Is Investing in Housing a Losing Proposition?

Last week two Federal Reserve researchers answered that question with an analysis of returns on investment since 1926 and their findings won’t make the housing industry happy.

If a home is purchased only as an investment and not as a place to live, a comparison of average annual returns clearly shows that though most homeowners make a positive return, investing in equities offers favorable returns more often than investing in housing. That’s the bottom line from Ellyn Terry and Jessica Dill, two economists at the Atlanta Federal Reserve, in a working paper published June 12.

The two researchers set out to answer the questions: With average returns so close to zero, just how often has the housing market produced losers? And how does investing in housing compare to investing in equities? They did not look at the “buy and hold” strategies popular among investors seeking cash flow from rents, but only appreciation. Nor did they account for political incentives like the mortgage interest deduction or savings resulting from not paying rent.

They computed the average annual return of home prices across all possible combinations of start and stop points using the Shiller house price series from 1926 to 2012. The distribution depicts returns concentrated around zero with some skewness to the right. Eighty percent of all start-stop point observations experience some degree of positive return.

To take into account the duration of ownership, they assumed that the average homeowner lives in his or her home for 13.3 years, based on analysis by Paul Emrath at the National Association of Home Builders. They found the average annual returns for an asset held for a period of 13 or more years is substantially less volatile than for an asset held for fewer than 13 years, and those investing for the longer term were much more likely to have positive returns.

“We compute that 40 percent of homes owned for less than 13 years have negative average annual returns, compared to 12 percent of homes owned for 13 years or more. Interestingly, while a much greater portion of those owning for 13 or more years obtain positive returns, the average annual return was actually slightly higher for those owning fewer than 13 years (0.95 percent versus 1.03 percent),” they found.

They applied weights for average length of ownership. Using the weights, we recomputed average annual returns across all possible combinations of start and stop points for average length of ownership. The distribution continues to show that returns are concentrated around zero with skewness to the right; two-thirds of all investors in this distribution experience some degree of positive return.

They ran through this same exercise with the S&P 500 Index (which we used as a proxy for the stock market) to provide an apples-to-apples comparison of the average annual returns that one could expect from an alternative investment in stocks. The results depict a wider distribution, with longer, fatter tails and some skewness to the right. In other words, there is more volatility in terms of return, but with that volatility comes an opportunity for larger gains over time. In fact, the weighted average annual return of the S&P 500 is 4.55 percent, compared to 0.97 percent for the Shiller real home price index.

“It’s important to note that the distributions of returns for housing in all these computations are not the distribution of returns for every possible house purchase. Likewise, the returns shown for the S&P 500 are not the entire universe of returns from buying and selling individual stocks. Instead, these returns are based on a pool of housing and a pool of stocks,” they wrote.

“Further, the returns to housing in the chart ignore the fact that homeowners might have additional gains from owning if their mortgage replaces rent. Indeed, according to some calculations, homeowners who buy a home today and hold it for seven years can expect to pay 44 percent less than people who choose to rent,” the concluded.