Housing Investment Returns = Price Appreciation + Rental Dividends

Professer Robert Shiller has a new NY Times article entitled Why Land and Homes Actually Tend to Be Disappointing Investments. He computes the historical, long-term inflation-adjusted returns for both farmland and housing:

Over the century from 1915 to 2015, though, the real value of American farmland (deflated by the Consumer Price Index) increased only 3.1 times, according to the Department of Agriculture. That comes to an average increase of only 1.1 percent a year — and with a growing population, that’s barely enough to keep per capita real land value unchanged.

According to my own data (relying on the S&P/Case-Shiller U.S. National Home Price Index, which I helped create), real home prices rose even more slowly over the same period — a total increase of 1.8 times, which comes to an average of only 0.6 percent a year.

Over the same time period (1915 to 2015), the total inflation-adjsuted return of the S&P 500 index including dividends is roughly 6.7% annualized. Here is a recent version of his famous Home Price chart:

Shiller is a smart guy and so I’m sure he knows this, but he always seems to leave out the fact that most people don’t just buy a chunk of land and let it sit there idle until they are ready to sell it again.

People use farmland to grow stuff. You know, things like apples and corn and cows. Or you could charge rent to farmers.
People either charge rent to others or avoid paying rent themselves on residential housing.

These are all additional sources of investment return beyond just price. Therefore, even if you assume your home’s price will only rise between 0% and 1% above inflation over time, you are still getting more “return” from it in the form of either rent or imputed rent.

Rent will rise roughly with inflation. Indeed, the biggest portion of the Consumer Price Index is housing as shown in the graphic below (source). The great majority of the Housing component is “rent of primary residence” and “Owners’ equivalent rent of primary residence”.

From FRED, here’s the rent part of CPI divided by overall CPI for as far back as the data series goes (1947). Sometimes rent grows faster than CPI, sometimes rent grows more slowly than CPI. Mostly, it evens out, as one might expect.

For most of the last 20 years, rent has increased faster than CPI inflation:

Estimating your “rental dividend” return. If you have a house that costs $200,000 that would otherwise be rented for $1,000 a month, that is a price-to-annual-rent ratio of 16.7. The inverse of that number is a rough idea of the annual “rental dividend” you could get from the house. That is, $12,000 divided by $200,000 is 6%. Now, a proper real estate investor would take out things like property taxes, insurance, repairs and maintenance. Let’s continue to be very rough and call that 3%. Now, if you assume both rent and expenses will rise roughly in step with inflation, that is an additional 3% real return.

Adding the two parts together, and you’re getting a very rough 3% to 4% real (inflation-adjusted) return. Now, most people acknowledge that housing is local and your specific return can vary widely. Your housing price return if you bought a house in Detroit in 1985 and a house in Mountain View, California is quite different. At the same time, your current housing rental dividend return is going to be a lot higher in Detroit than in Mountain View, California.

(I’m not nearly as familiar with farmland, but I do know people who rent out their property to farmers and ranchers. They seem satisfied with the arrangement. I’m also not including all the psychic rewards of owning your home like being able to remodel and customize things as you wish, nor am I including the costs of doing that remodel.)

If you look at various broad estimates of future stock and bond returns, they are not forecasting much more than 3% to 4% real returns on a diversified and balanced 60/40 stock/bond portfolio. Do housing prices only go up? No. Is every house a good investment? No. However, I also don’t agree with the broad statement that land and homes are disappointing investments.

I’ve explored my own situation and income tax effects more in the previous post Mortgages, Imputed Rent, and Early Retirement.

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