When looking at long term investment opportunities, investors have a variety of options to choose from. For those seeking to mitigate their exposure to risk while maximizing yield, two asset classes are often the go-to choice: real estate and dividend stocks. While both options are suitable investment strategies, each has its own unique set of benefits and drawbacks. Depending on which investors you ask, you’re likely to get a myriad of responses about which option is the best strategy.
However, as is often the case with investing, you’ll find that there’s no one size fits all answer. Instead, investors need to consider their own personal situation, goals, and risk tolerance — among other factors that we’ll get into — when deciding on the choice that suits them best. Let’s take a look at both options and break down the benefits of each.
Dividend Stock Investing
Investors have been using the stock market to grow considerable wealth for as long as the markets have been around. As one of the oldest and tried strategies out there, you aren’t likely to go wrong investing in quality dividend paying stocks.
The biggest advantage and difference when it comes to stocks vs real estate is that the former pays you for owning it, rather than requiring you to continuously pay to own it as with real estate.
Additionally, investing in dividend stocks has the advantage of requiring significantly less capital up front. Unlike real estate, investors are able to purchase stocks for a fraction of the cost of a residential or commercial property (or the equivalent cost of a down payment for a mortgage). After purchasing a stock, ETF, or investing in a mutual fund, the investor hasn’t acquired any debt in doing so. There’s no need for continued payments other than the reinvestment of dividends paid out to you as a byproduct of ownership. Assuming you continue to reinvest your dividends, investors get to take advantage of compounding interest and growth over the years.
Unlike real estate investing, dividend stocks have a much lower barrier to entry and can be easily purchased by anyone over the age of 18. The key, of course, is not simply investing in stocks, but investing in good stocks. If you don’t have any experience with equities, then check out our guide on how to get started and what you need to know before putting money in the market.
Doing the Numbers
Like anything else in the markets, returns are going to be different across different assets. High dividend yields can be attractive to investors, but it’s crucial to look at more than simply the yield and focus on stable companies with strong fundamentals. Here are some of the top choices for investors seeking cash dividend-paying stocks on the TSE with room to grow in the future while remaining stable. Take a look at our full list of the best Canadian dividend stocks to watch in 2019 for more on the analysts top picks for the upcoming year.
- Dividend Yield: 5.45%
- Dividend Payout Ratio: 74.39%
Canadian Imperial Bank of Commerce [TSE:CM]
- Dividend Yield: 5.27%
- Dividend Payout Ratio: 45.67%
- Dividend Yield: 4.78%
- Dividend Payout Ratio: 82%
TD Bank [TSE:TD]
- Dividend Yield: 3.99%
- Dividend Payout Ratio: 43.43%
RioCan REIT [TSE:REI.UN]
- Dividend Yield: 6.02%
- Dividend Payout Ratio: 78%
Real Estate Investing
Investing in real estate is an entirely separate animal and is incredibly lucrative for investors given the total ROI it offers in the long term. While reinvesting dividends in the stock market is a proven strategy for growing wealth over time, it simply can’t provide the same ROI that real estate offers after factoring in the total amount you’ve invested. With a dividend stock growth plan, investors are continuing to invest not only their dividends, but additional funds over time as well to see true growth.
Real estate, on the other hand, operates differently. Rather than continuing to invest in your stock portfolio, real estate investors typically invest a down payment of roughly 20% of the total property’s value (though some put down less than that). Investors can leverage their money by getting a mortgage to purchase a piece of property. Then, following the initial investment, owners seek out tenants to effectively pay off their debt over the years, all while building equity in the property that can act as another source of capital in the future. By the time the mortgage is paid off and you own the property outright, you’ll find that you’ve only effectively paid 20% of the total value of it. Imagine purchasing a $100,000 asset for only $20,000 — not a bad proposition.
It should be noted that real estate investing requires you to take on more risk, especially as most owners will be borrowing money to purchase the property. And in addition to that risk, real estate investors have other factors to consider when looking at the total expense of the asset. Things like property taxes, homeowners insurance, mortgage interest, and the actual maintenance/upkeep of the property must all be factored in as expenses from the total value of the property. Keep in mind, if this is a secondary property, it’s also subject to a capital gains tax.
For those who do decide to go the real estate route, one of the exciting parts of the industry is that investors can get involved in more than just their local area. The United States offers a vast selection of real estate markets that foreign investors can gain access to with the potential for even higher yields.
While the American real estate markets are attractive options for investors (see the numbers below), the choice to enter them requires even more factors to consider. Perhaps the biggest struggle and bottleneck throughout the process is the logistics — and actual cost — of CAD-to-USD transfers. Fortunately, there are companies who specialize in handling these types of transactions, like OFX that can on-board Canadians to help streamline the process. Working with professionals in the field makes the transferring process easier and more affordable, meaning that investors can focus on what matters.
Doing the Numbers
Investing in real estate is more complex when it comes to looking at the actual yields and is dependent a lot more on an individual investor’s situation and location. However, depending on where you’re located, rental yields can outperform those coming from dividends.
The average gross rental yield in Canada comes in at 3.95%, expressed as a percentage of property purchase price. While the average yield is higher than many of the lower yield dividend stocks, it’s important to note that gross yield is what’s expected before taxes, maintenance, and other costs to the owner.
Depending on location, that yield can be significantly higher. In Toronto, the average gross rental yield in the city center was 4.2% for owners and in American cities, the yield can be even higher. If you’ve taken an interest in the American real estate market, here are some of the highest yielding areas for real estate investors along with property appreciation.
- Rental Yield: 5%
- Increase in Home Values: 10.3%
- Rental Yield: 7%
- Increase in Home Values: 10.7%
- Rental Yield: 8%
- Increase in Home Values: 10.1%
Colorado Springs, Colorado
- Rental Yield: 6%
- Increase in Home Values: 10.3%
- Rental Yield: 9%
- Increase in Home Values: 9.2%
The Bottom Line
At the end of the day, the question really isn’t which option is better than the other, it’s about weighing the pros and cons of both choices and seeing how they fit into your personal investment strategy. The real estate industry, while lucrative, requires most investors to leverage their money significantly and while leverage can be a beautiful thing, it’s always important to remember that the tool functions in both directions. If you’re interested in exploring the real estate markets, start with our real estate investing in Canada overview and start learning about what it takes today.