I almost
let an article about how great luxury real estate has performed sneak by
without comment until I saw a dubious comparison to the stock market. Here's
what caught my eye: Adjusted for inflation, that’s a compound annual growth
rate of 8.7 percent.
The S&P
500 stock-market index averaged an inflation-adjusted annualized return of just
4.1 percent.
This makes
for a good teachable moment about how to analyse investments, in much the same
way as the presidential election or March Madness or the saving habits of a janitor.
I say this while reminding you that I am not a housing basher, unlike some. I
have been positive on residential real estate for a long while.
Let's dive right in:
Don’t use
outliers to prove your point: Yes, the estate of newspaper magnate William Randolph
Hearst is a formidable and impressive home. But it hardly makes for a good
sample to use when describing the advantages of real estate in general, or even
luxury real estate in particular.
Just how
many 50 000-square-foot, five-acre properties in one of the most-expensive zip
codes in America
are there? Like Picassos and rare Ferraris, it is a one-off, not representative
of residential real estate as an asset class.
Use actual
transactions, not aspirational pricing: Owners of illiquid assets have to come
up with credible ways to price their holdings. Wishful thinking doesn't count.
The market hasn't improved enough to justify lofty asking prices for seller who
hope to flip a property. Homes that don’t sell experience price declines, not
increases.
Include all
costs and fees: As an investor, I have spent the past few decades watching my
costs go down. As a homeowner, I have spent the past few decades watching my
costs go up.
As for that
that Standard & Poor's 500 Index 4.1 percent annualised inflation-adjusted
return. Yes, that may be accurate, but only if you omit dividends. Include them
and the return jumps to 7.4 percent. That’s pretty close to the fictional
8.7 percent return cited above.
Taxes, mortgage interest, insurance,
maintenance, utilities?
Although
mortgage rates may be near historical lows, that probably is temporary.
Meanwhile, the cost of almost everything else has gone up. Yale economist
Robert Shiller pegs annual inflation-adjusted residential real estate returns,
after costs, at 0.2 percent.
Don’t
compare an outlier in one asset class to a broad index in another: Imagine if I
cited Amazon.com or Apple to demonstrate the relative underperformance of bonds
or commodities. You would rightly criticize me for cherry-picking. Use
median returns of different asset classes to make appropriate comparisons.
Pay attention to date ranges and
exceptional factors:
The article
in question cites a property purchased in 1978 in Sagaponack,
New York, in the Hamptons for $140 000 and now listed for
$5.75 million. The article reports that this is a 6.61 percent annual return.
But note that this is a calculation based on the asking price.
That's like
saying I'm calculating the return on my Apple stock based on a price of $125 a
share - which it may reach again someday - even though it trades for $110
today. What's more, the Hamptons aren't exactly
representative of anything other than the fact that in the past 40 years the
financial industry was on a tear and the Hamptons
became Wall Street’s summer playground.
The bottom
line is that you have to live somewhere, and owning is often better than
renting - especially during the past few years, when the cost of capital has
been so inexpensive. But try making the case that residential real estate, even
luxury real estate, has done better than equities during the past 30 or 40
year? The data just doesn't support that conclusion.
This column does not
necessarily reflect the opinion of the editorial board or Bloomberg LP and its
owners.
BLOOMBERG