What’s A Better Investment In 2022: The S&P 500 Stock Index Or The Toronto Real Estate Market?

What's A Better Investment In 2022: The S&P 500 Stock Index Or The Toronto Real Estate Market?


There’s a lot more uncertainty in all markets these days, and both the stock and real estate markets are pretty shaky.

Rising inflation and borrowing rates combined with slower sales growth puts us in stagflationary scenario that isn’t good for stocks. These factors are also not great for real estate investing since it’s mostly fuelled by mortgages. As costs and rates go up, net income get compressed and holding power gets weaker.

If you’re trying to figure out what’s a better place to put you money, keep watching. In this video, I’ll walk through how returns in stocks might compare to investing in real estate in 2022.

Investment Risk vs. Returns: Bonds, Stocks, Real Estate Crypto

I believe in a diversified portfolio, and so it’s always a good idea to invest in a mix of stocks, real estate, crypto and bonds. These markets don’t always move in line with each other. So as a whole portfolio, you will see lower volatility when you have more varied assets in the mix.

Having said that, the returns of different assets will be different and their risk profiles are also different. We have bonds that have the lowest returns and the lowest volatility, stocks that have higher returns but higher volatility, and then we have crypto, which might have the potential for the highest returns but also has the highest volatility.

The class that kind of sticks out from this bunch is real estate, because it actually has higher total returns compared to stocks, and yet it actually has lower volatility.

S&P 500 Returns: 1976 to Today

Let’s go back all the way to 1976, 45 years back in history. If we look at the annual returns of the S&P index, you’ll see that the average annual return has been 10% per year. We can also look at how much prices fluctuate, and you can see that the standard deviation of the prices is around 0.16.

Toronto Real Estate Returns: 1976 To Today

Now let’s look at Toronto real estate from 1976 all the way till today. Real estate is made up of appreciation and rental income. What you see is that appreciation on average has been around 7%, but its volatility is also significantly less than stocks. 

Then, we need to add rental income. It turns out that on average, cap rates on Toronto freeholds have been around 9% over the past 45 years, but we’ve obviously seen this drop like a rock in the past 10 years, and right now it’s compressed to around 3.8%.

What’s been happening is that before, real estate returns were more heavily weighed on rental income. But as Toronto continues to grow into a global city, our city’s price growth sped up drastically outpacing inflation and rental price growth, and so appreciation now makes up a lot more of our Toronto real estate returns pie. 

Basically the distribution of appreciation and rental income got shifted over the years, but as a whole, real estate returns don’t vary as much. What we see is that the returns fluctuations are still less than stocks, but total returns are much better at 16%. So from a risk-adjusted returns standpoint, Toronto real estate really sticks out as a superior investment class.

The Power Of Leverage With Real Estate

Most real estate investors don’t buy properties with straight cash, and you can get much better returns if you get a mortgage to invest in real estate. This is the concept of leverage, which I go through in another video right here. Leverage isn’t a buy and hold strategy for many investment classes like stocks, it makes a lot more sense for real estate. 

You get the best loan to value ratios with residential real estate, the lowest borrowing rates out there, and your rental income helps you pay for your monthly mortgage payments, so you continue to have strong holding power. The thing that you need to know is that when you use borrowed money to increase your returns, you are magnifying your real estate returns.

Gains gets magnified, but losses also get magnified. In other words, your return swings a lot more, so your investment does become higher risk with leverage. If you dive in to the numbers, with a 20% down payment, average real estate returns get magnified from 16% to 44% per year. 

The results are pretty drastic over a ten-year period. Assuming that you have $300,000 to invest in, if you put it in the S&P index at 10% per year, at the end of 10 years, he would have gained $479,00, which is amazing.

If you put it into Toronto freehold investment, getting a 44% annual return per year based on a 20% down payment, this is a whopping $11 million, which is insane. Now keep in mind that your risk with levered real estate with a 20% down payment is higher than just investing in the S&P 500 index with cash.

Real estate returns after leverage have a standard deviation of 0.38 compared to a standard deviation of 0.16 with stocks. Now, if you wanted to get your risk level closer to what you’d get with stocks, your average real estate returns will still double what you can get on average stocks.

Tax Advantages Of Real Estate

Besides leverage, another huge benefit for real estate is tax advantages. When you collect dividends from stocks, you will have to pay income taxes on it. With rental income, you have the ability to depreciate part of your building each year to lower your taxable income. In today’s market, it’s possible to have minimal taxable rental income because of this and defer a good chunk of your income tax until the time of sale.

The second tax advantage for real estate is the capital gains tax. Principal residences have the biggest advantage of not being subject to capital gains tax. But even for investment properties, you have the option to refinance your property to take cash out to reinvest instead of selling it, so you are again able to defer capital gains taxes until later down the road. What this means is that you’re able to invest with pre-tax funds, which will increase your total returns.

Comparison Of Returns 2022 - 2023: Stocks vs. Toronto Real Estate​

Now if you’re thinking that Toronto real estate is a great long-term investment, but given that interest rates are on the rise, does it make sense to buy an investment property? In my personal view, real estate should be a long-term investment, so I’m comfortable with using average appreciation rates in my returns projections. The factor that I’m more concerned with is holding power. 

Given that the rent yields are still low and interest rates are rising, I would need to ensure that my real estate investment provides strong holding power in the short to medium term so that I can hang on and reap those great long-term returns.

Let’s walk through this with a starter investment freehold that’s priced at around $1.2 million on the market today with cap rates at 3.8%. If we assume overnight rates go to around 2.5% in a years time, so variable rates will be around 3.5%, which is consensus so far, then our rental income will be lower at $12,000.

After we deduct depreciation, we’ll have no taxable income and our monthly cash flow would at negative -$550 per month. Of course, this is not ideal, but note that this is still much better than condos that have returns but still cash flowing negative at around these amounts each month.

Let’s see how much we’ll get if we invest the same amount of money into stocks. We are currently in a weaker economic situation, and Goldman Sachs predicts 4% gain for its best case scenario S&P 500 index from today. Worst case? A drop of 21% by year end! So even at the best case, that’s equivalent to $11,000 of gains. So even if real estate investment returns come purely from rental income with no appreciation, then rental income alone will still beat stocks.

Toronto Real Estate Fundamentals

We’re in much more volatile times right now, it’s very possible to experience short term negative returns no matter which market you get into at the moment.

With real estate, I recommend entering with the mentality of buying and holding and making sure that you can withstand the negative cash flows if rates go up to 3.5% or even higher at 4.5%. But note that in the long run, investing in Toronto will generate better, more stable long term returns compared to stocks.

I don’t like to speculate I don’t know where Toronto real estate prices will go, but I continue to be bullish on the Toronto low-rise market purely based on fundamentals. We know we have a housing crisis, and the government is finally admitting to it after trying various tactics to curb demand. 

We might also be undercounting our demand numbers, which makes actual conditions even worse that what the numbers show. CIBC is saying that we’re probably currently hundreds of thousands of homes short because students who are renting somewhere else when they go to school are counted as living with parents on the census. 

Plus, the census might also be underestimating the number of homes needed for new immigrant fresh grads, who most likely need their own housing but is counted the same way as fresh grads who’s more likely to go back to their parents’ homes once they graduate. 

In Toronto specifically, our urban centre benefits the most from the COVID recovery story as demand for housing in the core continues to rebound, plus our city has limited vacant land to build new homes. So, investing in land in Toronto will always be desirable.

How We Can Help

We’re big believers in investing in freeholds in Toronto, and if you want to chat more about this, we’re ready for you! We can look at your requirements and preferences and then match you up with the best investment property that fits your needs. 

After we help you buy it, our team also provides renovation guidance, leasing and property management if you need it. Just connect with us if you want to learn more about our services!

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