Economist's Commentary: May 2, 2008
Real Estate vs. Stocks
By Lawrence Yun, Chief Economist
A recent article in the Washington Post implied a better return on investment from stocks compared to real estate. I had spoken to the reporter for this article and thought the article to be fair in presenting different perspectives - except in one key area.
It says that home values have risen by an average of 5.3 percent a year over the past 30 years while the stock market index rose 9.9 percent a year. The figures were attributed to NAR, though I do not recall saying this. With these figures it was extrapolated to show that a $22,000 investment would have yielded an accumulated asset value of $98,000 for a home and $340,000 for stocks. Therefore, a stock investment won out easily.
Such thinking is misplaced. When people buy a home, they do not generally pay all cash. People take out a mortgage. A $22,000 - assuming used for a 20 percent down payment - would have permitted a home purchase of $110,000. That $110,000 home in 1978 would be worth $491,000 today. Furthermore, this homeowner did not have to pay rent. Rather, she was paying down her mortgage. A $110,000 home with $22,000 down payment means a mortgage of $88,000. This homeowner would have faced mortgage rate of 9.6 percent in 1978 - with many opportunities to refinance into a lower rate at different times. But assuming for the sake of simplicity, she did not refinance throughout the 30-year term, the monthly payment would have been $746 per month. That is $746 per month in 1978, in 1988, in 1998, and the final payments of the equal amount in 2008. Over the 30 years, she would have paid $268,000 in mortgage payments. However, those payments would result in paying off the mortgage this year. In other words, the $491,000 home value is all hers with no mortgage. The net gain for this homeowner is, therefore, $491,000 minus $268,000, or $223,000.
By contrast, a person who chose not be a homeowner and invested solely on stocks would have accumulated - as the article says - a nice $340,000. Hold on. This person surely did not live under a bridge or without a shelter. An adjustment on rental payment needs to be made. Rent in 1978 would have been about $400 per month or $4,800 per year. Rents rise over time. According to Consumer Price Index, rents would have more than quadrupled over the past 30 years. My calculation says cumulative rent payments of $269,000 over the past 30 years. Therefore, this non-homeowner would have a net gain of $340,000 (from stocks) minus $269,000 (in rents), or $71,000.
The bottom line: $223,000 net gain for the homeowner versus $71,000 for the stock investor.
What happens in 2009 and beyond? The homeowner pays no mortgage and the stock investor has rent payments to worry about.
The above case was only a scenario. It is no wonder that the Federal Reserve data consistently shows a colossal difference in net worth accumulation between homeowners and renters. The most recent data as of 2004 showed a typical net worth of $184,000 for a homeowner versus $4,000 for a renter.
An updated report using 2007 data is expected to be published later this year. I expect even further gains for homeowners even though prices declined in 2007 by 1.4 percent because of a price gain of 12 percent in 2005 and 1 percent in 2006.
Americans should certainly own a home as part of their financial planning. This does not mean people should stretch to the limit to be a homeowner using funny exotic mortgages. Save for a down payment and buy that first home. Buying an investment home to rent out may also make sense for some people in some localities. I would also say owning stocks and bonds is a nice complement (as I have in my 401K). But to somehow imply that not owning a home and relying on a strict stock investment to pay off big time is wrong - big time.
This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >
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