Why a Primary Residence is often the Best Investment for Everyone
An Introduction to Financial Leverage
As discussed in this prior post, after evaluating our volatility profile, my wife and I felt comfortable moving forward with a 100% stock allocation. This was decided right after a period of precipitous stock market decline of 2008-2009 when fear of stocks and global economic collapse was high. Everything I could read told me this period of fear would be an incredible opportunity to begin our portfolio at a time when the stock market was cheap. I felt my future self would thank me tremendously for allocating as much savings as possible into the stock market at these significant lows. Real estate had also been booming in North America and it was hard to figure out how to decide on a focus to invest in the stock market or direct those funds to real estate.
Real Estate - The Best Investment of the Baby Boomers?
I had been reading quite avidly about real estate investment properties as well during this period. Almost every baby boomer I met would tell me that their stock portfolios gave mediocre results, but real estate had worked every time. I found this incredible since interest rates on average during the 1970’s - 1980’s was 11-14% in Canada which seems like an incredibly high hurdle rate cost associated with the growth of an asset. I had read literature on long term investment returns for real estate averaging around 4-5%/year compared to stocks in the 6-8% range and had difficulty reconciling this discrepancy. The tendency to say real estate was superior for the average investor comes from 2 main reasons:
1. Investor Behaviour
The volatility profile of real estate tends to go through much longer periods of steady lower growth followed by protracted periods of flat to mildly declining markets. This leads to a smoother return profile than the lumpy returns of stocks. There can still be periods of real estate speculation and excess that leads to more volatile losses such as in the US real estate bubble or what may occur in the Vancouver and Toronto markets within Canada.
Most people hold all their real estate exposure within their primary residence. A smaller percentage will be lucky enough to have a 2nd vacation home or cottage. An even smaller percentage buys real estate as a separate investment class via acting as a landlord of an investment property. When the real estate is a primary residence, it holds sentimental value. It isn’t viewed as a disposable asset in the same way a stock or bond is. Market panic leading huge swaths of people to sell their primary residence will not occur, because most don’t view it as an investment until they are retired and the property becomes too large or difficult to manage.
This view creates perfect investment behaviour. A long-term investment orientation is assumed, and the rational behaviour is encouraged by society. Can you imagine family and friends’ response if you decided to sell your house after your annual property notice showed a decline in 10-15% value? It also takes significantly more effort to sell real estate as it proceeds over several months. This makes it an illiquid asset, which likely will lead to more rational analysis to buy and sell.
Stocks have a larger absolute percentage swing of gains and losses that lead to fervent buying and selling at the wrong times. They are also highly liquid, which means fear or excitement can quickly be turned into action. There is excellent evidence that stock market investors achieve lower returns than the quoted returns of their funds because of poor behavioral choices in buying and selling.
2. Leverage
Investor behaviour has a definite influence, but the dominant reason real estate is often the best investment a person makes in life is because of leverage. Leverage is simply borrowing to invest and has many different forms.
Society has become so accustomed to a home purchase requiring a mortgage that the leverage component is often ignored. Down payments in the 1970’s and 80’s were often in the 20-35% range because mortgage interest rates were so high as noted above. This compares to the last 20 years where down payments of 5% became common. It is important to recognize how significant the absolute level of leverage is when it comes to the purchase of a primary residence. A key understanding in future posts that I’m hoping to demonstrate is that conservatively financed leverage employed with optimal investor behaviour can lead to incredible long term results even when short term interest rate costs are very high.
Home Ownership Leads to Optimal Behaviour in the Setting of Extreme Leverage
Let’s imagine a hypothetical home valued at $400,000 that is purchased with 20% down purchased by Brad. I will assume mortgage payments and housing maintenance costs paid during ownership is the same as if Brad decided to pay monthly rent. We will also ignore principal payments made on the mortgage just to keep the concept simple.
It leads to an $80K down payment and a $320K mortgage.
An overall home price increase of 25% from $400K to $500K over 5 years would a CAGR of ~4.6%/year. This is well below long term stock average returns in the 6-8%/year range. Yet it is imperative to recognize that Brad only used $80K of his own money to purchase the asset.
Therefore, to sell his home after 5 years it would be:
$500K sale price - $320K mortgage - $80K cost basis = $100K profit (ignoring selling costs)
Turning $80K into $180K in 5 years is a phenomenal 17.6%/year CAGR investment return! Being able to borrow to invest has magnified the actual return significantly. It is important we recognize the absolute leverage being employed on this transaction to achieve this result.
With a 20% downpayment and 80% being borrowed, Brad has 5:1 notional leverage or 500% levered on his original $80K cash asset. This is an enormous amount of leverage! (2025 Update - this makes me gawk when we think 5% downpayment became common through the 2000’s and finally needed regulatory capping in the last decade. A 5% downpayment is 20x leverage or 2000% notional leverage!)
Leverage does come at a cost – the mortgage paid the bank a hefty amount of interest over the 5-year mortgage term. If we assumed a 4% interest rate, Brad would have paid around $37,000 in interest. Conventional wisdom has typically ignored the view that mortgages have leverage cost, because the interest cost is viewed equivalently to the basic cost of shelter. A roof over your head is a necessary expense and rent is seen as a permanent loss of shelter cost, while home ownership is seen as providing forced savings over the long term. I think the cost of renting is often lower than the annual cost of home ownership especially when considering maintenance, property taxes and accounting for personal time expenditure, but that can be for a different post.
If Brad chose to keep the home and enjoy a 4.6%/year increase in home value over 25 years of slowly paying the home off, the final value of the home would be ~$1.23 million.
Doing the same math on his original $80K purchase price, the levered return would be 11.55%/year which is still quite impressive. This return rate is lower than the 17.6%/ year rate because the degree of leverage diminished over time as the house was being paid off. This is because the borrowed amount keeps reducing as more principal is paid.
Home owners benefit greatly from housing leverage precisely because it doesn’t feel like borrowing to invest. It is rationalized as the requirement to purchase long term shelter which is a fundamental necessity.
Leverage does cut both ways however when asset prices decline. A 10% housing decline in 1 year is totally reasonable. In Brad’s case, a 10% decline on his home of $400K is a $40K loss in value. On his originally $80K investment or 20% down payment, this is a 50% market loss! (2025 Update: at 10% down payment this is 100% market loss of his original investment!)
A 50% stock market loss would be amongst the worst possible results and leads to market panic. Yet in the housing market, this decline would barely make people bat an eye. The requirement for housing and long-term belief in real estate keeps Brad from doing anything emotional. He maintains an appropriate long-term outlook of a patient investor and rides the temporary blip.
The Baby Boomer Real Estate Math
AI can be a great resource to run random projections and also to analyze historical data. I haven’t fact checked the whole dataset, but I’m positive the info is directionally correct and can act as guidance regardless of what real estate market or broad based stock index you wish to compare against.
The prompt given was:
“What has been the average cash on cash return for a primary residence in Canada from 1982 (my birth year and happened to be when my parents bought their first house) assuming a 20% downpayment and a 35 year holding period”
Answer:
“ Calculating a precise historical average for Cash-on-Cash (CoC) return on a primary residence is complex because CoC is typically a “rental income” metric. For a primary residence, the “income” is the imputed rent (the rent you save by not living elsewhere).
However, we can calculate the Annualized Cash-on-Cash Return by looking at the total profit upon sale relative to your initial cash investment over that 35-year period.
The 35-Year Case Study (1982–2017)
Based on historical Canadian real estate data, here is how the math breaks down for a home purchased in 1982 and sold 35 years later in 2017.
Variable 1982(Purchase) 2017 (Sale) Average Canadian Home Price ~$71,000 ~$510,000 Initial Cash Outlay (20%)$14,200 — Mortgage Amount (80%). $56,800Paid Off Estimated Total Profit. — $439,000
Calculating the Return
If you invested $14,200 in 1982 and ended up with $439,000 in price appreciation alone (ignoring the principal you paid down, which is also yours), your total return on that initial cash is roughly 3,091%.
Simple Annualized Return: Over 35 years, this represents an average annual return of approximately 10.5% to 12% on your initial cash.
The Leverage Effect: While the property value grew by roughly 5.8% annually, your cash-on-cash return is nearly double that because you only put down 20%. This is the power of leverage in real estate.
Critical Factors to Consider
Mortgage Rates: In 1982, 5-year fixed mortgage rates in Canada averaged a staggering 18% to 19%. While price appreciation was high, the “holding cost” in the early years was massive.
The Principal Paydown: By year 35, the mortgage is gone. Your “return” includes the $56,800 of debt that was paid off, which effectively acts as a forced savings account.
The “Tax Free” Bonus: Unlike stocks or gold, this gain is 100% tax-free in Canada due to the Principal Residence Exemption. To get a similar net return in the stock market, you would need a much higher gross return to account for capital gains taxes.
Note on Imputed Rent: If you factor in the “saved rent” (what you would have paid a landlord over 35 years), the effective Cash-on-Cash return often exceeds 15% annually, as the shelter benefit usually covers the cost of property taxes, insurance, and maintenance.
Would you like me to run a comparison of this return against the S&P/TSX Composite Index for the same 35-year period - Yes
Comparing real estate to the stock market is a battle between Leverage and Compounding.
When you use 5x leverage (a 20% downpayment) on a home, you are amplifying a lower growth rate. When you invest in the stock market without leverage, you are relying on a higher growth rate that compounds more efficiently over time.
35-Year Performance Comparison (1982–2017)
Assuming an initial investment of $14,200 (the 20% downpayment on an average $71,000 Canadian home in 1982).
Investment Type Annualized Return (CAGR) EndingValue
Average Canadian Home (5x Leverage) ~10.5% – 12% $510,000
TSX Composite Total Return (No Leverage) ~8.4% $237,000 S&P 500 Total Return (CAD) (No Leverage) ~11.2% $572,000
Is A Primary Residence Actually An Investment?
I’ve pulled a fast one on you - the Substack title here is really just clickbait. I don’t actually believe that your primary residence is an investment which can be a controversial opinion to some.
I view your primary residence as an appreciating asset that helps subsidize an essential living cost. It clearly feels like a great appreciating asset due to the leverage noted above, but retirees rarely actually utilize any home equity as part of their retirement process. Financial studies have shown that on average, only 5-10% of retirees actually use any of their home equity through sale, reverse mortgages or HELOC’s. This is for the same reason that the primary residence has perfect behavioural investment - it has sentimental value.
Owning a primary residence is valuable as a way to reduce your living costs in retirement and as a generational wealth transfer, but shouldn’t be viewed as an investment to support your retirement.
Final Thoughts
I was actually surprised at the AI final table above that the S&P500 approached a similar final return to real estate without leverage. This analysis helps reiterate that the nominal returns of stocks far outstrips real estate over long periods of time, BUT real estate provides a method to apply leverage to an asset that is fairly unique when comparing investment opportunities.
The AI analysis also ignores one important feature - most baby boomers likely did not achieve those actual investment returns over that 35 year cycle. Mutual funds were far more prominent at that time leading to a 1-2% annual compounding loss on the average return noted above AND it is highly likely that those same investors did not employ perfect behavioural investing within the stock market over that 35 year cycle.
Numerous studies show that the average investor underperforms the long term mutual fund or index fund they invest in over long periods of time due to attempting to time entry and exit of funds due to short term market sentiment. Focusing on a long time horizon and a consistent strategy is essential to optimizing your long term investment performance.
This post was intended to introduce the concept of leverage which will be discussed further in the Aggressive Wealth Builders Series to see if there are conservative forms of leverage that can be applied to investments outside of real estate.