The median sales price of existing homes sold in the United States was $329,100 in March 2021, an all-time record both on a nominal basis (i.e., not adjusted for inflation) and on an inflation-adjusted basis (source: National Association of Realtors, BTN Research). How should real estate be considered in a portfolio when planning for retirement?
As noted previously, 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, before carrying costs, has totaled about 1% per year.
The average property tax paid in 2020 on a single-family home in the U.S. was $3,719, equal to 1.1% of the fair market value of the average home nationwide. The most expensive property tax states are New Jersey (2.20% effective property tax rate), Illinois (2.18% effective rate), and Texas (2.15% effective rate). An average single-family home in New Jersey paid $9,196 in property taxes in 2020 (source: Attom Data Solutions, BTN Research).
With a real estate net return of 1% per year, after deducting annual property taxes, lending/leverage costs, insurance, maintenance and repairs the net historical average return on real estate is negative. 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.
-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.
-Real estate is by nature illiquid, costly to buy and sell, and requires time and effort to manage effectively.
-Local legislation and tax policy can regulate rents and restrict a landlord from evicting tenants.
Real Estate can be a diversifier in a portfolio of financial assets. But by definition, an asset is not the same as an investment (https://thefinancebuff.com/asset-vs-investment.html) By itself, it's very difficult for an investor to 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.
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 (REIT) or a REIT ETF. However REITs still have liquidity restrictions and the properties in them still mirror historical real estate returns of annualized 1% net before expenses (versus 7% net annual returns for owning equity in 500 of the largest companies of the world).
Sources: Nick Murray, Robert Shiller