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Is Real Estate the Best Long-Term Investment? Thumbnail

Is Real Estate the Best Long-Term Investment?

By: Mike Earl, CFP®, CPWA®

Every spring, the Gallup organization surveys Americans for an answer to this question:

Which of the following do you think is the best long-term investment:

  • bonds

  • real estate

  • savings account/CDs

  • stocks/mutual funds

  • gold

For this year, the clear winner to the survey is real estate, with 34% of respondents saying it's the best long-term investment. Only 26% of Americans said that stocks/mutual funds are the best long-term investment.

While the survey is a small sample size (about 1,000 respondents), I would bet a much larger sample size of Americans would yield a similar result. Think of it this way: how many times have you heard someone say that "real estate is a great investment."

Does the data confirm such beliefs? The great part about this survey is that we can mathematically show what has proven to be the best long-term investment. Through Yale economist Robert Shiller's tireless efforts, we have U.S. housing price data all the way back to 1890. That's 127 years of data!

The compound annual growth rate for housing values in America is about 3.15% since 1890. When inflation is subtracted, your real rate of return in housing prices is 0.38%. That's a measly rate of return.

What about stocks, you might ask? I obtained stock market returns dating back to 1928. The compound annual growth rate of U.S. stocks from 1928-2016 was 9.53%. During that same period, residential real estate increased at a rate of 3.94% per year.

Let's go back in time to 1928. Imagine you were alive and had $10,000 sitting in the bank. You wanted to get that money invested for long-term growth, so you invested half of that money into buying a home and half into the U.S. stock market. Mind you, the Great Depression was right around the corner, a period which saw the stock market decline 90% from peak-to-trough in the early 1930s.

After 89 years, here are the results:

Over time, the difference between earning stock market returns vs. residential real estate returns is astronomical. This person would have more than 100 times greater wealth through stock investing vs. real estate investing.

TWG Take-Away

What does this mean to our clients? We hope it means they will focus on building a liquid investment portfolio that is many times larger than the value of their primary residence. We are not at all against home ownership. We all have to live somewhere, so owning a home is a good decision for people who are sticking in one place for the long haul. It's more a question of keeping real estate in its proper place: a smaller portion of your overall net worth (as compared to your investment portfolio, which should be the centerpiece of your financial life).

As with so many areas of personal finance, we think having simple ratios in mind is really helpful. For instance, the greater your ratio of liquid portfolio to real estate value, the better. To illustrate:

  • 65-year old married couple has a $2,000,000 liquid investment portfolio.

  • This couple owns a home in Eden Prairie valued at $400,000.

  • Their ratio of portfolio:real estate is 2,000,000 / 400,000 = 5:1

  • The higher that number is, the greater your likelihood of growing your wealth over time.

We all have a limited number of little green soldiers to deploy (i.e. we all have a finite amount of wealth). Therefore, we all face a decision about how to allocate our wealth. Do we want a $750,000 home and a $250,000 investment portfolio? Or a $250,000 home and a $750,000 investment portfolio? If we are seeking to grow our wealth, then we want to maximize our investment portfolio while keeping a lid on our real estate holdings (at least until Financial Independence is reached, when your wealth is self-sustaining). 

The rebuttal: "what about a hot market like the Bay Area?"

We have some younger clients that are having great success in Silicon Valley. In the past 5 years, San Francisco real estate prices have experienced a 78% surge. It's easy to buy into the hype of a hot real estate market, thinking that you must buy soon -- or prices will be even higher in a few years. And while it is true that real estate prices could continue increasing in the near-term, the long-term picture in a city like San Francisco still overwhelmingly favors stock investing over real estate investing. 

I obtained data back to June of 1988. Since that time, San Francisco real estate prices have increased by 311.6%. That sounds impressive, until you consider the S&P 500 total rate of return during that same period: 1,550%.

I'll take the US stock market here, again.

1) http://www.gallup.com/poll/208820/americans-favor-real-estate-long-term-investment.aspx
2) Professor Damodaran of NYU
3) Professor Shiller of Yale