Sunday, April 15, 2012

Housing vs. Stock Market Growth Revisited

Devising a way to make a simple, fair, high-level comparison between housing and stock investments is more difficult that you might think. This post is my second attempt to develop such a comparison.

U.S. Housing vs. Stock Market Price Growth

DJIA (Dow Index) growth vs U.S. residential real estate / housing growth since 1900
U.S. Housing vs. Stock Market Appreciation

In the above graph (click to expand) the blue line shows Shiller's nominal home price index, treating 1900 as 100. As a reminder, Shiller's methodology attempts to track the price of a home of constant size and quality; it adjusts out the upward price drift caused by the average home becoming larger and more feature-rich over time. The red line represents yearly closing prices of the Dow Jones Industrial Average (DJIA) -- again treating 1900 as 100.

In both cases, we're using nominal, "then current," dollars -- i.e., I have not adjusted for inflation. In both
cases, we are tracking price appreciation only, and ignoring any income from the investments. As a result, this is clearly only a gross approximation. However, I think this is a fairer gross approximation than my earlier comparison since we are ignoring income for both investments to put them on more of a level playing field.

Results Are Closer To What You Would Expect

My revised graph is much more consistent with most people's intuition. We know that historically both stocks and housing have been good investments. It seems reasonable that the results of the two investments would be at least in the same ballpark.

According to my data, the inflation-adjusted growth rate of residential real estate prices over the last century or so has been about 0.2%/year; the inflation-adjusted growth rate for the Dow Index on a closing price basis was 1.6%. This approximately 1.5%/year difference, compounded over 100 years, accounts for the significant difference in the size of the ending portfolios; the stock portfolio is 5 times larger than the real estate portfolio.

On the other hand, the "feel" of the graph is that the two growth rates have historically been in the same "ballpark" -- at least until the extended bull market starting in 1982. Adding income to the equation could conceivably reduce the gap even further.

Analysis Still Incomplete

Since this analysis is at such a high level, the results are by necessity preliminary. A complete analysis would, of course, have to include the income derived from each investment. Thus, dividends would need to be included for stocks. For housing, the analogous income is either rental income from the property, or some measure of "rent expense avoided" in the case of owner-occupied homes.

However, as I have said, this is a complicated issue. So, even including the above does not complete the picture. Here is a more complete list of additional factors.

Factors Favoring Housing/Property/Real Estate Ownership

Here are some key additional factors that have generally favored housing over stocks:

  • Home prices are much less volatile than stock prices -- especially on the downside. The housing market has historically been much less prone to bubbles and crashes. 
  • Housing investments are typically leveraged, magnifying the owner's gains. (Note, however, that leverage also magnifies losses. See The Risks of Low Down Payment Mortgages.) 
  • Housing investments provide tax advantages since real estate taxes & mortgage interest are tax deductible, and some gains are exempt from taxes. (Note: stock capital gains also enjoy favorable tax treatment. IRAs, 401ks, etc. can also help reduce the tax load on stock holdings.)

Factors Favoring Stocks

Here are some key factors that have tended to favor stocks:

  • Stock investments are more liquid; it is easier to buy and sell on short notice. 
  • And, when you do, stocks typically have lower transaction costs. Buying and selling a property can easily cost 10% of the price of the property. 
  • Stock portfolios tend to be more diversified; it's easier to avoid having all your eggs in one basket. 
  • Stock portfolios require less ongoing cost & effort. Property owners generally have interest and taxes to pay, even if the property is not appreciating. In addition, keeping a property well-maintained can be costly.  


We do not yet have enough information to determine which is the "better" investment in any general sense. I suspect that housing vs. stocks is best thought of on a case-by-case basis. The above factors, and still other factors not listed above, including psychological factors, could lead different people to different conclusions -- or even the same person to different conclusions under different circumstances.

Since housing and stocks are both good, but very different, investments there are often significant advantages to including both in your financial plan.

I plan to take another, more detailed, look at this issue later this year.

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 Material

Stocks vs. Property
Stocks vs. Real Estate, from CNNMoney
Real Estate vs. Stocks, from Forbes, May 2005
Real Estate vs. Stocks - Which Is the Better Investment? from About.Com
A Home Is a Lousy Investment: from the Wall Street Journal.
Comparing Housing vs. Stock Market Growth: my original post on this topic. Includes an extended discussion of factors that tend to limit housing price growth.
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
The Risks and Disadvantages of Low & No-Down Payment Mortgages

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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