Real Estate Verses Stock, Summary

By far the most common form of individual investing in the United States today is stock.  Over half of the US population owns stock either directly or indirectly through mutual funds or retirement accounts. Today, employer sponsored retirement accounts drive stock purchases by making stock ownership easy and automatic. To balance risk and return, many investors diversify among different stock classes, using a buy and hold strategy.   Over time, this investment approach has proven to be effective, especially if employers match contributions in employer sponsored retirement plans (e.g. 401k).  Many people believe that stocks are the best performing asset class, over time.

In contrast, only about one percent (1%) of the US population owns real estate investments, in spite of the fact that about half of the US owns a home.  It is not common knowledge that real estate investments provide excellent returns compared to stock and is the best hedge against inflation.  

Comparisons between the historical performance of stock and real estate investments usually show that real estate does not look like a great investment.  This type of comparison tries to present real estate investments and stock on an equal basis along with a bank savings account, a sort of “apples to apples” comparison.  What these comparisons fail to account for are the eight advantages of investing in real estate: leverage, appreciation, other people’s money (OPM), inflation hedge, taxes, equity access, depreciation and management. When you correctly account for these advantages, real estate has the highest return, over time, while providing the best hedge against inflation.

The following figure shows how a $1000 investment being used as a 20% down payment, just a 4:1 leverage, to purchase $5,000 in real estate compares to stock and a saving account.  This example assumes that stock is purchased through an employer sponsored retirement plan (401k) with 1:1 matching for a total of $2000 in stock.  This is a higher leverage play than buying stock on margin.  The bank saving account is treated as a simple compounding interest account. 

For these comparisons, the S&P500 index (including splits and dividends) represents stock.  The S&P500 index embodies about 75% of the US equities market.  The average US house prices represents real estate.  Finally, the 30-day US Treasury bill rate represents a bank saving account.  In addition, all returns are adjusted for inflation using the Consumer Price Index for all Urban Consumers, all items. 

The figure below shows the inflation-adjusted growth, or lack of growth, of the three investment classes over 45 years, starting in 1963 to 2008.

The inflation adjusted return for the real estate investment jumps to 725% over 45 years, which is almost three times greater than stock!  With 10% down, the inflation adjusted return for real estate jumps to about 1,500%.  The bank savings account still loses about 81% over the 45 years. 

This amazing return for real estate investment includes:

         8% APR                        Interest only mortgage (principal is not paid down)

            2%                            Annual property tax on current year home value

            0.4%                          Annual insurance cost on current year home value

            Rent:                          Initially 10% negative cash flow, after PITI

                                              3% per year increase – straight line

            Income Tax Rate:      19.5%

            No tax deduction for depreciation

It is easy to see why so many wealthy people made their fortunes in real estate!!!

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