Sell Side Handbook regularly advocates for young professionals to invest their savings in the stock market as it is the best way to grow wealth. Cash in a savings account is stagnant and erodes in value over time due to price inflation over time. Investing spare funds ensures that money that you work hard for works hard for you – whether an investment banker, a nurse or a business owner, any cash outside of an emergency reserve should be plowed into vehicles that will grow the money over time.
The two most popular ways for young professionals to invest are real estate and stocks. Outside of residential real estate, as in condominiums, most real estate investment is out of reach for most working professionals.
Purchasing Residential Real Estate
Real estate is a large ticket purchase and even one property may be too much for a salaried worker to buy. However, it is important to enter early in the right location as real estate is not purchased outright with your own funds, but with leverage (via a mortgage, or even more aggressively as we will elaborate on later).
When purchasing property, there is always two elements of fear. The first is the fear of missing out (FOMO) whereby in hot markets, condo prices have been jumping at unsustainable rates over the last 5-10 years. If you do not buy now, you will miss out on gains.
The second fear is the fear of a bubble crashing or asset price collapse. This means getting in at a high price and being stuck with the mortgage debt when the house price sinks.
Over the last few years, FOMO for real estate has been validated (for condos in growing, urban areas), but less so for detached houses in certain jurisdictions). The trend towards urbanization and densification has strengthened and will continue.
There are fundamental advantages of clustering in cities via the proximity of services and entertainment as well as the economics of mass transit and the efficient use of real estate and a sharing economy. It is not worthwhile to build a metro system for a town of 30,000 people, but it makes a lot of sense for a city of 3 million.
As professional jobs are more concentrated in urban areas where the trend is towards increasing densification (higher buildings, more people living per square kilometer), picking the right location is not necessarily a hard activity as you would purchase property where you would choose to rent. Real estate investing is about location, location, location, but is more predictable in this aspect unless in a boom-bust city such as Calgary where housing prices may swing in volatile fashion in line with oil prices.
With recent price controls, we can expect that upwards pressure has abated to some extent, so fears of a bubble can be downplayed. Also, a house is not bitcoin – there is proven value from owning a property. 1) you can live in it; 2) you can rent it out.
By purchasing real estate today, a young professional is leveraging their future earnings to build wealth. Waiting to purchase real estate entirely in cash is futile, the prices will rise as income and savings rise – and the opportunity for the appreciation of equity is lost.
Other Considerations in Purchasing Real Estate versus Stocks
Additionally, there are usually other benefits to purchasing residential real estate that may be compelling over stocks for initial capital – at least for the first property. For many jurisdictions, there is no capital gains tax paid on the sale of the primary residence provided that it has been lived in by the owner for a period of one year or more. Given that the capital gains tax is half of the marginal tax rate for a well-paid professional, this can be extremely punitive in high tax areas such as Ontario.
Also consider that without purchasing property and being subject to the mortgage (plus any additional financing), there is still a fixed cost every month – rent. Unless rent is far lower than a prospective mortgage interest payment (not the principal), consider putting money into your own equity instead of someone else’s pocket. In some countries, mortgage interest is also deductible against income.
Purchasing Real Estate with 100% Leverage or Financing
If you have amassed a sizable holding of stocks, you can consider getting a property with 100% financing while keeping your stocks. In purchasing a property as a working professional with a stable income, the bank will be willing to give you a certain sized mortgage. The rest is funded by cash and represents the equity in the house.
However, it is possible to get a secured loan against your stocks – usually the bank will give you a loan where you offer 200% collateral on the loan via putting your stocks in a hypothecated account (the loan will be 50% of the stocks you secure against the stocks).
If you choose to leverage your investments to purchase real estate, this is best paired with blue chip, dividend paying stocks. As such, you minimize the risk of a margin call and can use dividends to meet interest payments and pay down principal – or reinvest into the same stocks if there is a pullback in stock prices to take advantage of a higher dividend yield.