“How Good is Housing as an Investment?”

I had another query about housing today from a friend named Mike, who is convinced that the stock market is overpriced in general, and that real estate may be the best place to put his money: “I mean, what else is there?” he asked.

Well, real estate certainly is a place to lay down your head and plant petunias, but let’s break it down a bit. The S&P Case/Shiller 20-City Composite hit a high of 206.52 in 2006 and the most recent was 182.75. In 2007, the national median home price was $230,400 and is now at $210,800 according to the National Association of Realtors. It was, of course, a bubble situation just like those we have had in the equity and commodity markets in the 1920s, 70s, 90s, 2000s and 2008, but the difference is that the real estate market clearly has not fully recovered while the equity market is quite a bit higher – in fact, very close to making new all-time highs.

The big difference in my mind is the expected average returns. According to Robert Shiller, co-creator of the housing index referenced above, housing essentially provide “negligible” real returns, in part because of taxes and the continual upkeep including roofs, furnaces, floors, paint, plumbing, etc. Plus, it depreciates – it always gets older and more out of style, even if the land doesn’t. For those of us who own homes, we know that we have a piece of our budget each year that is dedicated to the home. Shiller writes: “From 1890 to 1990 the appreciation in US housing was just about zero (Taking inflation into account). That amazes people, but it shouldn’t be so amazing because the cost of construction and labor has been going down.”

Obviously, there are a lot of moving parts here and I am not sure I completely agree with Dr. Shiller. Well run rental properties and commercial properties can be good investments, but most of us are living in our homes. We’re consuming our home one day at a time and hoping that the scarcity of housing and land will result in prices outperforming inflation. But there’s a flaw in that thinking also, because housing is such a large portion of most people’s expenses, it has a very close connection with wages, which have a very close connection with inflation. So it’s not surprising to see house prices revert to the mean when they diverge from the annual rate of inflation – in general, that’s a sign that prices aren’t supported by incomes. (This is another way of saying that if homes are outpacing inflation, they are probably overpriced).

In a 2015 interview with USA Today, David Reiss, a professor of law and the research director of the Center for Urban Business Entrepreneurship at Brooklyn Law School, agrees: “Some people buy real estate expecting it to appreciate a lot over time,” he said. “But it can be risky – or even foolish – to pay so much for a property that you’re losing money on an operating basis just because you think it will appreciate.” In fact, when adjusted for inflation, as Shiller suggests, the average house hasn’t appreciated much at all since 1987.

In contrast, the S&P 500 has produced an inflation-adjusted, annual return of 6.53% since 1929. Even investing in government debt would have resulted in returns of about 3%. Further, a Gallup survey indicates that wealthy Americans, more than any other income group, are more likely to choose stocks as a long-term investment vehicle over other options such as real estate or gold, presumably because investing in stocks is the easiest way to become wealthy yourself. Last year, wealthy Americans were even more convinced of stocks efficacy as a long-term investment than in years past. In 2015, of those Americans surveyed whose annual income exceeded $75,000, 38% said that they believed stocks were the best long-term investment available, compared to 30% in 2014. My next issue with real estate is cash flow. I see many people who have too much house already. They don’t have a lot of liquid assets for retirement, and have way too much tied up in their homes. Even if it’s paid off, which I understand is a wonderful feeling in retirement, many who fall short of income will have to sell their dream house and look for a lower cost place to live.

Last, but not least, are costs and flexibility. It’s expensive to buy and sell a home, with realtors’ fees, filing costs as well as limited marketability. You have to find someone who wants your house, and is willing to pay the price you want.

Don’t get me wrong – The pluses of real estate are many: you get to deduct the interest on your mortgage, and if you have some appreciation you may be able to borrow against it and leverage your gains. If you bought your property at a great price and time – like 2009-2010, you probably will make a return over and above inflation. You can generally paint it any color you want and you can show it off to all your friends. And of course you can plant the petunias.

Thank You Very Much for Your Business.

Phil

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Some of this research material has been prepared by LPL Financial. The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. All indices are unmanaged and may not be invested into directly. Approved Tracking #: 1-499076.