Real Estate vs. The Stock Market: Stocks Win. However....
Most people think that real estate has been a great investment. Who hasn’t heard someone say at a social gathering,

"Why, I bought my house 30 years ago for $50,000, and today it’s worth over $300,000!"

...at which point we are all expected to nod our heads, cluck approvingly, and marvel at what a great deal property was back then. Of course, I also remember how then chocolate bars were 10 cents, and are now about a dollar. I’m tempted to point out that chocolate bars beat real estate, and that if I had only put a few truckloads of O' Henry’s into storage, I’d be a richer man today. Several studies have compared real estate to stocks:

But if you take a longer view--say 25 years--you'll find that the S&P 500 has actually stomped the real estate market, from Boston to Detroit to Dallas. From the start of 1980 to the end of 2004, home sale prices increased 247%. A pretty sweet deal, it would seem. Over the same period, however, the S&P 500 shot up more than 1,000%.

Sara Clemence, Forbes Magazine, www.forbes.com/2005/05/27

But over the long run stocks win easily. A new study by Jack Clark Francis, a finance and economics professor at Baruch College in New York City, and Yale's Roger G. Ibbotson compared the annual returns of real estate from 1978 to 2004 compared with those of 15 different "paper" investments, including stocks, bonds, commodities futures, mortgage securities and real estate investment trusts (REITs).

The results? Housing delivered a solid but unimpressive annualized return of 8.6%. Commercial property did better at 9.5%. The S&P, however, delivered a crushing 13.4%.

Other studies argue that real estate's returns are much worse. Yale finance and economics professor Robert Shiller, author of Irrational Exuberance, who looked back to 1890, contends that only twice has real estate produced truly outstanding returns: after World War II, when returning troops were starting their families, and from 1998 to 2005, a period he thinks is a bubble.

By Marlys Harris, CNNMoney.com, April 2007

A few years ago I read a fascinating article on very long term returns in real estate. It studied a neighborhood in Amsterdam, the Herengracht, which had a unique characteristic: it was always the best region of Amsterdam. The Dutch kept meticulous records of property transactions in this area going back almost 400 years, so when Piet Eichholtz, a professor of real estate finance at Maastricht University in the Netherlands, analyzed the data, he produced ‘the Herengracht index. The results were startling:

That is to say, where everyone from your wise old uncle to the broker who sold you your house holds it as gospel that real estate is one of the best long- term investments, this longest of long- term indices suggests that, on the contrary, it sort of stinks. Between 1628 and 1973 (the period of Eichholtz's original study), real property values on the Herengracht - adjusted for inflation - went up a mere 0.2 percent per year, worse than the stingiest bank savings account. As Shiller wrote in his analysis of the Herengracht index, "Real home prices did roughly double, but took nearly 350 years to do so."

‘From Dutch history, a real estate lesson’, by Russell Shorto, The New York Times, March 3, 2006

Now, what does this have to do with investing? Am I telling you to avoid real estate? No, not at all. That is not the purpose of this newsletter. In fact, I would venture a guess that the vast majority of investors have made more money by owning their own home than by investing in the stock market.

But why? If stocks are so superior, why haven’t people made more money there?

It is because real estate investors BEHAVE COMPLETELY DIFFERENTLY than stock investors. Most people stay invested in the property market. Sure, they might sell their house, but will then either upsize or downsize to a new property. They are still ‘invested’ in that market. Through good times and bad, they hang on.

Not so with stocks. And not just stocks: any investment is subject to the same effect. Investors’ preferences change like the wind. When things are going well, they pile in -only to exit when things get scary. Countless studies have shown that they almost all get it wrong, buying in at the high, after things have gone well for a while, then selling out at the low when gripped with fear. But why? I can identify three main reasons.

The first is ease of transactions. It’s easy and cheap to trade in stocks. All it takes is a quick phone call or click of a mouse. Houses on the other hand are notoriously difficult to liquidate - just ask the Americans! You have the house ready for sale, then get an agent, have it listed, wait, then negotiate a bit, pay a lawyer, arrange financing, etc. Costs mount up too: real estate commissions, lawyer’s fees, land transfer taxes, and moving costs. All these factors work to dissuade the house owner from casually buying and selling property, not to mention the obvious need to actually have a place to live in.

Secondly, stock prices are completely transparent. At any given moment you can know exactly what they’re worth. It can become quite addictive, checking up on prices day-by-day, or minute-by-minute. Eventually, as gyrations occur over and over again, a thought eventually creeps in, "Why don’t I just temporarily exit these stocks if I think they are going down?" And so we let fear take over. House prices on the other hand are a bit foggy. We only have a general idea where the market is. This inhibits hasty selling.

The most important reason though is lack of confidence. With houses, we are sure that the house is worth something. The seemingly random, wild swings of the stock market can lead investors to sometimes wonder if their stocks will go down to zero. Investors lack the certainty that what they own is worth something. All they see is the latest share price, not the underlying value. Unlike houses, they can’t touch bricks and mortar, and be reassured that what they own will not disappear.

My recommendation is to treat your investments as if they were an extension of your house. Build it, pay for it, then KEEP IT regardless of the opinion of some people who temporarily don’t think it’s any good. Think long term.

If you’d like to meet to discuss your investments and retirement blueprint, feel free to call me at any time.

Sincerely,

Scott Swallow, HBA, MBA, CIM