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Stock markets vs. real estate

Where's a better place to put your money: the stock market or real estate? These days the accepted wisdom (at least at cocktail parties) says to pick real estate. But is the accepted wisdom right?
/ Source: Forbes

Where's a better place to put your money: the stock market or real estate? These days the accepted wisdom (at least at cocktail parties) says to pick real estate. But is the accepted wisdom right?

It is — in the short term. U.S. real estate sale prices increased more than 56 percent from the beginning of 1999 to the end of 2004, as tracked by the Office of Federal Housing Enterprise Oversight, part of the U.S. Department of Housing and Urban Development. The S&P 500 index dipped nearly 6 percent during that same period.

But if you take a longer view — say 25 years — you'll find that the S&P 500 has actually stomped the real estate market, from Boston to Detroit to Dallas. From the start of 1980 to the end of 2004, home sale prices increased 247 percent. A pretty sweet deal, it would seem. Over the same period, however, the S&P 500 shot up more than 1,000 percent.

To be sure, pitting home sale prices against the S&P is an imperfect and less than highly sophisticated comparison, for a host of reasons. The stars have been aligned over the stock market for the last quarter century, even with the dot-com bust taken into account. And, there are limitations on the data — it's far easier to track stock prices, which are centrally traded, than home prices, which change hands in individual, and individualized, deals around the country.

Beyond that, for most people, a home has traditionally not been seen as a portfolio device or financial instrument, but rather as place to live and raise a family.

But recently, more and more people are looking to their homes to be something more, fueling speculative markets in some areas of the country, such as South Florida. Even in less investment-driven markets, though, skyrocketing home prices are all the buzz.

So it begs some kind of comparison, however imperfect, to see how each investment has fared.

We used home sale price data from OFHEO, which includes mortgage data from the two institutions it oversees: Fannie Mae and Freddie Mac. The data set only includes single-family homes, not condos and co-ops, which might put cities such as New York and San Francisco at a disadvantage in our comparison. Also, it doesn't include mortgages where the principal exceeds $333,700.

We used the S&P 500 because, as its name implies, the index tracks the market value for the stocks of 500 leading companies. That allows us to do a broader price comparison than if we had used the Dow Jones Industrial Average, which averages out the prices on 30 large-cap stocks.

Real estate is at another disadvantage here, because we're not taking into account potential income tax breaks. And, though dividends aren't included in the S&P 500, Jeremy Siegel, an expert in financial markets and economics at the Wharton School of the University of Pennsylvania, points out that a house pays a benefit that is not measured in its price. In other words, you can live in it. Rent free.

"That's like a big dividend," Siegel says. "When you take a look at a stock market index, a lot of the dividends are reinvested by the company. The dividend yield is much lower, but you get it back in capital appreciation."

"Some people today think they are going to get a tremendous increase in real estate investments," he says. "This illustrates the fact that your home is not going to do as well as stocks, because you're taking part of the return on housing services."

So you can't shack up in your shares of Microsoft or General Electric. Then again, you also don't have to buy a new roof for them or pay their condo fees. Plus, stocks are very liquid, says Laszlo Birinyi, president of Westport, Conn.-based financial consulting firm Birinyi Associates. You can sell out quickly, paying only a small fee. A house can take months to sell and cost several percentage points in commission.

"I guess I'm not surprised, at the results of the comparison," Birinyi says. "A lot of our view is influenced by the past three to five years. But I can remember some very, very weak periods in housing over the last 25 years. In the late 1980s, when I lived in New York City, you couldn't sell a one-bedroom apartment."

Still, the historical real estate data show blips and dips, but over years they tend to smooth out to an upwards-trending curve — just like equities. Even where they do decline, however, real estate prices tend to be stickier on the way down than on the way up, because home owners are more reluctant to sell in downturns.

"Historically, the largest real home price decrease is on the order of 5% in any given year," says Jonathan McCarthy, senior economist at the Federal Reserve Bank of New York. "Whereas you talk about a real stock-price decline, you could probably see 20 percent or even more."

When certain property markets have stalled over the past quarter century, however, they have remained stuck for years.

A study by economists at the Federal Deposit Insurance Corporation concluded that while local real estate booms can result in major price declines, it happens very infrequently. "Boom does not necessarily lead to bust," says Richard A. Brown, chief economist at FDIC. "Busts are very rare when you're not having some sort of local economic distress."

Instead, booms usually end in periods of stagnation, he says, an assertion that is supported by the accompanying charts. Incomes catch up with prices, and the market slides back into equilibrium.

All the speculation about a coming real estate bust doesn't seem to be keeping home buyers out of the market, however. According to the National Association of Realtors, in April a record 7.2 million homes changed hands, at a median price of $206,000, up 15.1 percent from a year earlier. The last time home prices rose so fast in one year was in November 1980, when prices shot up 15.6 percent. But if housing prices contract, many home owners may find themselves wishing they had spent more time with their stock broker and less with their real estate broker.