Home-buying or investing – which is better?

Gen Y & Millennials, this could be the defining question of your financial life. Don’t make the mistake of passively accepting the line that housing is a great investment. Ask questions so you can make an educated decision.

Houses are a lovely place to live and raise a family, and they’ve solidly appreciated in price over the past several years. But stocks, even after the mega-crash of five years ago, can still be a good long-term investment.So which is better?

National price data from the Canadian Real Estate Association shows an average annual gain of 5.4 per cent nationally from 2004 through 2013 for resale homes. However, if we just look at the BC housing market we can see that in the last 5 years we had a 50.5% gain.  The comparable average return from stocks was just under 8 per cent. We can easily see that the other question to ask here is, “Where do you intend on buying?”.

Home values compared to stocks, or at least the benchmark for the British Columbia market, win. Case closed.

So the question is, why don’t more people invest in houses as an investment? For one thing, we think people take a much longer-term view of housing prices than they do with stocks. With stocks, they focus a lot on short-term price fluctuations and lose sight of long-term results.

People sometimes ignore the true cost of owning a home and thus come away with an overly optimistic view of how much money they’ve made. Property taxes, furnishings, maintenance, improvements, insurance and mortgage interest all have to be factored into calculations of how much money is being made on housing. This will play into the investment return of home buying home but when you consider the 50.5% gain compared to 8% return on stocks, you can still see home buying as the more prudent option.

It’s worth noting at this point that while investing only in the stock market is doable for young investors, most will be happier with some bonds as well. This will result in lower overall returns, but less of that scary stock market volatility. Can you still beat house values as an investment with a diversified portfolio? That would be a great question to pose to the different financial gurus located in the Fraser Valley. But the quick answer for people living in the Fraser Valleywould be no since the diversified portfolio typically has lower returns.

Meanwhile, the 20- and 30-somethings of Millennials  are told endlessly by parents, family and friends that extending yourself financially to buy a house is okay because it’s a great investment. It seems to be true in our case here in the Fraser Valley.

Part of owning a home is a culture thing. It’s a status symbol showing your “financial success”. It’s called recency bias – people look at where they’ve made money recently and think it will continue to be a good investment.”

Can the housing market maintain it’s current gains? We believe housing prices can maintain their momentum, which means stocks are a riskier and more volatile investment. “But what about a market correction?” Even if this does happen, the gains that have been realized (even on a Y-o-Y) shows that home ownership will still win. The challenge is purchasing a home in a high home priced market will be whether or not individuals will be “land rich” and “cash poor”. We really need to be wary of over extending ourselves.

But what if you’re set on buying a home in this housing market? In that case, consider a five-year plan. Essentially, you’ll rent for five years and invest the money you save because you don’t have the higher costs of a homeownership. We estimate, you’ll come out financially ahead with this strategy, regardless of whether housing prices rise, stagnate or fall.

There’s an argument against delaying your foray into the housing market by five years – the threat of rising mortgage rates. Given how expensive houses are in many cities, even a modest move up in rates would have a noticeable impact on affordability.Rising interest rates will cool the housing market and cause prices to fall. In any case, the five-year investing plan will help you build a bigger down payment and reduce the amount you need to borrow when you buy.

Based on a 5 year plan on a couple with household income of $78,000 (Valley average) and $22,500 saved for the minimum 5-per-cent down payment on a $450,000 house. If they buy, they’d spend about $2,764 on mortgage payments, taxes, utilities and maintenance. If they rent, they would pay $1,850 per month. Considering the present year over year rate of return on houses in the Fraser Valley, you should see the value of your home increase to $495,000 in a year’s time. That would appear to be a great investment, and it is.

It is important to remember the cost of owning a home. The maintenance, taxes and utilities alone can make it that a large portion of your income goes to your mortgage.

If you decide to rent, renters can generate wealth through the stock market, but what if the stock market fouls things up with a big crash? Be prepared to stay invested for one or two extra years to let the market come back to its long-term average performance level.

In a Personal Finance column last year, a McMaster University finance instructor and ex-banker explained how it’s possible to generate more wealth as a renter over a lifetime as well as the short term (read it online here). But doing so requires diligent saving and, anyway, most people want to own a house for lifestyle and family reasons.

Decide for yourself between buying and renting, but do it with a full understanding of how housing has performed as an investment.

The record for houses is great and it did better then investing. However, the ideal situation is doing both. But for the young family getting into an expensive housing market, this may not be an option. And there is no end in site for the housing market decline or the simple fact that you will invest perfectly and avoid any stock loses. Happy house hunting everyone. Please feel free to share!