Should you Invest in Stocks or Real Estate ? Part 1

[00:00:00] Hey everyone, in today's episode I'm joined by the one and only Dan Fosch who co-hosts the Canadian Real Estate Investor Podcast.

[00:00:09] We had a great conversation to show the pros and cons of investing in the stock market but also actual real estate.

[00:00:18] You're about to listen to the first part of the episode. The second part will be released on April 30th on the Canadian Real Estate Investor feed.

[00:00:28] If you're not already following the Canadian Real Estate Investor Podcast, which by the way you really should because it is a fantastic show,

[00:00:38] you can find the link in today's show notes. And now on to the show.

[00:00:59] Welcome back to the Canadian Investor Podcast. I'm here with Dan but not Dan Kent. So Dan Fosch, special episode here.

[00:01:07] We'll be talking about investing in the stock market versus investing in actual real estate. Pretty excited.

[00:01:13] We've been wanting to do that for a while. Dan, how's it going?

[00:01:16] I'm good. Yeah, it's finally answering the age old question of whether or not stocks or real estate are a better investment.

[00:01:23] I know it's definitely a heated topic in Canada because we're pretty obsessed with real estate,

[00:01:27] which I think is what led you guys to do a spin-off of your show into the real estate asset class as sort of the first foray into a spin-off show.

[00:01:36] And I think we had initially thought it would be more of a debate but I don't know that's the same.

[00:01:44] I think we'll agree on most things. I know.

[00:01:46] I know. That's knowing you.

[00:01:47] Yeah, for sure. I think you're right.

[00:01:49] I always say it this way. You have to be a really bad investor to not be able to beat the returns of real estate,

[00:01:56] but most people are bad investors and so that's what makes real estate such a good investment, right?

[00:02:02] Yeah, and real estate has performed pretty well and I think we've almost been conditioned as Canadians

[00:02:08] to own real estate and it's the way to go and you know, a friend of a friend or family member

[00:02:14] that is like a multi-millionaire because they started buying real estate in the 1990s when there was, you know,

[00:02:21] a correction with home prices and then they've done really well ever since.

[00:02:25] So I think you hear those stories quite a bit.

[00:02:28] I mean, I know people obviously you and Nick own quite a few properties,

[00:02:32] but I know people in my personal life that have done quite well over the years

[00:02:36] and I think people tend to focus on that thinking that real estate is always the best investment.

[00:02:41] I mean, I think you can do quite well, but there's definitely some drawbacks,

[00:02:45] but also some I think there's some pros of owning real estate compared to investing in the stock market.

[00:02:51] And I'm saying investing in the stock market because I'm going to be talking about different asset classes

[00:02:56] that you can have access when you invest in the stock market.

[00:02:59] So that's why I'll use that term a bit more.

[00:03:01] Yeah, for sure. Love it.

[00:03:03] Okay, well, let's just get started here.

[00:03:06] So in terms of the historical return, so I'm going to have to lean on you a little bit here for real estate.

[00:03:12] I know we were texting, but essentially if you looked at the past 25 years,

[00:03:17] I did a little graphic here and for joint TCI listeners, you'll be able to see what it looks like.

[00:03:24] I know most people are probably familiar listening to the podcast.

[00:03:27] So last 25 years, you're looking at 523% returns for the TSX-60.

[00:03:35] So these are typically the 60 largest companies listed on the TSX and very close behind 512% total returns for the S&P 500.

[00:03:45] And total returns does include dividend payments during that period of time.

[00:03:49] And you're looking at roughly 7.778% that time period of annual returns, which is very solid.

[00:03:57] Obviously, no guarantee it will continue in the future,

[00:04:01] but do you want to kind of compare that with what real estate has returned over that time period?

[00:04:07] Yeah, so when you try and analyze real estate in the same way,

[00:04:11] it would be tough to really arrive at a similar metric.

[00:04:17] But if you're to annualize that, and I think if you look at the S&P alone,

[00:04:21] it's like a 10% annualized return over the last 10 to 20 years.

[00:04:25] And if you're to say real estate prices or house prices grew,

[00:04:30] you could argue that they've grown at an average of about 5.11% on a compound annual growth rate basis.

[00:04:38] But the challenge is that doesn't necessarily capture...

[00:04:42] It would almost be more akin to thinking about a dividend stock that also has capital appreciation

[00:04:50] because that compound annual growth rate doesn't really account for yield, cash flow,

[00:04:56] and principal paydown that you would get from owning a rental property

[00:04:59] and having tenants amortize your mortgage.

[00:05:02] And so on a purely speculative basis, I would say that stocks outperform real estate

[00:05:09] in their ability to go up in value.

[00:05:12] But when you think about the yield piece, your real estate assets,

[00:05:18] typically if you're buying a rental property in the last decade,

[00:05:22] it would need to have a cap rate of typically over 6% to make sense,

[00:05:27] other than that period during COVID when rates were 2% or whatever.

[00:05:33] So if you're a cap rate, that's basically your net operating income to your price.

[00:05:39] So I guess almost like a price to income ratio.

[00:05:42] Yeah.

[00:05:44] And net operating income is just a profitability metric, very similar to net income,

[00:05:49] but it's just widely used for real estate.

[00:05:51] Yeah.

[00:05:52] And so that would say like your return...

[00:05:54] This is before debt service, so it doesn't account for your capital cost either,

[00:05:58] but your return from that asset would be 6%, let's say,

[00:06:02] and then you take your debt service out.

[00:06:05] So a portion of that return goes to debt service,

[00:06:07] a portion of that goes to interest, which is a complete sunk cost,

[00:06:10] and we're going to get into some of those after.

[00:06:12] So it ends up...

[00:06:13] The best metric you can end up using to look at it would be like an internal rate of return, or IRR,

[00:06:18] which is basically what is the asset return if your NPV, your net present value is equal to zero?

[00:06:26] And usually a typical investment property, like a duplex in a secondary market that you would rent out

[00:06:33] and it would be cash flow positive would be like an IRR of about 15% to 20%.

[00:06:38] So I'm not sure how those two charts annualize out,

[00:06:43] but that's kind of the way I would look at it.

[00:06:45] Yeah.

[00:06:46] So it comes with a lot more risk and costs though from my perspective.

[00:06:50] Yeah, and the returns I mentioned too,

[00:06:53] I think I probably did a disservice to stocks because the starting period was October 6, 1999.

[00:07:00] That's as far back as I could go for the data from FinCHAD.io.

[00:07:05] And for those who are well versed in the stock market, you'll know that that was almost at the peak of the tech stock bubble in the 1990s.

[00:07:13] So in early 2020, the bubble was essentially burst.

[00:07:17] So clearly if I picked a date more like, you know, 2001, I think it would have looked a little better.

[00:07:24] But nonetheless, I think that's some good context that you provided there.

[00:07:27] In terms of...

[00:07:28] I think you did reference it a little bit indirectly.

[00:07:31] I think probably one of the biggest pluses for stocks or investing in the stock market,

[00:07:36] whether you invest in stock bonds, real estate investment trusts,

[00:07:40] or you know, could even be any Bitcoin ETF, whatever it is, there's a low barrier to entry.

[00:07:46] So you can invest in the stock market with just a few dollars.

[00:07:49] I actually did last year a little project where I wanted to prove to people that if you only have $50 a month,

[00:07:56] you can still, you know, get something pretty significant in terms of return over long periods of time.

[00:08:02] So I actually invested $52 a month because my broker does not allow fractional shares and I put that into the index fund.

[00:08:10] So it's a global index fund ticker VQT.

[00:08:13] Pretty low fees, I think around 20 basis points, so 0.2% fees annually.

[00:08:20] And the goal was really just to show that you don't need to have thousands of dollars to invest in the stock market.

[00:08:26] And at the end of the year, I invested just shy of $630 and it was worth $668.

[00:08:33] So that gave me about 6% returns for the year.

[00:08:37] And if you invest $50 a month and get that 6% return over 25 years, which is, I think, pretty reasonable,

[00:08:45] relatively conservative, especially compared to the last 5 to 10 years, you'd end up with $34,000 actually a bit over that over that time period.

[00:08:55] So it just shows that in the stock market, you can definitely, you know, it's more accessible to a wider range of people.

[00:09:02] And I know you're big on housing affordability.

[00:09:05] And I know we're talking about real estate a bit more broadly here, but that's been one of the hot issues, right?

[00:09:11] Because it's just very difficult for people to save enough money to put a down payment on, you know, a home that they would live in.

[00:09:20] And I guess even more so if they want to put a down payment on a rental property because then you're going from 5% to 20%, I think minimum.

[00:09:28] If you're it's an income property that is not owner occupied.

[00:09:32] Yeah, typically like even 20% would be pretty low for the down payment like a lot of lenders are expecting.

[00:09:39] And with those new osfi rules, I expect that that's only going to get worse.

[00:09:43] So osfi just capped the total debt universe that you can have with a Sked A bank to 4.5 times income.

[00:09:51] So a lot basically a lot of investors are going to end up going B side, which means that your rates are going to be higher,

[00:09:57] which means that you'll have, you know, your cash flow will be impacted.

[00:10:00] But also you're typically seeing the B side wanting, you know, 25, 30% down on a lot of these.

[00:10:06] They are assets and they do want a little bit more collateral safety to lend against an investment property.

[00:10:14] The only other piece that I'll mention in regards to that, you know, you mentioned it sort of in the context of being a barrier to entry.

[00:10:20] We pride ourselves on being like a coast to coast real estate investment show because I think a lot of people it's most of our listeners are from the GTA.

[00:10:28] I think 60% of our audience or something.

[00:10:30] But it's so it's easy to kind of end up with that geographic bias where you're like, oh, I know I'm familiar with these markets.

[00:10:37] So I want to own a property there.

[00:10:39] But the reality is like you could buy a cash flowing single family house in Saskatchewan or Winnipeg or many places in the East Coast for under $100,000.

[00:10:50] And, you know, at 20% down it's a $20,000 commitment assuming just purely the down payment.

[00:10:57] So the barrier and still more than $50 a month.

[00:11:00] Yeah, no exact.

[00:11:01] You can't dollar cost average to do it.

[00:11:03] It's certainly more than 50 bucks a month.

[00:11:05] But you know, I mean where where investing is like when you start getting into those more meaningful amounts, that's where real estate is good at, you know, and we're going to talk about it next is kind of that access to leverage.

[00:11:17] I'll let you finish the couple of things that you had to mention on the closing costs and stuff.

[00:11:21] And then there is one thing I want to point out to people in regards to going high loan to value.

[00:11:26] Yeah, yeah.

[00:11:28] And that's a really good point.

[00:11:29] I know you've been pretty vocal on that.

[00:11:31] I don't have your periodical PSA that you know, if you put 5% down, you literally have negative equity in the home.

[00:11:40] And the 5% down obviously it's for CMHC insured mortgages that you'd only be able to do that.

[00:11:47] So if you don't have, that's the bare minimum and there are some additional costs.

[00:11:53] So for example, say you want to buy a property that's half a million dollars, which is pretty, you know, it's definitely under the average for the national average.

[00:12:02] It's probably on the high side for certain communities across Canada on the low side.

[00:12:07] Obviously if you're Toronto, even in Ottawa, that's probably on the lower end of prices for Ottawa.

[00:12:13] But I took that to be relatively conservative and try to catch all a little bit.

[00:12:18] So you'll need like a $25,000 down payment.

[00:12:22] If it's more than 500,000 then it would actually be any tranche that is above 500.

[00:12:28] It's 10% minimum, right?

[00:12:30] Yeah, exactly.

[00:12:31] So like up to a million, it ends up being 12 and a half to 15% usually.

[00:12:36] Yeah, okay. Yeah, that's it.

[00:12:38] So I just want to make sure I know this stuff pretty well, but I'm not an expert like you are on that.

[00:12:43] So you need a $25,000 down payment there and for Ontario, you'll need to pay at least $6,000, $475 in land transfer tax.

[00:12:52] And this of course will vary from province to province.

[00:12:56] You'll need to pay 19,000 in CMHC insurance, which most people just tack onto the mortgage.

[00:13:01] And let's say you'll pay, I think it's reasonable to pay about $2,000 in lawyer fees, title insurance, stuff like that and just other fees for closing.

[00:13:11] So when you calculate all that in, and again, let's assume that most people don't pay the CMHC insurance upfront and they just add it to the mortgage.

[00:13:21] Just means that you'll have to come up with $33,375 as a bare minimum to buy the property and even more like we mentioned if you buy an income property that is an owner occupied.

[00:13:34] So if you're buying an income property, you'll have to come up with at least pretty much $110,000 for a half million dollar property.

[00:13:41] That's factor in the 20% down payment.

[00:13:44] So it is and again, obviously with the caveat that depending where you're located across Canada or the different markets, you may be looking to invest in that will vary.

[00:13:54] But for a lot of people even if you know with your $100,000 example, I mean it's still a decent chunk of money for a lot of people, especially as you know cost of living or rising and people have less and less disposable income.

[00:14:08] At some point, I mean you got to find some ways to make money to be able to afford that down payment.

[00:14:15] Yeah, for sure. I think this is really where stocks stand out to me is the barrier to entry is obviously a lot lower and there's really there hasn't in the US it's a little bit different because they have crowdfunding from the Jobs Act.

[00:14:27] But crowdfunding in Canada is you don't get access to as good of deals because our laws are different.

[00:14:33] So I'm not sure if you're familiar with this but crowdfunding US they can crowdfund any real estate deal but in Canada, they're capped at $2 million per issuer.

[00:14:44] So that's the size of the raise so it doesn't really give you access to really good deals.

[00:14:49] And then I think it's 5000 or 10,000 per subscriber per year depending on the type of deal.

[00:14:56] And so you end up it ends up basically just being an investor relations nightmare and and so you it doesn't select for the best deals really.

[00:15:06] So we don't really have a good way to invest incrementally in real estate in Canada.

[00:15:11] So I guess to go back to your example, the one thing that I always insist that people think of is how land transfer taxes are sunk costs.

[00:15:20] So basically like when you're buying this house for $500,000 using the example that you did at you know, 6500 bucks, you're paying 506,000 for this house now.

[00:15:30] Right because so it gets added I would just add that to the price hypothetically in your head and BC it could be up to like $8,000 on a property of that value.

[00:15:39] And so let's say you paid $508,000 now for this property.

[00:15:42] This is where I really want people because a lot of people think about their home as a as an investment.

[00:15:48] And which is fine, I think the home is more of a savings vehicle.

[00:15:52] I think real estate is really good at forcing Canadians to save money by creating a debt obligation.

[00:15:57] But when people buy owner occupied they're typically using mortgage insurance because they're buying higher loaned value.

[00:16:03] So they will typically buy with 8085 90 even 90% 9095% mortgage.

[00:16:11] And I'm just going to run the math on that.

[00:16:14] So for this comes from the CMHC website.

[00:16:16] So at 65% your CMHC premium is only 60 basis points at 75%.

[00:16:21] It's 1.7% at 80 it's 2.4% at 85 it's 2.8% at 90 it's 3.1% at 95% loaned value mortgage is 4% CMHC premium.

[00:16:33] So that's an insurance premium that gets paid one time and gets added to your mortgage.

[00:16:37] And that's a default insurance. So if you stop paying your mortgage the bank takes less risk.

[00:16:41] That's why they're willing to give better rates like the cheapest interest rates in Canada are the highest risk borrowers.

[00:16:48] But it's the lowest risk because they're insured by CMHC by us the taxpayer through Canada mortgage bonds.

[00:16:54] So if you do them that makes you feel good.

[00:16:57] No, it makes me sick and if you I don't know if you guys have talked about the CMB stuff but I mean we haven't but we've talked about it.

[00:17:04] You and I quite a bit. Yeah, yeah.

[00:17:06] I mean it scares me that we can chat on it maybe briefly here so because before I get into this this little thing about the actual risk and equity position that these borrowers are in.

[00:17:16] I mean the government basically increased CMB issuance by 50% so they added 20.

[00:17:23] Yeah, CMBs are Canada mortgage bonds just for those not familiar with the term.

[00:17:27] Yeah. And so what they're doing is they're actually they're issuing government of Canada bonds to get cheaper debt.

[00:17:33] So let's say a government of Canada bond is that like what is the yield for let's just say it's 4% mid threes on the five year.

[00:17:40] Yeah, yeah. So they'll probably right. Yeah.

[00:17:42] Yeah. So they'll issue that bond and they'll pay less interest on it and then they'll use that money that they just raised from from selling those bonds to buy Canada mortgage bonds.

[00:17:52] So that's the idea being like a bit of a spread capture revenue generator.

[00:17:56] But well that's sort of how I think bankers positioned it to them as a good idea.

[00:18:00] But what this really effectively does is it adds a ton of liquidity into the market and it's almost like a bit of a yield curve control.

[00:18:08] So they're introducing a buyer who has not who's not an arms length buyer right a buyer who has a vested interest in keeping the rates down to the market because they're buying their own bonds that they ensure now to reduce functionally reduce rates.

[00:18:21] So it allows these CMHC rates to stay low just for historical context.

[00:18:26] The only time I know I know Braden rags on me for being too bearish but the only time that things like this that sovereign is not here.

[00:18:33] Yeah, exactly. Sovereigns tend to get involved with with mortgage bond purchases.

[00:18:38] The only time that really takes place is usually on the forefront of a bit of a debt crisis.

[00:18:43] So I would just mention that it's very, very similar to the Fannie and Freddie set up in 0708.

[00:18:49] So do you have anything to add on that before I go back?

[00:18:52] No, well just to clarify yield curve control.

[00:18:54] So like kind of the yield curve control in the truest sense is you have like the Bank of Japan has been famous for doing this.

[00:19:02] So essentially they'll establish an interest rate for longer duration bonds.

[00:19:07] Usually that's what they'll establish and they will the central bank will intervene and buy essentially whatever they need to buy in terms of government bonds to make sure that they're not going to be able to get into the market.

[00:19:18] So that's what they'll do is they'll establish a long duration government bonds to make sure that the interest rate is at their target rate.

[00:19:25] So it's it's manipulating rates to make sure that they don't go above a certain amount.

[00:19:31] You can essentially the way I like to see it.

[00:19:33] It's basically quantitative easing on steroids because quantitative easing usually they will obviously impact.

[00:19:40] There'll be a buyer of long duration government bonds.

[00:19:43] They can buy other assets, but we'll stick to those right now.

[00:19:47] In my mind, they'll typically intervene if there has not been enough demand from the private markets for that debt.

[00:19:52] Whereas yield curve control, they basically have no set amount that they need to buy.

[00:19:56] They just have a target interest rate and they will buy until that interest rate reaches that number.

[00:20:02] Yeah, well said.

[00:20:04] Yeah, so do you think then that the objective here would be to kind of stimulate the housing market a little bit or at least add a little bit of liquidity there in the absence of it?

[00:20:14] I mean...

[00:20:15] Yeah, I think that's probably the end game for sure.

[00:20:19] I mean, I think they're trying whatever they can.

[00:20:23] I think they probably realized that there was probably some...

[00:20:27] I'm assuming banks were probably a bit more reluctant to potentially issue mortgages and that's a way for them to get those mortgages off of the books of the banks

[00:20:37] and make sure that the banks have more money to be able to loan to individuals and businesses.

[00:20:42] Yeah, well, individual or investors.

[00:20:45] Yeah, I think a lot of people don't know that CMHC also functions as a lender for multifamily properties or not a lender, sorry, an insurer.

[00:20:54] So they have a multifamily product called MLI Select, which MLI just stands for Mortgage Loan Insurance.

[00:21:00] And they actually insure the same way that they would insure borrowers in the owner occupied market.

[00:21:06] They will insure builders or investors who own multifamily rental properties.

[00:21:12] And so I think the objective of the government is to, for all of that capital, probably to go towards purpose-built rental construction.

[00:21:19] But the reality is it's the same capital pool and the banks are going to lend to what makes the most sense as the easiest to deliver to them.

[00:21:26] And that's certainly going to be the marginalized first time homebuyers who are fired up to finally get in the market after everything.

[00:21:33] So on that note and to just illustrate to people what that would look like for them, if you borrow had a 95% loan to value.

[00:21:43] So if you're buying a property with only 5% down, you pay a 4% CMHC premium.

[00:21:47] So you don't have to be a mathematician to see that that kind of cancels out and you have only 1% equity left before realtor fees and closing costs.

[00:21:57] And that's also before considering the sunk cost of land transfer tax that I mentioned.

[00:22:02] So functionally, when you take possession of the house, you're actually in a negative equity position.

[00:22:08] Because I would say I'll add the realtor fees and stuff after but at a 90% loan to value, 10% down,

[00:22:15] you're adding 3.1% CMHC premium to the price. So you have about 6.9% before realtor fees closing costs and that sunk cost of land transfer tax on the way in.

[00:22:23] So if you say 5% to the realtor, 2 grand for the lawyer, you're still in a negative equity position at 90% loan to value.

[00:22:31] At 85% loan to value, that's kind of where you start getting into positive equity position.

[00:22:37] So 15% down, 2.8% CMHC premium, you have 12.2% equity before realtor fees and closing costs, which is about 5% to grand.

[00:22:46] And so only at that 85% loan to value do you start getting into a positive equity position as an owner occupied buyer.

[00:22:53] That's just something that I want people to be aware of when we kind of transition this discussion into leverage because while leverage gives you the ability to supercharge your investment by reducing the amount of money that you have to put in.

[00:23:04] It also supercharges the risk, right? High risk, high return seems to be the trade off.

[00:23:08] Yeah, and especially when you have almost no equity or zero equity or negative equity, I think a lot of people say, well, as long as house prices keep going up, I'm fine.

[00:23:18] I would add to that as long as you also keep your job and your income sources, you're fine.

[00:23:23] If one of those two variables happen or if both happen at the same time, we've seen in the last year, year and a half, a lot of people,

[00:23:31] I mean, you don't have to look very far. Just go on house Sigma.

[00:23:34] You can go if it was any kind of relatively large shitty at least in Ontario.

[00:23:40] You'll be able to see people that actually bought homes and sold them at a loss because you can assume whatever you want what happened.

[00:23:50] But I would say either they had a variable rate that they weren't able to keep up with or there was a loss of income and they weren't able to keep up with it.

[00:23:57] And then they had to literally take a big loss and most likely got their whole investment wiped out, especially if you're taking a 20% to hit and then some.

[00:24:06] Yeah, exactly.

[00:24:10] Anything else you want to add or?

[00:24:12] No, I think it's a good...

[00:24:13] The fun topic of leverage?

[00:24:15] Yeah, I think it's a good segue into leverage for sure.

[00:24:18] Yeah, so leverage, like you mentioned, you alluded to, it can be a great thing or a terrible thing.

[00:24:23] It definitely amplifies your gain and amplifies your losses.

[00:24:27] And sometimes I feel like depending on who you talk, people tend to focus on the gains being amplified and there's not much discussion on the losses being amplified.

[00:24:39] I would say even more so if we looked at pre, what?

[00:24:43] Pre-February 2022?

[00:24:45] March?

[00:24:46] Pre-March 2022?

[00:24:48] It was basically you're stupid to not use leverage because you're just going to get rich.

[00:24:52] Is that a good way to summarize it?

[00:24:54] Well, yeah, I mean, I think it was basically your real cost of capital so adjusted for inflation was so offside that you're functionally borrowing money at negative rates.

[00:25:06] And so you could buy a TV and it would hypothetically go up in value because of inflation.

[00:25:11] So yeah, it was financially irresponsible to not lever up at that point in time.

[00:25:17] Yeah, I mean, I guess yeah, I probably maybe I'm just too conservative.

[00:25:23] But for me, definitely I saw a lot of warning signs and I'm not just saying this for real estate here.

[00:25:30] This was also true for stocks because you can buy stocks and a lot of financial products that you'll find in your broker on leverage as well.

[00:25:39] So I'll just give an example because sometimes I find people don't fully understand how leverage works.

[00:25:45] So say you buy a home for a million and you put $200,000 down, we'll just keep it really simple.

[00:25:50] We'll just forget about the fees here.

[00:25:52] You have an $800,000 mortgage because it's a million minus the $200 down.

[00:25:57] The home goes up 20% in value.

[00:26:00] It's not worth 1.2 million.

[00:26:02] And you've now doubled your initial investment since you have $400,000 worth of equity, which is double what you put as your down payment.

[00:26:10] So who would not like that?

[00:26:12] Right.

[00:26:13] That's like the perfect outcome right there.

[00:26:14] But then the other way around, you bought the same home for a million.

[00:26:18] You put $200,000 down and I unfortunately a lot of people who bought in late 2021, early 2022 are probably in a situation like this.

[00:26:29] Maybe not as much now because I think prices have picked up a little bit depending on the area.

[00:26:34] But you have still the same $100,000 mortgage on the property.

[00:26:39] But now the home goes down 20% in value is now worth 800,000.

[00:26:44] Your equity is completely wiped out and that investment you made is now worth zero, which is probably not a bad outcome for some people compared to what I've seen at the very least.

[00:26:55] For sure.

[00:26:56] I mean, I think, you know, you imagine now imagine those same numbers if you put a smaller amount down, right?

[00:27:03] Like if you only put, if we use the 500k example, if you only put 5% down and it's gone down 20% in value.

[00:27:13] Now all of a sudden you actually can't even sell the property because you would have to fork out all of that negative equity to the bank to exit.

[00:27:21] Like you still have to pay off the remaining debt that you owe them.

[00:27:24] And so that's probably the more extreme situation that you're describing.

[00:27:30] So I mean, I think that when I think about real estate, the primary advantage of it is access to leverage.

[00:27:39] And it's not just access to leverage because I know you're going to discuss like people can trade on margin and there's a couple of examples that I have where stocks also carry embedded leverage within them.

[00:27:51] You know, REITs as an example are taking on their captain 65% leverage I think based on their legal structure.

[00:27:59] But like junior miners or 10x or whatever, right?

[00:28:02] So you can access leverage in the stock market, but I think that it's the structure of the debt.

[00:28:08] It's also the 25 year amortization and that you're not on this callable credit product.

[00:28:12] But the fact that you're on a credit product that has a fixed five year term with it, like they're very, it's very favorable debt term.

[00:28:19] So it's basically giving you access to probably the most favorable credit in the market.

[00:28:23] So it's not just purely the leverage, it's also the type of leverage and the nature of it that I think makes real estate compelling when you think purely about leverage, right?

[00:28:33] Yeah, exactly.

[00:28:34] I think people automatically associate real estate with leverage, but definitely like you're right.

[00:28:40] You can definitely access leverage if you want to buy stocks.

[00:28:43] And I think that's why it's important to talk about it because there's this conception that, you know, you can just just buy stock with money, especially if people are getting, you know, started and investing.

[00:28:54] But you there's different ways that you can invest on leverage.

[00:28:57] I mean, one that was popular, not so much anymore because it's, I think not not very advantageous to do so.

[00:29:06] But the smith maneuver where you could essentially use your HELOC, your home equity line of credit, borrow off of that and then invest the money into stocks.

[00:29:15] And then you're able to, I think deduct the interest income off of it, something like that.

[00:29:21] That's good.

[00:29:22] Yeah, basically because it's because it's yeah, so any of the income that you're earning from the stocks or whatever you use that with the investment income.

[00:29:31] So stocks, dividends, real estate, whatever you can deduct the interest costs as a cost of doing business against the income from whatever you use those funds for.

[00:29:41] Yeah, and that was pretty popular.

[00:29:43] But I've seen people who have been honest with this strategy and it used to do well for them.

[00:29:48] And now it's a bit more of a struggle because the HELOC is typically what prime plus couple percentage points.

[00:29:55] So you're looking probably at 7-8% right now if not more.

[00:29:59] Yeah, I think it's funny like an easy way to think about this is a lot of people use HELOCs to lend out money as private lenders as well.

[00:30:07] That's like the great Canadian carry trade right?

[00:30:09] Like it really is and so.

[00:30:12] Oh yeah, that's not scary at all.

[00:30:14] Yeah, I know.

[00:30:15] And well you think about how many did that and then how many also did it to purchase pre-construction condos, right?

[00:30:22] Like when you really think about the exam and where a lot of these funds from HELOCs were going, it starts to make you lose sleep at night a little bit.

[00:30:30] But I think that that's a good example because if you use a HELOC and you're at prime plus 1-2, maybe prime plus a little bit, some spread 3-4, whatever it is.

[00:30:43] You know, you started at TD's prime was what at the bottom 3% so you're paying like 3-5% and lending out money to somebody at 10%, 12%.

[00:30:55] And then all of a sudden in just one year, like you could have lent money out in 2021 at the end of 2021.

[00:31:04] And by the time that mortgage came up for renewal because typically when you lend a private mortgage out, it's on a one year term, you had no incentive to renew because your capital cost has now gone from 5% to 8%.

[00:31:18] HELOCs are basically in the 8th now, mid 7th to 8th.

[00:31:22] So it's also taken a lot of that rescue liquidity, that private debt out of the market as well.

[00:31:30] Yeah, yeah exactly.

[00:31:31] And if we come back to the stock markets, obviously the same kind of pros and cons happen with leverage.

[00:31:37] So obviously it can supercharge your returns but it can also really magnify your losses.

[00:31:43] You can also buy on margins.

[00:31:45] There's going to be different requirements.

[00:31:47] I think depending on the broker, it may be 30 to 50% requirement, but that's just people can still do that.

[00:31:55] You'll be able to do that in a margin account.

[00:31:57] So it's not just specific to real estate, but that's something I've stayed away from just because you have to come up with the money somehow when you're buying a stock and it goes down in value.

[00:32:07] Either they'll use the collateral that you have against it and the existing stocks that you have or they'll ask you to put money.

[00:32:15] If not, you'll have to liquidate some stock which if it's gone down in value, it's oftentimes not the best time to be selling stocks.

[00:32:24] It's definitely something that can be pretty dangerous in my opinion and I mean Warren Buffett says that all the time.

[00:32:31] And in terms of stats, I've seen, I don't know the exact numbers but the Ontario Securities Commission did with Lyceum at Marketing research a couple years ago.

[00:32:40] And I think they said at the time there was about 20% of retail investors that were using some form of leverage, whether it was getting a loan, whether it was using HELOC, whether it was using margin.

[00:32:52] So I think at the time, obviously there was a lot of hype in the market.

[00:32:56] So it may be closer to 10% now, it's hard to say, but maybe a 10-20% range that people are using leverage.

[00:33:04] So it is definitely possible, but again, I think it's important for people to understand the pros and cons.

[00:33:10] Unfortunately, I think with the current environment, a lot of people may resolve to getting leverage because they want to become rich.

[00:33:17] And one of, I don't know if you were aware of that, but I know you know NVIDIA stock and there's actually like a recently created NVIDIA 3X levered ETF that people can buy, which is obviously not risky at all.

[00:33:33] And I'm being sarcastic here.

[00:33:35] Yeah, I thought this was the lever up in YOLO show. I must be on the wrong podcast.

[00:33:40] Yeah, pretty much.

[00:33:42] It is funny. I'm going to mention this when we talk later about the sort of fourth section, which is liquidity, but you mentioned not selling at a loss and me, like I'm a buy, what is it? Buy high, sell low guy.

[00:33:58] The opposite of what you're supposed to do, right?

[00:34:00] Like that's most people in stocks. That's why I don't do well in stocks.

[00:34:04] And like I can usually do, you and I have talked about a couple of these trades like insurance policies or like trades against major macro moves.

[00:34:14] But usually if I'm trying to buy an actual stock, like actually invest in a company, I'm usually going to find a way to get into the red and then I'm going to sell at a loss.

[00:34:21] And real estate when we talk about the liquidity portion almost prevents you about that a little bit or prevents you against that a little bit because it forces you to diamond hand stuff because it's not as easy to sell.

[00:34:32] So I thought that was kind of funny, like the switching costs alone while they're a burden, they can also be a bit of a blessing.

[00:34:38] Yeah, I think that's 100% true. Yeah, definitely.

[00:34:41] I think it has a lot to do with temperament obviously. And just the fact that you can see when the markets are open, you can literally take your phone and refresh the stock every single second.

[00:34:53] And you can see the price go up and down whereas real estate, I mean you can have a ballpark idea of probably what the real estate you own is worth.

[00:35:02] But you don't have a minute by minute realtor.com or whatever site where like, oh, here's the real time value of your real estate that's not happening.

[00:35:13] You can look at comps and have a general idea but you won't know until you sell it.

[00:35:18] Well, and I think that leverage plays an interesting role in this respect where it also, like I was talking about how the nature of leverage it does give you access to really good leverage from a rate perspective and a loan value perspective.

[00:35:31] But the other piece is you're on a monthly payment schedule. So in order to really catastrophically blow up a real estate investment, it actually takes a long time because a lot of people, and we're seeing this in the current market,

[00:35:43] mortgage delinquencies are just starting to rise even though they probably should have been rising two or three years ago because people only have to pay their mortgage on a monthly basis.

[00:35:52] And so a lot of people can scrape together some money or go borrow from a friend or whatever it is to make a payment. And then it takes them, they're able to kind of white knuckle it and hold on.

[00:36:03] And the other piece is that typically if you're breaking a mortgage, if you bought on a fixed mortgage, you have a cost to get out of that mortgage.

[00:36:13] Usually you have to pay a prepayment penalty or a mortgage discharge penalty.

[00:36:17] Even on variable rate mortgages, which are technically open, there's still a small fee to exit. And so that adds into the switching costs of selling your real estate asset, which makes it less compelling to sell.

[00:36:30] And not only that, but also you'd have to stock, you put it on the market hypothetically through your broker and it's gone by the time you click the button.

[00:36:40] Right. And a real estate asset, even in a hot market, it's still you got to declutter, you got to move a bunch of stuff around, clean it, maybe paint it, do some repairs, put it on and all of a sudden you're a month's gone by and then it has to sit on the market for a week or two weeks or a month.

[00:36:58] And so you really have to be committed to be exiting a real estate asset. And you have to be committed to failing to pay for it too, to blow up the position because you have to not be scrambling to just make that one extra mortgage payment.

[00:37:14] Right.

[00:37:15] Yeah. And I'd be remiss if I didn't say that according to the Financial Consumer Agency of Canada, selling your home when you're actually underwater is probably not the best idea. That's the

[00:37:28] Did you see that video? They added it to the website.

[00:37:31] Yeah, I know that I saw they added. So just for some context Dan made a video on this Canadian government of Canada agency and basically they were like, you know, talking about what if you're having trouble making your mortgage payments, all the things you can do.

[00:37:47] Well, one of the most obvious things and I went through that myself about five years ago for a home I used to own where not that I couldn't make the mortgage payments but I was at the point was like, you know what? This is too much trouble.

[00:38:00] I've, you know, put some money in I will never like I may get it back at some point but I think the best option for me right now is just to selling this property, get rid of it and then use the money to invest somewhere else.

[00:38:13] That's what I did but it was interesting to see that apparently that's not what people should do when oftentimes it's probably the best option because if you're really struggling to make your mortgage payment, you probably can't afford the home.

[00:38:27] Right. Yeah. And I would say that's that's on a personal basis like on your primary residence but also on an investment property like if you're purely thinking of an investment property from a business perspective.

[00:38:37] And this is one of the differences between real estate and stocks I think is that you can like you can actively manage the asset. And so if your investment property is really underwater, you know, you have options.

[00:38:50] Selling is usually the option that ends up being the least friction to get out of a bad position but you could if you have a single family house as an example and it's and because of the mortgage product you chose it's now cash flow negative, you know, $500 a month.

[00:39:05] You could also spend more money and put a basement apartment in it as an example. And now you're adding to the value of the property but you're also adding to your exposure, you're increasing your position, but you're also increasing the yield of the property and increasing the value of the property.

[00:39:21] You could also add a detached accessory dwelling unit like garden suites which are incredibly popular right now they're in a lot of cases fully financeable for good borrowers let's call that because that's an important distinction the person I just described who needs this to make their asset work might not be able to get the credit but you could add a

[00:39:41] garden suite and add you know $1500 to $2000 worth of rent to the property. These aren't options that you have where you can actually inject more money I mean I guess you could average down if your investment is bad in stocks that would kind of be the best comparison, but you

[00:39:55] know what I mean like unless you're Warren Buffett go to the shareholders meeting and tell the person how to run their company better right so that's the active management pieces it's a blessing in a curse because you have to actively manage it as well you have to go collect the rent checks you

[00:40:08] know do the maintenance etc which we're going to talk about a little bit further but but you you you have so you have the luxury of being able to improve the investment but you also have the burden of being able to improve the investment right yeah exactly and I think before we move on to our next

[00:40:22] section because we weren't sure if we were going to do this in two separate episodes or not but given that we're probably a third to close to half of the way through and already more than 40 minutes in I think we'll do this in a two part episode then is that

[00:40:37] that makes sense okay okay sounds good so you'll be hearing this episode on the Canadian investor podcast and we'll have the second part of investing in the stock market versus real estate on the Canadian real estate investor podcast

[00:40:51] perfect we haven't figured out the release schedule just yet but we'll make sure that you're aware once you listen to that we'll probably put a little intro just to give people a context and where to find the first episode if they come across the second one first and vice versa so we'll see you on the other side

[00:41:09] we'll call it you know a day for the first part of the episode and we'll see on the next side for the second part

[00:41:17] the Canadian investor podcast should not be construed as investment or financial advice the host and guest featured may own securities or assets discussed on this podcast always do your own due diligence or consult with a financial professional before making any financial or investment decisions