With (still) historically low interest rates, Norwegians are looking for alternatives to traditional bank savings. A question that often arises is whether to invest the money in the stock market or in real estate. Although these are two very different things, the two are often set against each other.
The Norwegian Association of Mutual Funds (VFF) asked a few years ago what Norwegians thought would increase most of housing and equity funds in the short and long term.
According to the respondents, "own home" was not only the investment that would give the highest return, but also the one with the lowest risk!
- Norwegians thus disregard the financial theory, which states that it is not possible to achieve a high expected return without at the same time taking on a large part of the risk, said director of VFF, Bernt S. Zakariassen
Another example of people's general understanding of risk is the couple who in 2003 won NOK 2 million in "Do you want to become a millionaire" on TV2.
They were asked what they should spend the money on. (1 minute earlier they gambled NOK 1 million with the risk of being left with only NOK 100,000).
The answer was; "In any case, we will not invest them in equity funds". Bad luck, because if they did, they would be sitting with about 8 times as much money to this day.
If we look at data from the turn of the millennium, however, we can see that housing has actually given a better return than shares. So maybe Norwegians' perception of investing in real estate is not so stupid after all?
Source: Nordnet
We look at the calculation if you had invested in housing versus the stock market in the period 2008-2018 with a specific example. In 2008, debt-free Ola Nordmann decided to invest his savings in both real estate and in a global equity fund. He had NOK 1,500,000 in his bank account and wanted to invest 750,000 in both shares and real estate.
During this period, the global world index (MSCI All Countries World Index) has given an average of 7.02% in annual return. This period also includes a large stock market crash of -42% in 2008. The housing market has given an annual average return of 5.43% (Your Money) in the same period. However, it is worth mentioning that if you look at an even larger period of time, the best return will go in favor of shares with a good margin.
Source: Nordnet
But back to Ola Nordmann who in 2008 invested in both shares and real estate. By investing in a global index fund, Ola Nordmann would in 2018 have a shareholding worth NOK 1,478,123.52. In other words, almost a doubling of their money by doing nothing but having ice in their stomachs when the financial crisis hit hard.
But how has it gone with the housing investment? We have used the rental housing calculator for Smart Money to find out how much you can expect to get in return on housing investment.
In other words, the 750,000 would have grown to NOK 1,808,371 in 2018 with an annual return on equity of 9.2%, which is significantly more than what you would have received if you had invested in the stock market. One mistake many people often make when calculating the expected return on housing investment is to forget the costs associated with this. If you leave out the costs, the expected return will be higher. This can also apply to investments in equity funds, where costs can quickly be forgotten.
In the light of hindsight, the housing investment turned out to beat Ola Nordmann's equity investment. The last few years have been exceptionally good for the housing market, but as shown in previous graphs, equities have historically been "the place to be" if you have sought the highest possible return. The example above is comparing apples and pears. When the real estate investment is mortgaged, both the expected return and risk will be higher. Getting a higher return without taking on a higher risk goes against financial laws of nature. So how would it have gone if the equity investment had been mortgaged to the same degree, on the same terms as the housing investment? Using the same calculator as in the example above with an investment of NOK 3,000,000 in global shares where 750,000 is equity financed and the rest is mortgaged at an interest rate of 3.91% pa, this would give a return on equity of 13.2% and the 750,000 in 2008 would have been NOK 2,591,346 in 2018. That is more than what you would have received on a housing investment (which is mortgaged to exactly the same conditions).
Many people will swear by real estate in front of stocks, and there may be several reasons for just this. One of the main differences between a stock and a property is that you can physically see and touch the property. It will be there "anyway". Stocks are abstract and not something you can see daily. Fluctuations in value are also something you see daily on the minute everywhere in the media. No one receives daily visits from the appraiser who tells you how much the property has risen or fallen in value from day to day. This is a very big topic, and something I will come back to in a new post soon.
To conclude, many of these comparisons that are often made are poor comparisons when comparing apples and pears. The vast majority of housing investments are mortgaged, which leads to higher returns and at the same time higher risk. The same will happen with the return on the shares if they were also mortgaged. There is no doubt that it has made sense to invest in housing over the past twenty years, but if you look at a housing investment without a mortgage, shares would still have given a higher return. It is with mortgaging that you get a higher return on housing than shares, but then you have to compare with mortgaging on shares which in turn would have given an even higher return. Shares will fluctuate more in value than homes. There are several reasons for this, including the fact that shares are bought and sold much more frequently than real estate. In 2008, the world index fell by just over 40 per cent. But the real estate market was not untouched and in fact fell 18% inflation-adjusted between 2007 and 2009. In the late 80s and early 90s, the real price of housing also fell by 42.2%. With the exception of the financial crisis, the housing market has been rising since 1993, but this is something I will return to in a later post.
If you have a longer perspective on your money, maybe stocks are the best option? It is probably no coincidence that the world's best investor Warren Buffett has said that on the day he dies, 90% of his wealth will be invested in an equity index fund.
Tobias Aardal, Noon Invest