo in Toronto's posh Yorkville, in new building across the street from the Royal Ontario Museum. Suite 1400 at 155 Cumberland Street has four bedrooms and five bathrooms on two stories, with tons of balconies and verandas surrounding the whole thing.
Swank terraces adorn the building.
The unit has 5,000 square feet of terraces, and a pretty nice view.
The second floor.
Looking south towards the downtown core.
A custom-built, 7,851-square foot home with five bedrooms and nine baths in Winnipeg's Ridgedale neighbourhood.
The great hall.
The living room.
A very post-modern entertainment room.
The games room.
A rustic kitchen, despite all the amenities.
Now that's a bathtub.
The view from the back.
This is the only image we have of the most expensive property for sale in Saskatchewan, as the seller has not provided any other photos. The realtor describes this five-bedroom, six-bath house on 4,300 square feet near Saskatoon as a "must see property." We'll have to take his word for it.
Six bedrooms and eight baths in this house located in the scenic mountain town of Canmore. The house was an Architectural Digest showpiece.
Vaulted ceilings in the great room.
A hidden staircase leads to the wine grotto.
The media room.
Drawing from my experience as a real estate broker and erring on the side of caution, I will estimate the average annual dividend rate to have been a constant three per cent during the years of comparison. This is to say that the average $300,000 single-family home would have an NOI of about $9,000 per year -- perhaps being rented for $1,100/month (heating and electricity excluded), with other expenses (taxes, insurance, maintenance, vacancies, management fees etc.) plus contributions to a reserve fund representing roughly 32 per cent of gross rental income. It is a conservative estimate, but its degree of accuracy is not of great importance, as discrepancies in capital gains are much more substantial in this comparison.
I will refrain from presenting esoteric statistics. Instead, I will present a dollar-and-cents example that fellow simpletons can understand -- and certainly relate to. Imagine two people, Mr. Jones and Mr. Smith, who both inherited $100,000 at the end of the year 1999. Mr. Jones, an educated man and an avid reader of The Wall Street Journal, decides to invest in an Exchange Traded Fund (ETF), which attempts to mimic the dynamics of the Toronto Stock Exchange (i.e. iShares XIU). Mr. Smith, a common working-class man, decides to buy a $100,000 house on the island of Montreal and lease it on a yearly basis. At the end of 2012, Mr. Jones' ETF shares are worth approximately $144,000. In addition, Mr. Jones had been saving the dividends he received over the years in a bank account yielding two per cent interest; he now has roughly $36,000. Ultimately, his $100,000 investment has grown to about $180,000 dollars -- not too bad.
On the other hand, Mr. Smith just met with his local real estate broker, Jonathan Saveriano, who appraised his house at $257,000 (note: the median price of a single family home on the island of Montreal has gone up by about 157 per cent since 2000). Throughout the last twelve years, he had been saving his "dividends" in the same manner as Mr. Jones; he now has roughly $138,000. Mr. Smith's initial investment has grown to a staggering $395,000 dollars.
The returns of residential real estate in Montreal have without a doubt been much higher than those of the TSX since 2000, but that would not imply anything with regards to investment quality without a measure of risk. For those of you who are not familiar with the theoretical basis of finance, one must always take risk into account when measuring the performance of a portfolio as riskier investments should yield higher returns. Surprisingly, the standard deviation of annual real estate returns was much lower than that of the ETF -- 6.5 per cent compared to 18 per cent (roughly).
Given that the returns were higher and the risk was lower, we can conclusively say that Montreal real estate was a better investment than the TSX during this period. However, I make no claims as to whether these trends will continue or not, nor as to the extent which these results can be generalized to the entire Canadian real estate market or the market of other major Canadian cities. That being said, although I am not privy to statistics on the Vancouver and Toronto markets, I would be absolutely stunned if the same basic conclusion was not derived.
The Montreal real estate market has been under scrutiny for decades, but it has remained resilient in the recent tumultuous economic times and has surpassed all expectations. The market is by no means bullet-proof, but the incessant fear-mongering from skeptics diverts attention away from how good of an investment it has been historically.
As a result of the empirical evidence presented in this article, it can be said with confidence that the residential real estate market on the island of Montreal has outperformed the TSX since the year 2000. Real estate seems to have defied the principles of finance and economics -- perhaps because it is a little more than just a financial product or a commodity -- and that is what some seem to have a hard time understanding.
As once explained by Pa Bailey in the film "It's a Wonderful Life", home ownership is, "...a fundamental urge. It's deep in the race for a man to want his own roof and walls and fireplace." Unlike most other goods or services that financial assets are based on, real estate responds to an innate desire -- the desire to have a piece of this earth one can call his own. This basic yearning has been, in my opinion, the driving force of the real estate market, and the reason I continue to believe in it.
This article was originally published in the Prince Arthur Herald