Is real estate still a good investment?

Posted by on September 7, 2010 in Real Estate

Time Magazine’s cover story,”The Case Against Homeownership” (the link is only to an abridged version of the article given it is a recent issue) takes an over-arching look at the state of home ownership in the context of a relatively battered asset class globally.  The article raises the larger question of whether all the government subsidies promoting home ownership has been a good use of public funds and whether owning your home is the right finance decision for all households.

No other financial topic tends to evoke a purely emotional response as real estate.  It has become, over the last 10 years, the financial topic du jour in the backyards and dinner tables of the middle class. With real estate appreciation either slowing or continuing to decline, many continue to ask whether real estate is a good investment.

The problem with this question is two-fold (at the very least). Real estate, as the adage goes, is all about location. To read a headline in a national publication about the real estate market tends to obscure local effects and it becomes folly to use national data to make decisions which are local in nature. For example, the existence of a local school or employer can, and often does, insulate that immediate community from some of the negative effects of a national economic slowdown. Similarly, locations which structurally have high tenant-to-owner ratios (such as New York City or neighborhoods close to large educational institutions) tend to maintain their relative value.

Thus, the answer to whether real estate is a good investment is not found in the front pages of your paper but by simply looking around you. Is your local school ranked highly, are “average” homes in your community being sold quickly, is the government investing in your community (where the stimulus money is going, other than the absolutely necessary repairs,  is a good barometer of whether the bureaucrats think your community is expanding and where the politicians need to build or maintain political capital)?

The second issue is how do you define a “good investment”? One of the subtexts of my posts lately is that 1991-2007 was a historically anomalous time.  A 17 year period with a minor rescission is not normal. Correspondingly, our notion of good investment returns went askew as well.

Most prudent investors believe that a 5-8% nominal return per annum (return before inflation) is considered a healthy return for equities. This rate of return balances risk and reward of a retail investor. Yet, to repeat a story I once wrote pre-credit crisis, I met a real estate investor who once said that nothing less than a double-digit return in an 18 month period was acceptable for his real estate investments. I do not believe that he was alone in his thinking.

However, economic data seems to indicate that real estate investing, as undertaken by institutional investors, has approximately the same range of returns per annum as equity. In other words, the debate about stock investing vs. real estate investing may not be a debate about rates of return but different methods of achieving the same range of return (file this under “Different doesn’t mean better or worse. It just means different.”). But the key, like stock investing, is that time is often a large factor in driving returns; the longer you hold onto an asset, the more likely you will make a reasonable return.

It would be foolhardy to throw an entire asset class overboard due to recent history. However, like everything else in life, patience and reasonable expectations would do us all well.

7 Comments on Is real estate still a good investment?

By Traciatim on September 7, 2010 at 9:32 am

Are you talking real estate investing only, or owning your own home? If it’s the latter, I am of the opinion that since you have to pay to live somewhere, why not pay to live somewhere that the payments end eventually. A huge key to a comfortable retirement is low living costs. One major portion of that is either owning your own home or significantly downsizing.

By Dr Dale Rathgeber on September 7, 2010 at 11:51 am

Great post. For ordinary Canadians real estate is likely to be a “good” investment absent a great depression, given household formation forecasts, depending of course upon a myriad of factors including location. A pricipal residence plus a revenue property or 2 can also act like a forced savings plan, as part of a well-diversified portfolio.

By jesse on September 7, 2010 at 4:18 pm

So what is a reasonable return for housing? Given the risks involved, net 8% isn’t unreasonable. Why? Compare RE investing to a utility like a gas company, hydro transmission company, or a water works. They have capital assets and land, and generate revenue based on the use of those assets. They have depreciation and infrastructure to collect the revenue and maintain and rebuild the capital. In other words a house is effectively a utility. Why would it be valued any differently?

Looking at property valuations based on this, housing is not fairly valued, even in many (mostly high end) parts of the US that have seen significant drops from peak.

By A Tale of Two TIME Magazine Covers | Canadian Capitalist on September 7, 2010 at 10:55 pm

[...] in the Fall of 2003, the magazine is at it again putting the housing market on the cover (thanks to Thicken My Wallet for alerting us to the story), only this TIME the caption reads “Rethinking Homeownership: [...]

By larry macdonald on September 8, 2010 at 12:56 am

Looks like President Obama is going to announce a round of new stimulus measures in Sept. It seems policy makes will keep trying to pump life into the economy until key sectors like housing get a pulse.

By admin on September 8, 2010 at 12:17 pm

Larry- I worry the US is caught in an endless cycle of trying to prop up consumption as opposed to rebalancing towards making key industries productive and healthy. As I indicated before, Obama is US’ Trudeau; a popular guy but the books will look worse going out than in.

By Real Estate is Still a Great Investment | Landlord Rescue on September 10, 2010 at 8:02 pm

[...] doom and gloom about the real estate market. Today on Thicken My Wallet there’s a post asking Is Real Estate Is A Good Investment?. It’s time to go shopping that’s what I [...]

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