Your home as an investment

Where is the error here?

There is no error, would say everyone on the street these days. If it appreciates in value over time, as it did for so many years, it is a wonderful investment. Instead of buying stocks or mutual funds, buy a rental property and reap the reward of collecting rent and capital gain when you sell. That formula worked for many people, why do we have to look for any flaws. After all, wise people have said it long time ago “Don’t fix it if it works”.

Your idea how to retire?

Treating real estate as investment is a relatively recent phenomena and it baffles even some professionals within the investment community. Vedran Vuk from Casey Research recently published an article pointing out what he sees wrong in this idea. To compare apples with apples, he looks at the growth potential of a company like Apple (pun not intended) and a house. Going back in history homes, according to Vuk, has been considered “a very long term consumption good” and nobody has expected to triple in value over their lifetime.  Somehow over the last few decades we managed to change the meaning of a home from “consumption good” to an “investment vehicle”. But they are not even close:

Consider the difference between your house and an investment such as Apple stock. At a major company, the opportunities can be truly limitless. Apple can produce cashflows from computers, iPods, iPads, and future innovations that are just dreams and concepts today. If the local market is oversaturated, Apple has the option of spreading out all across the world. As a result, Apple’s stock price has gone from $17 in 2005 to $540 today (my note – now over $600). Can your house do the same? Unless there’s a hyperinflation ahead or your house is located in the New York City or London of the 21st century, the answer is no. Why? Because your house is ultimately a product – and products have an upper bound to their prices.

That’s exactly where the error is – a house, as a product, has its price limit. Higher demand and home improvement may result in some appreciation of the home value, but at some point, it will hit the ceiling. When the selling price exceeds significantly the purchasing power of the average consumer, demand will simply disappear and the price will drop.

Where are home prices in Canada now? Is there any room for further appreciation? In my opinion, they are up there, close to the upper limit. Homes within the lower price bracket ($150,000 to $250,000) may still appreciate in value over the next few years. It may happen, because those, who can’t afford a half a million dollar house, would look at anything available within their reach. However, those who expect their home to double in price in 10 years, may be in for a surprise – at this point it sounds like a pipe dream.

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