Long-term, a cottage will likely yield costs rather than returns, but it's more fun than a share certificate, writes John Heinzl, reporter and columnist for Globe Investor.
Q: I'm curious to know what has been the better long-term investment: Buying a cottage, or owning a stock such as Royal Bank. We bought our cottage in 1974 for $26,000, and we've put in another $56,000 in maintenance and renovations including new windows and a new floor, plus paying our property taxes every year (about $2,000 in 2012). Today, the cottage is worth about $250,000.
A: This is a great question, but it's tricky to answer because of all the variables at play, including intangibles such as the pride of cottage ownership and the benefits of family time together. But let's put aside the emotional stuff for a moment and crunch some numbers.
Let's say that, instead of buying the cottage, you had plowed the $26,000 into Royal Bank (RY) shares. My Bloomberg data only goes back to March 31, 1975, so we'll use that as a starting point.
If you held the shares until December 31, and reinvested all your dividends along the way, your stock would have grown in value to $1,262,388. That's equivalent to a return of about 10.8% on an annual basis.
Now, keep in mind that your actual return would have been lower, because you would have had to pay tax on the dividends every year. Plus, you would face capital gains tax when you sell the shares. These costs are difficult to quantify, because they depend on marginal tax rates—which change over the years—and the reinvestment price of dividends.
But let's very roughly estimate that the dividend yield accounted for 40% of the stock's annual return, and that the tax rate on dividends was 20%. Taxes would therefore chew up about 0.864 percentage points (0.4 times 0.2 times 10.8) of the annual return.
That gives us a net annual return—before capital gains taxes—of about 9.9%. Suffice it to say that most investors would still be quite pleased with that.
Now let's look at the cottage. Based on straight price appreciation, the cottage gained about 6.2% on an annual basis-significantly less than the return on Royal Bank shares.
But again, this overstates the cottage's actual return, because it excludes maintenance and renovation costs, property taxes, and capital gains tax. If we include the $56,000 in maintenance expenses, and assume they were spread out over the 37-plus years of cottage ownership, the annual return drops to about 4.1%.
If we then include property taxes of, say, $1,000 a year on average (it was much lower than that in the 1970s), the return slips to about 3%. After inflation and capital gains taxes, the real after-tax return is probably closer to zero, or even negative.
Now, I want to stress that these are all very rough calculations based on the past performance of one stock and one cottage, so we can't generalize from the results or make any predictions about the future.
What's more, in the first scenario, we didn't factor in the cost of renting a cottage—something you might well have chosen to do had you not purchased your own vacation property.
Jason Weinstein, who runs the investing Web site adjustedcostbase.ca and has written about real estate for Canadian MoneySaver magazine, said he's not surprised that the stock handily beat the cottage in a straight-up investment comparison.
"I don't own a cottage, but if I were to buy a cottage I would buy it solely for the purpose of the enjoyment of it," he said. "I definitely wouldn't try to rationalize the purchase by saying this is going to end up being a huge cash cow for me, as opposed to the reality where it is probably going to cost a lot of money over the long run and most likely only keep up with inflation."
Indeed, based on US housing data, real estate prices in general have shown virtually zero growth after inflation over the past 120 years, he said.
But while a cottage may not be a fabulous financial investment, it does have tremendous emotional value. After all, going for a swim, lazing in a hammock, and roasting marshmallows with your kids are a lot more fun—and provide more lasting memories—than staring at a share certificate.