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How Real Estate is Suicide to Purchasing Power

How Real Estate is Suicide to Purchasing Power

September 07, 2023

Owning the same residential home for many years or decades has been shown to be less costly to the resident versus renting over the long-term. However - real estate is also frequently advertised as an “investment” or a “diversifier” in a portfolio of financial assets.  

The definition of an ”investment” is an asset that increases money or purchasing power over the long-term, and real estate is advertised as such.

Millionaires and multi-millionaires know better.

From Thomas Stanley’s bestselling The Millionaire Next Door: 

“…as I mentioned in Stop Acting Rich, 64% of the millionaires surveyed never owned a vacation home, beach bungalow or mountain cabin, not even a lean-to or a tree hut in the woods.”

In truth real estate can, slowly or quickly, destroy an investor’s purchasing power, create liquidity crises and increase portfolio risk substantially over an investor’s lifetime.

Money is defined as “purchasing power”. Here’s how real estate drains your money over time:

+4%.  Historical annual return Single Family Home per Robert Shiller (Case/Shiller Housing Index)

-3%.      Average annual inflation rate

-1.1%.   Average annual property tax expense 

-.5%      Average annual property insurance expense 

-1.5%    Average annual property repairs and maintenance expense 

-2.1%    Total Average annual loss in purchasing power - single family home 


By itself, it's very difficult for an investor to ever have a diversified portfolio of real estate.  Most holdings become pieces of a few similar assets (condominiums, apartment houses, office buildings) in the same areas.  The result is often under-diversifying, both by location and by property type.  Here are some important facts:

1.  It is a myth that one's home provides a significant growth of capital.  Since 1945, American single family home prices have risen at a rate of about 4% per year. (Case-Shiller Index - Nobel laureate Robert Shiller).   So after inflation, Net return on property has totaled about 1% per year.  By comparison, the return of the S&P 500 index has been about 10% (Net 7%) per year - a return which requires no maintenance, repairs or tenant vacancies.  

2. The advertised returns of real estate usually rely on high leverage, which increases risk significantly.  The loss of a tenant, or their financial distress can force a leveraged property into negative cash flow which the investors may be liable.

3.  Real Estate is by nature illiquid, costly to buy and sell, and requires time and effort to manage effectively.

4.  Local laws/legislation and tax policy can regulate rents and restrict a landlord from evicting tenants.

If there is an insistence to own a large percentage of real estate, there are options to avoiding risky concentration such as a diversified Real Estate Investment Trust.  However REITs still have liquidity restrictions and the properties in them still mirror historical real estate returns of annualized 1% Net (versus 7% Net annual returns for owning equity in 500 of the largest companies of the world).


Sources: Nick Murray, Robert Shiller 

http://www.econ.yale.edu/~shiller/data.htm

https://wealthtrack.com/robert-shiller-nobel-prize-winning-economist/ 

https://awealthofcommonsense.com/2013/03/real-estate-investment-performance/

In truth real estate can, slowly or quickly, destroy an investor’s purchasing power, create liquidity crises and increase portfolio risk substantially over an investor’s lifetime.