Should You Dump Real Estate and Buy Stock?

Oh no, it’s back, the eternal question of which is a better investment, stock or real estate?

Writing in the Wall Street Journal, Robert Bridges tells us that “a dollar used to purchase a median-price, single-family California home in 1980 would have grown to $5.63 in 2007, and to $2.98 in 2010. The same dollar invested in the Dow Jones Industrial Index would have been worth $14.41 in 2007, and $11.49 in 2010.”
 
The data provided by Bridges is hardly surprising. The article, after all, is entitled, A Home Is a Lousy Investment.

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Timing
Bridges makes a carefully constructed comparison which includes 2007, the top of the real estate market. According to the Federal Housing Finance Agency, home prices this April were down 19.3 percent from the 2007 peak.

Surely the comparison would have been far more interesting if it looked at stock values and compared Oct. 12, 2007 with March 6, 2009. During this period the Dow went from 14,093.08 to 6,626.94. As this is written the Dow stands at 12,446.88.

So, if you pick particular times you can truthfully say the Dow fell more than 50 percent in a given period or that prices actually doubled, depending on what you want to prove.

Reality
Bridges offers an interesting comparison of economic results

“If a disciplined investor who might have considered purchasing that median-price house in 1980 had opted instead to invest the 20% down payment of $19,910 and the normal homeownership expenses (above the cost of renting) over the years in the Dow Jones Industrial Index, the value of his portfolio in 2010 would have been $1,800,016.”
 
The reality is very different. Few buyers purchase with 20 percent down — that’s why the marketplace is dominated by conventional loans backed with private mortgage insurance as well as FHA- and VA-insured financing. Moreover, even if investors buy stock they still have “normal homeownership expenses” assuming they prefer to live indoors.

Segmentation
No less important, Bridges does not look at national home prices, he looks with laser-like focus at California, one of the hardest-hit foreclosure centers.

But just as Bridges has picked one particular real estate market for his comparison, we could also pick a stock or two. For instance, we might pick GM, a long-time member of the 30 companies which made up the Dow Jones Industrial Average.

Or, at least was a member of the Dow until 2009 when it was replaced by CISCO systems.
 
“The parlous state of GM has left us with no choice but to remove it from The Dow. A bankruptcy filing immediately disqualifies a stock regardless of a company’s history or its role as a cultural icon,” said Robert Thomson, managing editor of The Wall Street Journal and editor-in-chief for all of Dow Jones.

Such changes mean the Dow is not a consistent measure because the index evolves to include a changing cast of corporate characters. Imagine where the Dow would stand if it continued to include the results of such past index members as Standard Rope & Twine (1896), Federal Steel (1899), Studebaker (1916), Woolworth (1924) and Postum (1928).

The Dow components of 2007 and 2009 are different from the Dow components in 2011. If the same companies were kept in place then the index results would be different. This is the equivalent of looking at home values in 2007 and 2011, but excluding 2011 short sales and foreclosures — something not done by appraisers, lenders, investors or homebuyers.

Perspective
A segment of the population believes things are in such bad shape today that the only way to preserve economic value is to stockpile gold, tent pegs and sandwich makings. In this view, nothing else has value and it’s entirely possible that values will fall further — including both stock and real estate values.

Given events in Iceland, Ireland, Greece and Portugal — and looking at U.S. job erosion and the budget debate — it’s hard to dismiss those who believe our economy is contracting and with it much of our wealth, influence and social stability.

Yet as dim and dark as things are for many Americans, there’s also a case to be made that selected real estate remains an attractive investment option.

We have a massive internal market, an established infrastructure and much to do. We need to improve our roads and bridges, become energy independent and better educate our children, among many other needs. When we inevitably undertake such projects there will be a new round of job growth and economic development.

Moreover, our population is growing. We now have more than 311 million people inside our borders — that’s about 10 million new people since 2007 and they all need housing.

Want more? Mortgage rates are below 5 percent. Mortgage interest is deductible. Investment real estate is depreciable. Home prices are down. Home prices in major foreclosure centers — including areas with wonderful climates — are way down. Foreclosure prices are down most of all — distressed properties are selling with a 20 percent discount nationwide according to the National Association of Realtors.

 

Options
And what about alternatives? Yes, the stock market is alluring but can you really compete against the computer programs which make most of today’s trades in microseconds?

Or, how about a low-risk certificate of deposit? A five-year CD will now yield about 2.15 percent. That’s great, except that the inflation rate reached 3.6 percent in May. Your CD will lose buying power each month the rate of inflation is higher than the interest rate.

Meanwhile, what about rents? While home prices have swooned rental rates are rising. According to REIS, Inc., apartment rents were up 2.4 percent during the past year and vacancies were down.

“Large numbers of people have been foreclosed but they still need shelter,” said James J. Saccacio, chief executive officer of RealtyTrac. “While ownership may not be affordable and credit has been damaged, many such households can readily afford a good rental and that’s important to investors.”
 
Toward The Future
In the end I’d say Mr. Bridges is half right: Individual stocks have sometimes been better investments than specific pieces of real estate and sometimes particular parcels of real estate have been a better option than selected stocks.

And let’s just leave it at that.
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Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.

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