Are Real-Estate Returns Overstated?

Leaving out major renovations expenditures when calculating real-estate returns is a bit wacky… but that’s how everyone does it. Don’t shoot the messenger!

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 Okay, I almost didn’t put out this video because I don’t feel like getting yelled at in the comment section. I’m about to say something a little negative about real-estate returns, and I know that in Canada, where many feel almost a spiritual connection to real estate, I’m going to get smacked. But take it easy on me.

I’m old. Plus, what I’m going to say is true. And I’m not saying that real estate hasn’t been a good investment. I am not speaking out against homeownership. I am pro homeownership for many, most. So, those disclaimers made, here is my observation. Oh, oh, first, speaking of real estate, watch or listen to episode eight of the Wealthy Barber podcast with the king, Ron Butler — great stuff! Okay, some people, strike that, many people feel they’ve done much better in real estate than they actually have. Again, I’m not saying returns have been poor. I’m saying returns have often been poorly calculated. Let me use a real-life example to illustrate my point. A friend and his partner bought a place for $480,000 ish 18 years ago.

Today it’s worth just under two million. Wow! Incredible! And a tax-free gain to boot — principal residence. What kind of return does that represent? Well, he argues, two doubles in 18 years, so a double every 9 years. Rule of 72 says that’s about an 8% average annual return. Nice. Except three little facts got left out of his analysis.

They did $100,000 in renos just after buying. Then $250,000 more in a major reno in 2018 and recently spent over $100,000 on their backyard (landscaping and pool). Hmm, shouldn’t that have been factored in the returns math? Of course it should. That’s common sense. Now again, I’m not saying the home hasn’t been a wonderful purchase.

Many will point out that the money they initially put in — the down payment — was probably only about 20% of the purchase price. And they’ll also argue the mortgage cost was in essence their rent. And of course they’ll add to that, that the mortgage itself will be paid off soon, and calculated properly, all this math is still quite compelling.

Hey, for the most part, I actually agree with those arguments. I own my home and I’m glad I do. But I’ll stick with my point that leaving out major reno expenditures when looking at returns is kind of weird. And I really see this when some friends talk about their ROI on their cottages. Wacky examples there. Okay, fire away. No, don’t actually. I’m tired.