What is the True Rate of Return on Real Estate?
I am going to fully admit my bias up-front: I do not consider residential real estate a good investment. The costs of residential home ownership or upkeep of residential real estate investments are too great relative to other forms of investments (commercial real estate or residential on scale are different ballgame since the rules are different). Real estate should be considered shelter and no more. However, when real estate prices eventually find their true valuation, what type of return can only expect from real estate?
It depends on who you asked (to be as impartial as possible, despite my bias, I tried to find the high and low end)
- Fidelity Research Institute (funded by the mutual fund giant) found from 1963 to 2006 the average appreciation in real estate was 5.9% with great regional variances. Keep in mind who funded the research but a great piece on how we have moved from viewing our homes as a an asset of last resort to leveraging the door knobs off.
- The S&P/Case-Shiller Home Price Index found the that the value of residential real estate grew by 9.31% in the U.S. from the period of 1998-2007 (the survey period excludes the real estate crashes of the 80′s and 90′s). The study excludes new housing and any pricing out of the ordinary in a region (i.e. someone massively overbidding or a fire sale relative to other prices).
- Jack Francis and Roger Ibbotson published an academic paper called “Empirical Risk-Return Analysis of Real Estate Investments in the U.S., 1972-1999” updated in 2004. The researchers found real estate values grew at 8.6% annually during this period (sorry, I couldn’t find the paper, I am relying on Money.com as a source).
- The University of British Columbia Sauder School of Business summarizes nominal and real growth rate (growth after inflation) for real estate in selected Canadian cities from the period of 1985-2003. Real return growth rates varied from 1.65% to 3.89% implying real estate growth at mid to high single digits factoring in inflation.
With the exception of the last study, all the real estate growth/appreciation rates do not factor in inflation. However, assuming inflation runs at 2-5% annually, real estate returns historically are inflation protectors with a few percentage points of gain built in. All the studies find that real estate tends to return between 5%-9% but, once you subtract inflation from the return, real estate has t-bill like returns (on a pre-tax basis).
The perception that real estate is a good investment appears to derive from the fact inflation is not stripped out of the return and prices keep going up because of inflation and not necessarily a great return.
By comparison, Jeremy Siegel, in his book Stocks for the Long Run, found that the historical nominal rate of return on stock was 11.2% from the period of 1946-2006. After inflation, the return is 6.9%. All the studies cited above (with the exception of the Shiller index) show that stock had greater returns than real estate over the period studied (and the Shiller index finds REITS, which are stock, to be more profitable than real estate).
Having said that, I don’t believe the real estate market has collapsed completely (remember that the media reports on exceptions rather than the rule and ignores the 90% silent majority). Certain areas will maintain their value and certain types of housing will always be desirable. This chart is often used to discredit real estate investing altogether- careful how it is applied since it lacks any context (although I agree with Millionaire Mommy Next Door’s argument that, in some circumstances, it is better to rent than own). Real estate has its place; just don’t expect it to return double-digits over the long term. Four Pillars blogs about whether real estate investing is profitable from a slight different angle at Twice Paid.