Real Estate: The Forgotten Asset
It seems lately, every article and interview features reports and numbers demonstrating declining existing home values, declining new home sales, declining investment property prices, abandoned projects and doom & gloom for the real estate sector with no turn in site.
The continued beating delivered by the iron hand of a severe credit crisis, a “subprime” mortgage meltdown, as well as a new batch of CDO’s, SIV’s and mortgage backed securities seem to blow up a different financial institution every day…..Bear Stern’s style.
The real estate market sentiment for both primary homes as well as investment properties have gotten so negative that it feels like our houses lose value every moment. The more deeply affected market segments are portrayed as abandoned waste lands in which nobody wants to own a home, even if it was given to them. The current situation seems grim, and makes one wonder if anyone in the United States will consider owning a piece of real estate ever again.
We thought it was only proper to stop for a minute, take a breath, and put some perspective around the present situation and think about… “If real estate is so awful….why does anyone own it?....“Is real estate really an investment?” … “How has real estate compared to other asset classes over time?”
For in the end, perspective and reason trump panic and irrationality, especially when related to finance. Nobody ever made money by panicking!
Part 1: The S&P 500 Index vs. Real Estate
Which is the better investment?
The S&P 500 Index is widely considered by investment professionals to be a true indication of equity (stock) market performance because it contains 500 stocks of companies that are suppose to best represent the current architecture of the US economy. The S&P 500 Index is often considered the benchmark against which alternative investments, as well as, the performance of investment professionals are measured.
It is a worthwhile exercise to compare the return of the S&P 500 Index against the average returns of the real estate market to answer our earlier question of “Is Real Estate Really an Investment.”
According to Moody’s and Morningstar over the past fifty (50) years, since approximately 1958, the S&P 500 Index has yielded an average annual return of 10.99%. This is a healthy return that has been delivered in a very erratic fashion. Sixty-four (64%) of the time the return was at least 10% higher or lower than the average annual return. This means that roughly two out of every three years, the annual return was about 0% OR 20%. Markets that trade erratically in this fashion can be very exciting and opportunistic for trained professionals and “market-makers” on Wall Street, but scary for the average investor. If one was not fortunate enough to have their money invested for the good years…or really the good days within the year, the majority of these opportunities could have been missed, depleting the investments ability to produce a reasonable return for the accepted risk.
On the other hand, please see the below chart that shows average housing prices from (1964 – 2005) according to public data supplied by the Census Bureau. Note: Raw data numbers for 2006 and 2007 were not included in the following because only estimates were available at the time of publishing. The chart shows the average house price in 1964 of $20,500 rising to a staggering $297,000 in 2005. Over the measured forty-three (43) year time period the accumulated return is about 287% which is an average annual return of 6.67%. Not too bad for doing nothing but living in your house for awhile (and paying the mortgage and taxes of course).
At first glance it appears that the 10.99% average annual return of the S&P 500 Index is a much better place to invest one’s hard earned money than the 6.67% annual average real estate return. However, although slower to grow over time, real estate growth was much less erratic and had far fewer instances of inconsistent and/or negative growth. This means that the home owner would have the opportunity over a long period of time to realize and experience the gain versus the gain that may have been missed in the equity markets if not perfectly timed.
The average annual gain from the S&P 500 Index versus the average real estate gain is lessened and rationalized more when the phenomenon of leverage, tax benefits, and tangibility are examined and applied. In part two and part 3 of this series we will introduce and examine these critical elements and their impact on the average rates of return.
Until these critical elements are broken down and factored into the average real estate return numbers, it remains unclear at this time which is a better investment option.
Please read Part 2 of The S&P Index versus Real Estate; Which is the Better Investment, in which we will continue this analysis, and break down the property return advantages with respect to leverage, taxes, and tangible assets to see how it affects rate of real estate investment return.