Housing Investment Returns = Price Appreciation + Rental Dividends

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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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  1. Another factor that Shiller’s return calculations do not account for is the effect of leverage on your return. Since most people (and nearly everyone reading this blog) do not purchase a house with 100% cash, purchasing a house with 5 or 10 or 20% down will alter your returns.

    If I had to guess, accounting for the effects of leverage at minimum brings the returns much more in line/close to the S&P 500 returns. This additionally ignores the many tax advantages of owning a home

    • Yes, but leverage also costs money in interest.

      • With those costs being tax-deductible. For almost anyone outside of a hedge fund, being able to routinely borrow 4x your equity is unheard of outside of real estate, and your return on equity thus can be magnified well beyond what Shiller is suggesting.

        Point being, with the many additional systematic advantages to owning real estate in the tax code, Shiller’s argument is weak without more.

  2. Stick to stocks and bonds. An additional 3% return from inflation doesn’t get you to a 3-4% real return. It gets you to 3.09% the first year, 3.12% the second year, so on and so forth. Also most of the appreciation you have is from a positive delta between the cap rate you bought at and sold at if income and expenses go up at the same rate. You really need income to go up faster than expenses to make money in real estate. Hence buying when cap rates are up and rents low. You will piss all your returns away buying at these crazy low cap rates today unless you find a place (e.g. Seattle) where rents are shooting up very rapidly.

  3. Very good observations Jonathan. By ignoring the housing dividend, an individual is not looking at the whole picture.

    Another common error I have observed, is when people do not make apples to apples comparisons when they discuss rent vs own situations. ( e.g. they compare the rent on an apartment with the mortgage on a house ( which is usually larger), and assume that renting is superior)

    I believe that entry valuation does matter, whether we are talking about stocks, bonds, or real estate. So given the poor prospects for investment returns going forward, I believe that the housing market is indeed offering a decent bargain relative to other assets ( at least in my market that is the case)

  4. You can also throw in the tax advantages. That $200k house will likely have interest of ~$5k a year and property tax of ~2k. For people in the 25% bracket who itemize thats up to $2k off your tax bill. Adds an effective 1% to your return.
    THen when you sell a primary resident you don’t have to pay capital gains on the increase (up to a limit). For most people thats another 15% return at the end over simply buying stocks. Say you buy a house for $200k and it grows 7% a year in value and 20 years later its $438k. You can seel with zero tax bill. If you buy stocks for $200k and they grow 7% a year then in 20 years its worth $774k you’ve got gains of $574k with a tax bill of $86k. That cuts your 7% growth down to ~6.4%.

    Taxes can make ~1.5% difference.

  5. From my perspective as a homeowner for almost 25 years now, I tend to be closer to Shiller’s conclusion on this. I think an interesting exercise for any homeowner to go through on a rainy Sunday afternoon while watching a game on TV is to add up — or at least estimate — the cost of ownership beyond acquisition. This includes your annual property taxes, insurance premiums, termite treatments, hot water heater replacements, new roofs, plumbing repairs, and on and on and on. My feeling is once you take those things into account, the return on this “investment” is not as attractive as one first might think. In fact I would say that in my neighborhood — although I would make a “profit” if I sold today — it would it reality just be mostly a refund for all that the house has cost me over the year. Yes I know there are tax benefits, but those just go so far in offsetting all the expense of homeownership. And I’ve always thought this notion of “imputed rent” is just some kind of mind game the real estate industry has invented to make this situation seem better than it is.

    In contrast, I can buy stocks or mutual fund shares, and — beyond possibly some initial commissions and annual taxes on dividends — ownership is a relatively cost-efficient and hassle-free process. And the taxes can even be deferred with a retirement account.

    All in all, I think homeownership is a lifestyle choice. I don’t believe anyone needs to own a home a single day in their lives for purposes of improving their financial well-being. Although rents may be more expensive, I would contend that is balanced out by the costs you would not incur directly as a renter — and at a minimum come out just as well in terms of long-term financial status.

    • “this notion of “imputed rent” is just some kind of mind game”

      You do have to consider the value of rent. What would rent have cost you for the past 25 years?

      When you consider buying a house its not a choice between just buying a house or buying stocks. The choice is between buying a house or renting and investing your cash.

  6. I find it very very hard to save. I find it relatively easier to make debt payments. Even if your real estate does not cash flow year after year, it eventually gets paid off. It’s also hard to spend the real estate’s value because you have to sell or mortgage it to obtain liquidity. When it’s paid off you can then liquidate it for capital. This isn’t all that scientific, but it’s what has worked for me in the real world. My net worth is essentially all from just a few real estate properties. None of them have been stellar returners, but over a lifetime I’ve ended up with a net worth that’s pretty good for someone with a modest professional income.

  7. Jonathan does not seem to be accounting for the opportunity cost of having your capital tied up in home equity instead of the financial markets. If the price of land is rising by <1% real per year that would seem to be a substantial expense over time.

  8. Perhaps it is more useful to think of home ownership as inflation protection than as a real return investment. If you buy a home and live in it from many years, your monthly payment is locked in in nominal dollars (with the exception of insurance premiums, which do rise and also property taxes, though most jurisdictions have policies in place that keep property taxes from growing very much for existing homeowners). If you rent, your monthly cost is probably going to rise with inflation each year, and perhaps even faster depending on the supply/demand dynamics in your area.

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