Real Estate

Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.

Jason Zweig recently suggested that homeowners make far less money selling their houses than they believe. He cites Yale University economist Robert Shiller's data, which finds that “real estate generally keeps pace with inflation but seldom offers any return premium above that.”

Homes have done a bit better than that, but not by much. The S&P/Case-Shiller U.S. National Home Price Index, which measures the changes in value of single-family homes, has grown at a real rate of 1.1 percent annually since 1975. In reality, even this pittance overstates homeowners’ fortunes since it doesn’t account for the myriad expenses that also accompany homeownership and eat away at returns.

So how did homes get confused with goldmines? It turns out that a short-lived period of unusually high returns is to blame. As expected, that period coincides with the boom years of the real estate bubble, but the seeds were planted during the tech bubble that preceded it. This becomes apparent when looking at the NHPI's rolling ten-year real returns.

The average annual ten-year return was 1.1 percent -- the same as the NHPI’s long term annual return. The standard deviation, or volatility, of ten-year returns was 1.9%. This means that 95 percent of the time, the ten-year returns can be expected to be between -0.8 percent and 3.0 percent.

But if you bought a home between 1995 and 1997, your ten-year return turned out to be upward of 5.0 percent -- a pot of gold, indeed. Based on the ten-year returns and volatility of the NHPI, that kind of payoff can be expected 3 out of 100 times at best. So don't count on it happening again anytime soon.

Once Upon a Time
Rolling ten year real returns of the S&P/Case-Shiller U.S. National Home Price Index.
SOURCES: S&P Dow Jones Indices, US. Bureau of Labor Statistics

Homebuilders and realtors and buyers and sellers and real estate investors may all be tempted to say, “That’s nice, but my city is different.” They all should think again.

The S&P/Case-Shiller individual city indexes tell a similar story. My "Little to Love" chart shows the real rate of return for Boston, Charlotte, Chicago, Denver, Los Angeles, Miami, New York and Portland since 1986, the earliest year for which data is available for those cities. By comparison, the NHPI grew at an astonishingly resilient annual real rate of 1.1 percent during the period. Los Angeles and Portland are the only cities that did meaningfully better, but still not enough to get excited about. 

Little to Love
Real rate of home price returns for eight U.S. cities since 1986.
SOURCES: S&P Dow Jones Indices, US. Bureau of Labor Statistics

A better bet may be real estate investment trusts, or REITs. The FTSE NAREIT U.S. Real Estate Index has returned a whopping real annual return of 5.4 percent since its inception in 1972. And it didn’t require you to mow the lawn, unclog the toilet, change lightbulbs, or stop the kids from destroying their bedrooms. All you had to do was hang on.

REITs have another advantage. Unlike a home, a REIT's exposure is tactical. They are cheap and easy to buy and sell, and REIT yields provide useful information about REIT valuations. For example, the average yield of the NAREIT Index has been 7.7 percent. Today that yield is 4.3 percent, which implies that REITs are on the expensive side. (Like bonds, REIT prices and yields move in opposite directions.) If history is any guide, higher yields will be back.

No Contest
Real returns of REITs have crushed those of homes, and without home-ownership headaches.
SOURCES: S&P Down Jones Indices, FTSE Russell, US. Bureau of Labor Statistics

REITs have more market risk than houses – specifically, the risk that the market will erode and bruise the value of REITS and homes alike. Volatility is a customary proxy for market risk, and investors don't like rollercoaster rides. By that measure, homes feel safer: The NAREIT Index has a volatility of 17.7 percent, while the National Index has a volatility of only 2.2 percent.

Homes, on the other hand, have more idiosyncratic risk because they represent an undiversified investment (unlike REITs). In short, homes embody the hazards of Mark Twain’s famous quip : "Put all your eggs in one basket, and watch that basket!"

There are numerous non-financial benefits, and some personal financial benefits (the mortgage interest deduction, for example) to buying a home. But if you want diversification, and if you want meaningful expected price appreciation from real estate, buy a REIT and rent your home. Homes are wonderful places to raise a family. They  aren’t great investments.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nir Kaissar in New York at nkaissar1@bloomberg.net

To contact the editor responsible for this story:
Timothy L. O'Brien at tobrien46@bloomberg.net