Real Estate as Part of Portfolio Performs Better

Investing Strategies Retirement Investing
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“In our research, we found that portfolios that have a mixture of stocks, bonds and real estate outperform other portfolios,” said Ken. H. Johnson, Ph.D., a real-estate economist at Florida Atlantic University. “You get a better risk/return profile from owning real estate.”

Dr. Johnson said the “optimal mix” in a portfolio is 50% real estate, 30% stocks and 20% bonds. This formula, he said, would be considered sufficiently diversified to provide stability in retirement. The real-estate component can include your personal dwelling, investment property or a mixture of both.

https://www.wsj.com/articles/should-you-add-real-estate-to-y….

And it doesn’t have to be actively managed, (REIT, DST, TIC):

https://www.forbes.com/sites/jeffsteele/2021/09/15/building-…

In a massive data analysis, economists from the University of California in Davis, the University of Bonn, and the Deutsche Bundesbank (Germany’s central bank) collaborated on an incredible new economic report titled “The Rate of Return on Everything” from 1870-2015.

Their findings, in a one-sentence summary? “Residential real estate, not equity, has been the best long-run investment over the course of modern history.”

https://sparkrental.com/rental-property-returns/ and actual study: https://www.frbsf.org/economic-research/files/wp2017-25.pdf

As for our portfolio, we dumped bond funds about a year ago, keeping only our I bonds. Real estate net mortgages represents about 20% of our portfolio, with another 50% in stocks and 30% in cash that is looking for a good value to put it in, be it stocks or real estate. We consider our investment real estate to be a bond proxy that more than keeps up with inflation, often a challenge for bonds.

FWIW, there are alternatives to the 60/40 stock to bond portfolio.

IP

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Their findings, in a one-sentence summary? “Residential real estate, not equity, has been the best long-run investment over the course of modern history.”

That seems to be at odds with Robert Shiller’s findings and my own 40 years of personal experience.

When did these guys get their Noble Prize?

I love this stuff.

intercst

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That seems to be at odds with Robert Shiller’s findings and my own 40 years of personal experience.

The report says rental residential real estate, and the comparison was across various countries. In the US equities win, but that’s not necessarily the case in other countries.

If you want to view housing as an investment, you can’t look at just the straight line appreciation. You have to include the imputed value of rent and leverage (assuming you have a mortgage).

The latter is important because you get to keep all the appreciation while only putting up the down payment plus payments to principle. Schiller’s data say that real estate appreciates at about the rate of inflation. That’s okay. Let’s say you put 20% down on a $500,000 house and the house appreciates by 3.5% in one year (the historical inflation rate). That means you earned $17,500 on your $100K downpayment. Or a nice 17.5% rate of return. That’s not too bad.

Obviously, it isn’t that simple, there are transaction costs and other things I didn’t include. And the longer you live in the house the less and less leveraged it becomes. But inflation is your friend in other ways too. A nice fixed rate mortgage becomes cheaper and cheaper over time, which has obvious benefits.

And owning investment real estate has some beyond the straight line appreciation too. One is actually collecting the rent. Steady income that grows with inflation yet never diminishes your investment portfolio is a good thing. Another good thing is that mostly rich people own investment real estate, and tax laws are designed to benefit rich people. I own some investment real estate which is cash flow positive, yet for tax purposes it is money loser. Tax free income is a also a good thing.

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That’s okay. Let’s say you put 20% down on a $500,000 house and the house appreciates by 3.5% in one year (the historical inflation rate). That means you earned $17,500 on your $100K downpayment. Or a nice 17.5% rate of return. That’s not too bad.

You’ve left off a huge cost. Two of them, really.

If you put 100k down on a 500k house, you have a 400k mortgage. Ignoring amortization for simplicity, at an historically typical 5% interest rate for the mortgage, you need to pay $20,000 in interest for that year. And let’s not forget property taxes. I’ll use 1% of the property value, but many places are higher. That would be $5000 in tax, for a net loss of $7500.

If you use more recent rates, let’s say 3%, the loan costs you $12,000. Property taxes are still $5000, so your return is a whopping $500, or a 0.5% rate of return.

You can add in rental income and repairs and maintenance expenses. And insurance, which your lender will undoubtedly require. And that will change things. But at least we can start from a baseline that doesn’t ignore significant costs.

–Peter

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You’ve left off a huge cost. Two of them, really.

You can add in rental income and repairs and maintenance expenses. And insurance, which your lender will undoubtedly require. And that will change things. But at least we can start from a baseline that doesn’t ignore significant costs.

You can’t ignore significant inputs either. That’s why I stated you have to include the imputed value of rent. If you were renting you would be paying all those same costs, only indirectly to your landlord.

I kinda knew someone was going to point my example was simplified. That’s why I stipulated that it is simplified. There are closing costs, etc. There are other unstated assumptions as well. But the purpose of my post wasn’t to design a rent vs. buy calculator. I was just pointing that buying isn’t necessarily a crappy idea.

To be clear: Later in my post I jumped to investment real estate, so that might have been confusing. But is this example I did say you were living in the house.

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Obviously, it isn’t that simple, there are transaction costs and other things I didn’t include.

Sure, but our rental started out as our residence, on which we SAVED selling costs when we found our perfect residence and decided to turn our property into a rental. This was an option I had floated to DH when we bought the place in the first case. If we decide to move elsewhere, we will make this a rental. That is the point of my doing a 10 year profit projection spreadsheet on the alternative value for primary residences.

IP

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at an historically typical 5% interest rate for the mortgage,

So this what, ignores the ability to refinance? Just how long has it been since fixed rate mortgages were at 5%? Over a decade ago according to this: http://www.freddiemac.com/pmms/pmms30.html

Our current residence is mortgaged at 2% and our PITI is about half of what we would pay if we rented it out as an annual rental. The primary residence we left to move into this property has rents that pays the PITI in full, and with the sub typical 1.5% appreciation we assign to the 10 year profit projection spreadsheet, (actual appreciation over the 4.5 years we have owned it has been 66.2% or almost 15% per year, but I am an excellent buyer,) which includes such “expenses” as 10% of income for “repairs and maintenance,” whether they happen that year or not, 10% of income vacancy and collections, (which also rarely happens,) and management expenses given no one has any desire to manage this that myself, so it is analyzed in a “hit by a bus” scenario, has a 25% ROI. That’s after tax, btw.

IP,
pleased with that as a bond alternative

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I kinda knew someone was going to point my example was simplified. That’s why I stipulated that it is simplified. There are closing costs, etc. There are other unstated assumptions as well. But the purpose of my post wasn’t to design a rent vs. buy calculator. I was just pointing that buying isn’t necessarily a crappy idea.

https://www.mortgage-investments.com/resources/spreadsheet-d…

3rd option down is the 10 year profit projection spreadsheet. Don’t re-invent the wheel. There are tools for that, though unfortunately, seemingly no longer customizable.

IP