A recent study made this claim: “residential real-estate, not equity [stocks], has been the best long run investment over the course of modern history”. Can this claim, which runs counter to received wisdom, be true? Or is it just the product of yet another flawed, excessively theoretical, academic paper?
Whether you choose to own stocks or houses, each type of asset has pros and cons from a practical perspective. But what about when it comes to pure profitability as investments? Is one much better than the other?
Last week I updated my recommendations for how to split your investments within a financial portfolio, given the current environment (see here). One of the things I wrote was this:
“In a perfect world I’d always want most of my investment portfolio held in stocks. That’s because, over the long run, stocks perform better than any other mainstream investment, such as bonds, gold or cash.”
My focus was specifically on liquid (easily tradeable) financial investments. But, clearly, investors can also own non-financial investment assets, including real estate.
Knowing whether real estate performs better or worse than stocks is pretty important. Higher returns in real estate would encourage more money out of financial investments and into “bricks and mortar”. Not least because people think houses – something you can see and touch and stub your toe on – are easier to understand than stocks, rightly or wrongly.
Buildings are just a useful agglomeration of materials – bricks, tiles, wood, metal, plastics – sitting within some boundaries marked around a piece of dirt. Apart from the land, this means that they’re fixed assets that depreciate if neglected.
By that I mean they don’t grow and they need to be maintained. A house is a house, and it comes with an ongoing cost.
Companies are more complex and varied beasts. They bring together people, assets and material inputs. The aim is to produce and sell things – goods or services – for more money that those things cost to make.
A great many new companies fail. But most of the ones that survive the early years last for decades. Just like houses, businesses need maintenance spending just to survive. But they also expand over time, extending their reach and scope. This is especially true of the relatively large companies that you can invest in by purchasing their listed stocks.
So how could a bunch of bricks beat a collection of shares in big businesses? Especially in the context of the following chart, which shows the relative inflation-adjusted performance of US stocks (in blue), bonds (red), gold (green) and houses (purple) between 1890 and 2013. It was sent to me by an OfWealth reader, for which I’m grateful.
This kind of historical record convinces me that stocks should be the main asset in any medium to long term investment portfolio. The real (above-inflation) annual compound profits over this 123 year period were:
- Stocks 6.53%
- Bonds 2.28%
- Gold 0.69%
- Homes 0.24%
[Gold isn’t the focus today, but I’ll just make this quick comment on its relatively low historical performance. For most of the period the gold price was fixed in US dollar terms, until 1971. Also the amount of mined gold per capita was rising fast until 1950, and many people were banned from owning it for long periods – such as in the USA or China – or too poor to buy any. Those conditions have changed – see here for more, especially the unique chart of adjusted gold per capita since 1900.]
In the past, stocks massively outperformed bonds over the long run, even given bonds’ exceptional run since the early 1980s. It’s a similar story in practically any country that I’ve ever seen analysed.
The missing element
On the other hand, US house prices barely beat inflation. Stocks beat houses by 6.29% a year, on average. However, as I’m sure you will have spotted already, there’s a huge piece of the equation that’s missing: rental income.
In other words, if you had owned houses as investments to rent, you’d have made substantially more than this chart suggests. But, in the US at least, the average rental yield – which is missing from the chart – would have to have been well over 6% a year to beat stocks.
Is that possible? Perhaps. But the study I referred to earlier looked at 16 developed countries between 1870 and 2015. Understanding what’s going on will require time to dig into the data in more detail.
In fact a lot of issues come into play if you want to compare investments in stocks with houses. These include things like: taxes (on income, gains, asset value)…costs of ownership (maintenance, fees, etc.)…transaction fees and commissions…whether it’s possible to maximise profit compounding with reinvested income…whether it’s possible (in the case of property) to actually collect all theoretical income…potential use of leverage (mortgages)…jurisdiction and so on.
In fact, it even matters which historical time period you look at. A lot of the countries analysed suffered the destruction of both World Wars. Those were extreme events, which saw a lot of property blown to pieces, or companies decimated.
The long and the short of it is this: I need more time to think through the issues and crunch some numbers. I’ll get back to you with my findings.
Perhaps real estate beats stocks, perhaps it doesn’t. For now I’m keeping an open mind. In the meantime, I’d be interested to hear about any experiences you’ve had as a real estate investor (email address below).
More to come…
Stay tuned OfWealthers,