Is Real Estate Still A Good Investment?

Is Real Estate Still A Good Investment?
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Time Magazine's cover story," The Case Against Homeownership" (the link is only to an abridged version of the article given it is a recent issue) takes an over-arching look at the state of home ownership in the context of a relatively battered asset class globally. The article raises the larger question of whether all the government subsidies promoting home ownership has been a good use of public funds and whether owning your home is the right finance decision for all households.

No other financial topic tends to evoke a purely emotional response as real estate. It has become, over the last 10 years, the financial topic du jour in the backyards and dinner tables of the middle class. With real estate appreciation either slowing or continuing to decline, many continue to ask whether real estate is a good investment.

The problem with this question is two-fold (at the very least). Real estate, as the adage goes, is all about location. To read a headline in a national publication about the real estate market tends to obscure local effects and it becomes folly to use national data to make decisions which are local in nature. For example, the existence of a local school or employer can, and often does, insulate that immediate community from some of the negative effects of a national economic slowdown. Similarly, locations which structurally have high tenant-to-owner ratios (such as New York City or neighborhoods close to large educational institutions) tend to maintain their relative value.
Thus, the answer to whether real estate is a good investment is not found in the front pages of your paper but by simply looking around you. Is your local school ranked highly, are "average" homes in your community being sold quickly, is the government investing in your community (where the stimulus money is going, other than the absolutely necessary repairs, is a good barometer of whether the bureaucrats think your community is expanding and where the politicians need to build or maintain political capital)?

The second issue is how do you define a "good investment"? One of the subtexts of my posts lately is that 1991-2007 was a historically anomalous time. A 17 year period with a minor rescission is not normal. Correspondingly, our notion of good investment returns went askew as well.

Most prudent investors believe that a 5-8% nominal return per annum (return before inflation) is considered a healthy return for equities. This rate of return balances risk and reward of a retail investor. Yet, to repeat a story I once wrote pre-credit crisis, I met a real estate investor who once said that nothing less than a double-digit return in an 18 month period was acceptable for his real estate investments. I do not believe that he was alone in his thinking.

However, economic data seems to indicate that real estate investing, as undertaken by institutional investors, has approximately the same range of returns per annum as equity. In other words, the debate about stock investing vs. real estate investing may not be a debate about rates of return but different methods of achieving the same range of return (file this under "Different doesn't mean better or worse. It just means different."). But the key, like stock investing, is that time is often a large factor in driving returns; the longer you hold onto an asset, the more likely you will make a reasonable return.

It would be foolhardy to throw an entire asset class overboard due to recent history. However, like everything else in life, patience and reasonable expectations would do us all well.

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