In the reality TV shows, the “investors” gather around the courthouse at auction time, betting on the best property to buy and flip.
Amid the story lines and the personalities it’s easily to lose track of the real reality: the odds are that if they sell in less than 13 years they will do better putting their money in a checking account at two percent interest. Perhaps that’s why there’s usually a big time loser crying in his latte in every third show or so. Usually, however, the losers don’t realize the full consequences of counting on appreciation until they complete their rehab, put it on the market and find out that foreclosure discount and appreciation aren’t get the bad news.
Yes, there are rare markets that appreciate quickly—like the current one. But all the signs are pointing to a slow down and flattening out of prices for the balance of the year. Buyers can read those signs too, so if you’re getting ready to market a property, hurry up.
For investors who are in it for the long haul, including owner-occupants who are told to think of their home as an “investment,” it’s time to put aside the myths real estate agents and others like to perpetuate about the appreciation of real property and check in for a reality check.
A Surprising Study…
Two economists at the Atlanta Federal Reserve, Ellyn Terry and Jessica Dill, did just that and published their findings last week.
Three caveats: They did not factor in political incentives to own a home, such as the mortgage interest deduction, nor did they credit homeowners with savings from rent money that owners would have realized. They did not look at the “buy and hold” strategies popular among investors seeking cash flow from rents, but only at appreciation.
They crunched the numbers back to 1926 and found that, if a home is purchased only as an investment and not as a place to live, a comparison of average annual returns clearly shows that though most homeowners make a slightly positive return, investing in equities offers favorable returns more often than investing in housing.
With average returns on investment for owning a home so close to zero, just how often has the housing market produced losers? And how does investing in housing compare to investing in equities?
They computed the average annual return of home prices across all possible combinations of start and stop points using the Shiller house price series from 1926 to 2012. The distribution depicts returns concentrated around zero with some skewness to the right. Eighty percent of all start-stop point observations experience some degree of positive return.
To take into account the duration of ownership, they assumed that the average homeowner lives in his or her home for 13.3 years, based on analysis by Paul Emrath at the National Association of Home Builders. They found the average annual returns for an asset held for a period of 13 or more years is substantially less volatile than for an asset held for fewer than 13 years, and those investing for the longer term were much more likely to have positive returns.
“We compute that 40 percent of homes owned for less than 13 years have negative average annual returns, compared to 12 percent of homes owned for 13 years or more. Interestingly, while a much greater portion of those owning for 13 or more years obtain positive returns, the average annual return was actually slightly higher for those owning fewer than 13 years (0.95 percent versus 1.03 percent),” they found. So much for flipping.
They applied weights for average length of ownership. Using the weights, they recomputed average annual returns across all possible combinations of start and stop points for average length of ownership. The distribution continued to show that returns are concentrated around zero with skewness to the right; two-thirds of all investors in this distribution experience some degree of positive return.
They ran through this same exercise with the S&P 500 Index (used as a proxy for the stock market) to provide an apples-to-apples comparison of the average annual returns that one could expect from an alternative investment in stocks. The results depict a wider distribution, with longer, fatter tails and some skewness to the right. In other words, there is more volatility in terms of return, but with volatility comes an opportunity for larger gains over time. In fact, the weighted average annual return of the S&P 500 is 4.55 percent, compared to 0.97 percent for the Shiller real home price index.
“It’s important to note that the distributions of returns for housing in all these computations are not the distribution of returns for every possible house purchase. Likewise, the returns shown for the S&P 500 are not the entire universe of returns from buying and selling individual stocks. Instead, these returns are based on a pool of housing and a pool of stocks,” wrote Terry and Dill.
“Further, the returns to housing in the chart ignore the fact that homeowners might have additional gains from owning if their mortgage replaces rent. Indeed, according to some calculations, homeowners who buy a home today and hold it for seven years can expect to pay 44 percent less than people who choose to rent,” they concluded.
In a recent interview, Robert Shiller suggested two percent was about the appreciation to expect on a residential home, even after 13 years. The two researchers concluded that was about right.
Photo: Connor Tarter