Every spring, the Gallup Organization asks American adults this simple question: “What is the best long-term investment?” And for the fifth year in a row, the top response for 2018 was real estate. This year, the results came in like this:
- Real estate – 34%
- Stocks/mutual funds – 26%
- Gold – 17%
- Savings accounts/CDs – 15%
Stated differently, 3 out of 4 people think stocks are not the best long-term investment, in spite of the S&P 500 Index earning 9.5% per year dating back to its inception in 1926.
You have read our “takedowns” of residential real estate in the past, but it’s a polemic that bears repeating. Yet, before I launch this latest reckoning with real estate (wink wink), here is my usual disclaimer: I really like beautiful homes. I like the big homes and the small homes. Whether it’s Cape Cod homes in Wayzata, bungalows in St. Paul, or stunning estates around Lake of the Isles, I think design and architecture are critical aspects of our life here on earth. But that won’t prevent me from thinking critically about the role real estate purchases/values should play in our financial lives. A home is a place to live, but it is not an investment. It’s an asset, but not an investment.
We will review some data today for the Minneapolis real estate market, via the Case-Shiller Home Price Index. I was able to draw data back to 1989 (nearly 30 years of data). Our first step is to compare our local housing market to inflation. Inflation has averaged 2.49% annually over this period, while Minneapolis housing has returned 3.37% per year. That 3.37% figure is right in line with the national housing data that dates back to the late 1800s, also gathered by Robert Shiller of Yale University (http://www.econ.yale.edu/~shiller/data.htm). Click the charts below to enlarge them.
- A house purchased for $200,000 in 1989 would be worth $533,166 today. Wow! When you put it like that, it’s impressive growth.
- However, inflation alone means that $200,000 in 1989 is the equivalent of $414,023.
- So, housing outpaced inflation by $119,000 over this period.
- A common rebuttal to this line of thinking would be the impact of leverage on real estate returns. If the home-buying family in 1989 put just 20% down, their initial capital into the investment was only $40,000. That increases the return earned on this “investment” in real estate, correct? We think not, and here’s why:
- Most people finance their homes with 30-year mortgages. When the 1989 family financed $160,000 on their home purchase, they end up paying about $320,000 on that $160,000 (that’s a general rule of thumb; each loan scenario is slightly different).
- Any apples-to-apples return comparison of investments must account for costs. With annual property taxes in the Minneapolis area ranging from 1.2% - 1.8% of the home’s value per year, your net rate of return on real estate typically drops below the rate of inflation.
- Further, we’re not even getting into the costs of home updates and remodeling, furniture, maintenance and repairs, and home décor.
When we compare residential real estate to stocks, the results since 1989 are really striking:
- The total return on the S&P 500 Index since 1989 has averaged 10.6% annually, according to Standard & Poor’s. If you had achieved that rate of return on a $200,000 investment starting in 1989, you would have $3,966,000 today.
- Let’s say you had a balanced investment portfolio of stocks and bonds during this period, which earned you 8% per year. At that rate of return, the $200,000 investment would have grown to $1,950,000.
- Contrast these investment growth figures vs. the $533,000 home via housing appreciation, and the housing appreciation isn't so impressive.
What does this mean to you, our client?
Think carefully about the size of your real estate purchases. Frame these purchases relative to your liquid investment portfolio, and not necessarily relative to your income.
Because The Wealth Group, Austin B. Colby & Associates is independent of Raymond James, the expressed written opinions above are our own and not necessarily reflective of Raymond James’ opinions.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation.
Scenarios described are hypothetical and are provided to illustrate the potential benefits of prudent investing. It is not intended to reflect the actual performance of any security. Investments involve risk and you may incur a profit or a loss.
The S&P CoreLogic Case-Shiller Home Price Indices are the leading measures of U.S. residential real estate prices, tracking changes in the value of residential real estate both nationally as well as in 20 metropolitan regions.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.