Saturday, October 22, 2011

Comparing Housing vs. Stock Market Growth

Readers are interested in comparing increases in the price of U.S. residential real estate to stock market growth. While there have been periods where the prices of homes have appreciated faster than the stock market (especially recently), in the longer term the stock market has prevailed. This post compares historical growth in the two markets and suggests some factors that tend to constrain long-term growth in housing prices.

U.S. Housing vs. Stock Market Growth

DJIA (Dow Index) growth vs U.S. residential real estate / housing growth since 1929

In the chart above the red line shows the growth of $100 invested in the Dow Jones Index at year-end 1928, with dividends reinvested through year-end 2010. The blue line shows the growth of the Shiller residential real estate price index during the same period, assigning 1928 a base value of 100. All amounts are
in "then current" dollars -- i.e., not constant dollars. As you can see, the growth rate and ending amounts for the stock market are significantly higher. The ending value for the stock market purchase is over $100,000 compared to about $2,000 for the real estate purchase! (Note: The graph above is misleading since it includes income from the stock investment, but not equivalent income from property investments.  For a more balanced presentation of the historical returns, see  Housing vs. Stock Market Growth Revisited. The discussion below of factors that have tended to limit housing price appreciation is still appropriate. 4/17/12)

In 100 Years of Inflation-Adjusted Housing Price History we saw that since 1900 U.S. housing prices have increased only slightly more than inflation. For many readers, this result is surprising -- especially when compared to inflation-adjusted stock market returns (which, by the way, do not include the impact of reinvested dividends). Following are some key factors that help explain the relatively slow growth in housing prices.

The Cost of New Homes Tends to Limit the Price Growth of Existing Homes

If existing homes are selling for more than it would cost to build a comparable home, builders will build competing homes and sell them for less than the market price. These new homes will put downward pressure on the prices of comparable existing homes. Thus, over the long term it is difficult for home prices to grow faster than the inflation rates of the materials, manpower and land required. This assumes there are no "artificial" constraints on new construction. (This assumption is likely to be violated to a greater or lesser degree in some locales, but seems to be a reasonable assumption overall.)

Here it is also interesting to note that increases in productivity tend to lower costs. This is generally good for the stock market since it increases profits. However, to the extent that it lowers the cost of new homes, increases in productivity will tend to constrain the growth in home prices.

Family Income & Housing "Affordability"

Homes can sell only if there are buyers that can afford to purchase them. Thus, over the long term it is difficult for home prices to increase faster than family income. Over the long term, prices can increase faster than income if families are willing to commit more of their yearly budget to housing, but only to a point. (Note: housing affordability can also be affected by factors such as tax policy and interest rates.)

Rentals and Conversions

As home prices rise the demand from investors buying homes to rent them out dries up -- removing some of the upward pressure on home prices. At higher prices, investors are motivated to sell their rental homes, adding to existing supply, and putting downward pressure on home prices. Higher prices will also generate additional supply from conversions of existing non-residential structures (e.g., warehouse conversions). Finally, as prices rise more and more potential buyers will drop out of the market and decide to rent instead.

Is Homeownership Oversold/"Overhyped"?

As you can see, nation-wide appreciation in the price of homes has been nowhere near that of the stock market. (Note: Stock prices have grown faster.  However, the difference is not as large as it appears in the above graph.  4/17/12) There are powerful forces that, absent "artificial" (and generally local) constraints, tend to severely limit home appreciation to somewhere around inflation. Does this mean that the interest in home ownership is completely misguided? Not necessarily.

A fair comparison is much more complicated than most people realize. What's "better" always depends upon your evaluation criteria. I think the above results mean that the advantages of home ownership typically come from other factors. In the next post in this series, we'll broaden the analysis to include additional factors -- some, but not all, of which are more favorable to housing.

Notes: As always, we're ignoring the impact of taxes, commissions and other fees on stock market returns. The housing results assume you paid cash for the home (i.e., no mortgage), and ignore any associated rental income (or rent expense avoidance) plus all subsequent costs such as maintenance and taxes. If you're not familiar with the log scale used for the vertical axis, see About Log Scaled Graphs.

Related Posts

100 years of Stock Market History: Dow closing price history.
100 years of Inflation-Adjusted Stock Market History: again excluding reinvesting dividends.
100 years of Housing Price History: Using the Shiller price index.
100 years of Inflation-Adjusted Housing Price History
A Home Is a Lousy Investment: Another approach to comparing housing vs stocks from the Wall Street Journal, using different criteria.
Data Source
Robert Shiller "Irrational Exuberance" Housing Data: Shiller's housing price index data summarized to yearly data beginning in 1900.
For lists of other popular posts and an index of stock market posts, by subject area, see the sidebar to the left or the blog header at the top of the page.
Copyright © 2011 Last modified: 4/17/2012

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  1. California residential real estate used to sell for 10% more than the US average. Weather, jobs and schools.
    In 1978, property tax was limited by Prop 13 to 1% of assessed valuation.
    Within a decade, California RE was selling at a premium of 100% to the US average. A high premium remains, in spite of the bubble bursting.
    Property tax is a major factor in keeping real estate returns grounded.

  2. I'm probably missing something in your DJIA comparison to real estate graph. US Housing vs. Stock Mkt. price growth.
    Seems to suggest $1,000 in stock would be worth about $1 million today. OK.
    But a typical $1,000 home in 1928, and there were millions of the little 2 br. /1 ba. homes, would only sell for only $20,000 today?
    I'm thinking more like $120,000.
    The DJIA is still better, but the housing graph doesn't seem right.

    1. Did you look at the data? I'm just reporting Shiller's data -- which is acknowledged to be the best source available (but, not very precise). Shiller's nominal index in 1928 was around 6; in 2010 it was about 132. So, a $1,000 home in 1928 would be about $22,000.

      One reason the $22,000 seems low is that many areas of the country have appreciated more than this (probably including your area). However, don't forget the index reflects the national average.

      Also, don't forget Shiller's data attempts to adjust for size and quality. If, for example, the $120,000 homes you mention have added bedrooms or baths, they're no longer comparable to the original 2 br/ 1 ba. Shiller is measuring price change for a home of constant size and quality.

      I hope that makes the results seem a little more reasonable.

    2. Housing is missing the yield that you get from renting the house, you cannot compare stock market with dividends reinvested with housing without rental income reinvested.

      If we add rental income, we probably have less yield in the housing sector, but the housing sector is less volatile and the housing cycle is more predictable.

    3. Thanks for your reply,

      I'm sure that there is some historical data of average rentals, I'll try to find it.

      A rule of thumb is to take one third of the rent income as:
      - Void Periods
      - Bad tenants
      - Repairs
      - Insurances and other costs
      - Cost of looking for new tenants
      - Property manager (Look after the tenant takes time.)

      Obviously it depends on the property, laws etc... on average it is a good approximation.

    4. Dalamar,
      Thanks for your comment.

      While this post was intended to be a simplification, the more I think about it the more I agree that the original presentation is too misleading. I think this post needs to be re-thought & re-worked. That may also address The LoanRanger's issue. I suspect the real issue for him was not necessarily the housing results, but the huge difference between the housing and stock market results.

      Thanks again for helping me to see the light.

    5. Looks like I redid my reply while you were already responding to it.

      I'd be interested in the historical data if you can find it easily. However, my gut says it would be simpler for this very high level look to make the two investments more comparable by removing the income stream from the stock market side (rather than trying to add it to the housing side).

  3. Dalamar, TLR
    Thanks for the heads up on this one. The updated comparison seems a lot more reasonable, and gets real estate returns at least in the same (big) ballpark. See the new post:


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