Which has performed better historically, the stock market or real estate?
For the majority of U.S. history - or at least as far back as reliable information goes - housing prices have increased only slightly more than the level of inflation in the economy. Only during the period between 1990 and 2006, known as the Great Moderation, did housing returns rival those of the stock market. The stock market has consistently produced more booms and busts than the housing market, but it has also had better overall returns as well.
Any results derived from comparing the relative performance of stocks and real estate prices depends on the time period examined. Examining the returns from just the 21st century looks very different than returns that include most or all of the 20th century.
Reliable data on the value of real estate in the U.S. is murky before the 1920s. One inflation-adjusted value index between 1928 and 2012 placed the annual rate of appreciation for real estate prices at just 0.2%. The peak for real estate growth occurred between 2001 and 2005.
The inflation-adjusted appreciation on the Dow Jones Industrial Average (DJIA) over the same 84-year period was 1.6% per year. Compounded over time, that difference resulted in a fivefold greater performance for the stock market.
There aren't many investors with an 84-year investment horizon, though. Take a different time period: the 38 years between 1975 and 2013. A $100 investment in the average home in 1975 - as tracked by the House Price Index from the Federal Housing Finance Agency (FHFA) - would have grown to about $500 by 2013. A similar $100 investment in the S&P 500 over that time frame would have grown to approximately $1,600.
Apples and Oranges
While stock prices and housing prices both reflect the market value of an asset, one should not compare houses and stocks for market returns only.
Stocks represent an ownership interest in a publicly-traded company. They are not tangible, physical assets and serve no utility other than a store of value and a liquid security instrument. While there is some reason to believe that the overall stock market would gain in real (as opposed to nominal) value over time, there is little reason to believe that a single stock should grow in perpetuity.
Real estate is not like stocks. Some people speculate with real estate prices, but commercial and residential real estate serve tangible functions. People live in houses and condominiums. Businesses operate out of commercial property. Physical property has value in and of itself.
This introduces two conflicting phenomena. On the one hand, existing real estate structures should naturally lose value over time through wear, tear and depreciation. An unmodified home has no reason to grow in value over time; all of the floors, ceilings, appliances and insulation age and becomes less valuable.
On the other hand, the average homes built in 2018 are unquestionably superior to the average homes built in 1915. While existing structures shouldn't gain value, new structures should be more valuable on the basis of their structural and functional improvements.
Great question. The stock market, as measured by the S&P 500 Index, has had an average annual return of 10.31% from 1970 - 2016. The real estate market has had an average annual return of 11.42%. That is measured by the publicly traded REITS (the NAREIT Equity REIT Index from 1970-1977 and the DJ Wilshire REIT from 1978-2016). To put this into dollar terms, if you would have invested $10,000 in the S&P 500 in 1970, by the end of 2016, your investment would have grown to $1,005,588. If you would have invested $10,000 into the DJ Wilshire REIT index, your investment would have grown to $1,609,932. The Real Estate market is a little bit more volatile than the stock market, but not by much. The standard deviation for the S&P 500 is 17.12% which means there is a 95% chance that your return in any given year will fall between -23.93% and 44.55%. The standard deviation of the Real Estate market is 18.92% which means there is a 95% chance that your return in any given year will fall between -26.42% and 49.26%. The worst 1 year return for the stock market was in 2008, it dropped 37%. The worst 1 year return for the Real Estate market was also in 2008, it dropped 46.49%.
Stocks have performed better over the long term. However, absolute return doesn't tell the whole story. You want to know the risk/adjusted return. Stocks, once again, add better protection because they are diversified across multiple sectors (including real estate). The S&P 500 has exposure to technology, consumer staples, retail, energy, industrial, and even stocks with real estate holdings.
Real estate is a good asset class to have exposure in, but does have big drawdowns and are interest rate sensitive. That said, so have stocks. But if you think interest rates are likely to rise, the risk profile of real estate would be increasing as other interest rate sensitive sectors.
The way I personally would invest would be to have some broad, passive (beta) exposure while also having specific exposure in sectors I think will outperform over the mid-term (1-2 years) based upon economic and market conditions.
So based upon the way you asked the question, one approach would be to have somewhere around 50% in broad market exposure (S&P 500), 30% in real estate exposure, and 20% in sectors you believe will do well over the next few years. This may not be the right allocation for you personally, but you get the idea. Real estate and stocks are not mutually exclusive and there can be some overlap.
The investment community always talks about "your risk profile," but not enough about the "risk profile" of particular investments which changes over time. So in my opinion, you need to consider this as well.
Hope this helps your thought process. Best of luck, Dan Stewart CFA®
The data all depends on the timeframe. The issue that comes up from talking to clients about their own home, or rental properties, is they don't compare apples to apples. They don't take into account all the expenses of real estate, like property taxes, a new roof, etc. They also don't take into account liquidity, I can sell a mutual fund or ETF in seconds for a few dollars, not so for Real Estate. Lastly, they don't take into account leverage. With leverage comes risk, and you don't have leverage with most stock funds, but you most often do with personal real estate and some REITS.
Morningstar recently did a very good analysis of this very thing -- it is on my website "The Home As A Risky Asset": http://www.sonafinancial.com/articles-tools/
Several advisors have given you some great stats on some historical performance for REITS vs. the market. When I look at the data and I have to choose what asset class is best at building wealth on a risk-adjusted basis, I have to choose the stock market. If you take into account liquidity and the fact that most Americans have their wealth tied up in their own homes, I think Real Estate should be used, but used in moderation. Part of the reason I use Dimensional Funds is they separate out real estate because it is a special asset class.
Mark Struthers CFA, CFP®
On an inflation-adjusted, net of all related maintenance and tax expenses, US large cap stocks (like the S&P 500 Index) have performed much better than US residential real estate by a factor of 2X, depending on your time period of evaluation. The big difference is that real estate has the perception of being less volatile, since it's not visible on a daily exchange. Also, you can't live in a portfolio of stocks, but you can with a home. So, the usability factor adds a dimension, as a tangible asset class.
The answer to this question can be complicated by geographic locale, type of property (i.e. specific-use such as health care, technology, self-storage, residential, etc.), and timeframe. However, the average rate of appreciation for existing homes increased around 5.4% per year from 1968 to 2009 (Natl. Assoc. of Realtors). Adjusted by the trends in size increases, the increase is closer to 3.7% and the rate of inflation was around 4.5% on average during this time frame (source: Michael Bluejay, How to Buy a House, 2009).
Over the last 20 years, U.S. Stocks, as judged by the S&P 500, averaged a +8.2% return, U.S. Small Cap Stocks (Dimensional US Small Cap Index) averaged +11.5% per year, and International stocks (MSCI EAFE) returned 4.4% per year.
On average, we don't expect real estate investments to return more than the rate of inflation in terms of growth. However, you also have to look at the impact of tax advantages to the investor, income yield, and the fact that direct investments in real estate often allow for significant leverage (you have to put no more than 20% of your own money into your home purchase, for example). So, your rate of return has to include income yield, growth, and the limited amount of your own capital in the investment. Depending on the situation, this can look very attractive to the right investor.
Of course, if you buy real estate directly (instead of through a partnership such as a publicly-traded Real Estate Investment Trust), you also need to factor in your time in managing the property and the maintenance and repair costs.
In my opinion, if you are not interested in the hands-on management of a property, the stock market makes more sense because you don't have to factor in personal time, expenses, and vacancy costs.