When asked in a Bankrate study last July “What is the best way to invest money you wouldn’t need for 10 years or more?” 28 percent of millennials picked real estate and 23 percent chose cash. Only 17 favored stocks.
This is the wrong way to build wealth.
I’m not saying that real estate per se is a bad investment. Certainly owning your own home is a great way to put down roots in a community in which you wish to live. But when it comes to investing your savings for growth, if you think real estate gives you the best returns with the lowest risk, you would be mistaken.
A study by the London Business School, cited by Taylor Tepper at Bankrate, revealed that housing returned only 1.3 percent annually (on average) above inflation from 1900 to 2011.
Stocks, on the other hand, performed more than four times better. Elizabeth Sohmer, an analyst at Bernstein Private Wealth Management, reported that from 1975 through mid-2017, housing prices, according to the Case-Shiller National Home Price Index, rose an average of 4.9 percent each year, compared with the Standard & Poor’s 500 index, which increased by 12 percent annually over that same period.
More recently, from 2010 through the middle of 2017, stock investment returns blew away housing investment returns by more than 9 percent annually.
Even in the Bay Area, despite the tremendous run-up in home prices over the past seven years, real estate growth has still failed to outpace the growth in stocks.
Real estate risk
What about the risk – or volatility – of owning real estate?
Illiquidity, one of the factors that adds to the volatility of an asset class such as real estate, masks it at the same time. Unlike stocks, the media cannot report the daily change in the price of your rental property, because without a buyer, there is no way to determine it. So while you hear about the stock market soaring or plunging on a regular basis, the lack of reporting on real estate prices makes it appear to be a quiet and low-risk asset class. It isn’t.
Take San Francisco housing prices, for example. From 2000 through 2005, they grew by a whopping 12.7 percent per year (on average). A $500,000 house purchased at the start of the decade would have grown in value to $907,000 in just five years. But from 2005 through 2009, that $907,000 house would have dropped in value to $642,000, a -6.7 percent average annual decline. The data firm of Crandall, Pierce & Co. further identified three other periods (1969-1971, 1978-1981 and 1989-1992) when housing prices nationally plunged by more than 15 percent. That isn’t low volatility.
One of the biggest arguments I’ve heard for investing in real estate is the leverage you can get from borrowing money for the purchase. Putting 50 percent down and borrowing the rest (via a mortgage) will double the returns you will get. Very true. But what people forget is that when prices are falling, that same leverage multiplies the losses by the same amount. Let’s not forget 2008, with millions of homeowners finding themselves with mortgage balances higher than their homes were worth. Using leverage for wealth building does not help you manage the risk, it exacerbates it.
For every well-publicized, highly successful real estate investor, there are scores of investors holding poorly producing rental properties. Not to mention those who bought and sold for a loss. But you never hear about those in the media.
Investing in some amount of real estate as part of a diversified portfolio including stocks, bonds and other asset classes to grow your savings in a targeted, risk-managed manner is an excellent way to build wealth. Putting all or most of your savings into real estate is not. Millennials, take heed!