Has real estate ever been the path to wealth?

Posted by on July 28, 2008 in Uncategorized

I am clearly playing Monday morning quarterback but I stumbled upon something this weekend which seems to counter the saying that you become wealthy through real estate. Merrill Lynch and Capgemini have been publishing Annual Wealth Reports for 12 years which track what the high net worth individuals (individuals with net worth over $1 million EXCLUDING principal residence and consumables) and ultra-high net worth individuals (individuals with net worth over $3 million EXCLUDING principal residence and consumables) made their money, where they move their money and how they plan succession. If nothing else, it is an interesting study on the asset allocation, sources of wealth and investment patterns.

A couple of interesting statistics:

  1. In a study dated November 30, 2007 (i.e. which captures the peak of the real estate market and the beginning of the long march down circa August 2007), real estate allocation among the rich peaked at 24% of portfolios.
  2. In a separate report reviewing 2006 trends, the authors indicated that the preferred channel of real estate investments was real-estate investment trusts (REIT) rather than physically buying land.

In other words, real estate has never reached more than 25% of an average rich person’s portfolio and the preferred real estate of choice is actually a stock and not land. I do find it interesting though that real estate and “alternative investments” appear to be negative correlated. As real estate allocation goes up, alternative investments go down.

The primary source of wealth creation for high net worth and ultra high net worth individuals continues to be entrepreneurship (although I cannot tell if this class indicates people who own and operate real estate development companies).

If nothing else, the study remains us that wealth is created through appropriate asset allocation and not putting too many eggs in one basket.

If nothing else, borrow the book (don’t buy it, the data is out of date as soon as its published) Wealth: How’s the World’s Net High-Worth Grow, Sustain and Manage their Fortunes as a lesson on how the other side manage their money.

As a programming note, this blog hits the summer break for the next two weeks: this will be very light posting this week and then I am taking next week off.

11 Comments on Has real estate ever been the path to wealth?

By Traciatim on July 28, 2008 at 11:18 am

That’s fantastic if you want to be a high net worth individual, but how do you just live cheaply and save enough to retire comfortably. One of the major portions of living cheaply is to own your own home. I would hardly call it ‘investing’ in real estate, but owning where you live is a great way to build wealth.

Keep in mind the average of all of Canada is that Renters spend 25% of their income on housing, and Owners spend 16%. I think the big reason this disparity happens is that:
1) Renting follows inflation while a mortgage protects you from inflation.
2) Mortgages end. (29% of people own with no mortgage, about 40% own with, and 32% rent . . . doesn’t add up due to rounding, 2006 census data).

I suppose also you have to take in to account that generally higher income people buy over rent making their percentage lower, but I still believe that the above two points are the majority of the disparity.

A better study would be to find people that chose to rent over buy but can afford to buy vs. people with similar income and buy homes and find out which fared better over different time periods . . . someone should get that data and compare.

By telly on July 29, 2008 at 12:40 pm

traciatim, I would argue that in many (clearly not all) cases renters have lower incomes than home owners. Students, single parents, the unemployed, and other people going through a transitional period in their lives are generally renting rather than owning. This will skew those numbers drastically.

By A Lap Of The Blogs : WhereDoesAllMyMoneyGo.com on July 31, 2008 at 9:04 pm

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By Traciatim on August 1, 2008 at 12:32 pm

See, that’s why I would really like to see a study done on people who are in retirement who’s average life time income was between A-B and owned a home in their life vs A-B who rented and who ended up better off in the end, then repeat this process for B-C, then C-D . . . and onward up the income scale. We could put it to rest on which people end up better in the real world and not just in some numbers on a blog post that ‘prove’ either side depending on how a person writes the story.

By admin on August 1, 2008 at 1:15 pm

Traciatim: Most of the data I have seen only relates to debt loads of renters vs. owners but I will dig it up and post on it. However, most of the data are from Department of Housing, Federal Reserve etc. (i.e. those with a vested interest to promote home ownership) so, as with anything in life, take it with a grain of salt. But I’ll put this in the “things to blog about” list. Thanks for the suggestion.

You also have to remember that the survey I quoted removed principal residence from the equation so we are doing an apples to apples comparison. Mainly, after the house is mortgage for monthly your home, how are the rich investing their money? Your point is a valid one but it may be an apples to oranges comparison with the book since it looks at allocation of disposable income in investments and not essentials like shelter.

By Jon Kepler on August 1, 2008 at 1:57 pm

I think the validity of this study, while present, is limited by the fact that they don’t separate residential real estate from commercial real estate. Owning an office building is different than owning an apartment building, and the cycles and cashflow of each are not always comparable. In addition, someone like Donald Trump may appear to be completely exposed to real estate, when in reality a large portion of his business is licensing. Sort of. By licensing other peoples’ real estate, he’s still directly exposed indirectly, so it’s all in the technicalities.

By Yann on August 2, 2008 at 12:51 am

There is a saying that buying a home forces you to save, but I think that only applies to those who are not good savers in the first place. I currently live in Toronto central where I rent a wicked cool one bedroom apartment for ~$900/month. I also save/invest ~25% of my gross income, and I strongly doubt I would be able to sustain that savings rate if I bought a house or a condo of similar standard. If I add condo fees, property taxes, maintenance costs, furnishing costs, AND the opportunity cost of not investing that money and spending it on the house instead, I am not sure if buying is a better deal (financially speaking that is). The argument that mortgage protects you from inflation may be a good one, however there is a limit on rent increases in Canada – it is currently 1.4% in Ontario, which I suspect is less than the inflation rate.

By Riscario Insider on August 2, 2008 at 11:25 pm

At the Real Estate and Wealth Expo in Toronto in 2007 (headlined by Donald Trump and Tony Robbins), many presenters stated as a given that real estate was the path to wealth. There were claims that real estate outperformed stocks over various periods etc. How could you lose?

So it’s interesting to see there are other points of view. It’s hard to believe there’s a one-size-fits-all solution.

By Traciatim on August 4, 2008 at 6:47 am

Hey Yann, I hate to break it to you, but ” If I add condo fees, property taxes, maintenance costs, furnishing costs, AND the opportunity cost of not investing that money and spending it on the house instead . . . ” and then you add in someone else’s profit, the costs are exactly the same only renting is more expensive.

The only reason Toronto isn’t much of a good deal to buy right now is because the prices rose too quickly in the past few years making the price to median incomes go out of whack. This means that people who purchased the apartments 20 years ago can still rent them because they are protected from inflation and price increases while you are not. That just means it’s time to save your money for when the price/income ratio falls back in line, not that real estate isn’t a good place to hold money.

Take for example your 900 in rent, at 3% inflation, if you are 30 now when you retire at 65 you’ll be paying about 3550 for the same place. If you owned the same place you would owe nothing in 35 years, only having the maintenance and the upkeep (and taxes as always). Also, since our average saving rate is hovering right around nothing keep in mind that you are the exception and not the rule, the vast majority of the population doesn’t save 25% of their gross income.

Also your quoted 1.4% for the rent increase is only for 2008, it basically follows inflation. The increase will be adjusted each year, and if inflation spikes it will increase too.

Oh, and add in . . . do you really want to live in a ‘trendy in 2008′ sardine can for you’re whole life? You should move to the Maritimes where the average median incomes aren’t much lower but you can buy a nice house for 150K. ;)

By Plamen on August 22, 2008 at 2:39 am

Interesting numbers … I do not know much about REIT, so it is difficult for me to judge whether this is really a good investment option. As Yann says above for some people (including me) renting looks to be a better option having in mind the Quebec’s control on the rents and the current forecasts for real estate appreciation.

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