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Is Real Estate An Investment?

Is Real Estate An Investment?

April 27, 2021
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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. 

In addition:

-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 

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/

    








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