Thursday, June 17, 2010

Where are some insights in risk or assessment of risk ?

[quote name='Thomas' date='Jun 12 2010, 11:53 AM' post='87475']

Where are some insights in risk or assessment of risk ?

Getting back to Thomas' earlier question. I have done (and posted here on the forum as well as on my blog) some 'research' in comparing real estate and stock market risk. Over the last 30 or 40 years, both real estate and the stock market have appreciated annually between 6 and 8%. Also the cash on total investment (cap rate vs dividend yield) are not that far apart (around 4%).

When you compare the volatility, surprisingly it is similar as well (unless you use leverage which results in an amplification on your net worth - both positive and negative). The perception that the stock market is more volatile than real estate may be caused by stock market prices being reported on a daily basis versus monthly or even slower when dealing with real estate.

In fact, as a result of my 'research', I personally have added some leverage to my stock market holdings. Especially on U.S. stocks. I buy when the Cdn dollar is low with borrowed money and I pay off the loan when the Cdn dollar is high vs the U.S. These dollar fluctutions are short term ( 2 to 3 months) and I can make 4 to 6% profit following this strategy. That is 4 to 6% per 3 months or 16 to 24% on an annual basis ( minus 3.5% interest on the borrowed money).

Right now, the stockmarket is more profitable for me than real estate. Calgary/Edmonton rents are falling and so is my cash flow. Real Estate prices are also still falling. The stock market is in slow recovery with temporary set backs such as last month's European crises - i.e. buying oportunities and high dividend yields.

Risk or volatility are not an issue if you look at your overall portfolio over the long term. If you invest in stock market indexes or REITs it is easy to diversify. The real risk or volatility lies in when you are not enough diversified. When all your money is concentrated in this one dog property or stock. 5 to 10% citywide vacancy is not bad, but if you happen to own the one that is vacant you have a 100% vacancy. To concentrate your money all in BP stock is kind of similar.

With a stock market portfolio it is easier to diversify than with real estate. When you use leverage you need to be able to weather some big net worth or equity swings. So, from my personal experience, I think that real estate is just as risky if not riskier than the stock market. But you are in control of the asset and in the worst case you can actually live in it. I know nobody who because of bad cash flow moved into the offices of the Royal Bank or of any other stock issuing corporation.

It is also a lot easier and cheaper to get loans for real estate than for stocks. Most stock brokerages allow a max LTV of about 50% and at short term rates of around 375%; compare that to variable rate mortages (1.85%) and to investment properties where your LTV may go as high as 80% (with CMCH insurance).

I also think, as Thomas mentioned earlier, that it depends on the investor and his/her investment skills. For me right now, it is a 'toss-up' and it seems that no matter where you go, your return on PASSIVE investments (i.e. not including your labour), always hovers in the 9-12% range these days - that is the market rate in both real estate and in the stock market.

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