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

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

Housing vs. Stock Market Growth Revisited

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.
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Copyright © 2011 Last modified: 4/17/2012

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