Robert Shiller on Real Estate Investments

Robert Shiller had a great piece in the New York Times this week about real estate as an investment. He lays out some great points about real estate from a historical perspective that I thought were worth looking into.

The data for home prices has been pretty good in the past year and it has led some to believe that we having a nice comeback in the real estate market from the depths of the housing bubble. Here’s Shiller’s take on this phenomenon:

There has been some good news lately: home prices have risen over the last year, and with those gains there has been a renewed sense of optimism. But do these price increases mean that homes are now good investments for the long haul?

Unfortunately, no. We do know one thing from economic research: one-year home price increases, after correcting for inflation, have had almost no statistical relationship to increases 10 years down the road. Thus, the upturn last year is irrelevant to long-run forecasting. Booms are typically followed by busts, usually in far less than 10 years. In a decade, an entire housing boom, if there is one in inflation-corrected terms, is likely to have been reversed and completely washed away.

He continues on the affect that inflation has on housing over time:

Home prices look remarkably stable when corrected for inflation. Over the 100 years ending in 1990 — before the recent housing boom — real home prices rose only 0.2 percent a year, on average. The smallness of that increase seems best explained by rising productivity in construction, which offset increasing costs of land and labor.

All else equal, the current Fed policy would have this effect: a home selling for $200,000 today will sell for around $250,000 in 2023, though the real price — corrected for inflation — would be unchanged. But because people often forget to correct for inflation, they may have the illusion that the market is improving.

In an ideal world, steady and uniform inflation would have no effect on rational decision-making because it affects incomes as well as prices. But in the real world, inflation does affect our psychology. People feel more optimistic when their nominal pay rises or when a neighbor’s house sold for more than they paid for theirs. But in thinking about investments for the long term, we should focus on fundamentals — on real, inflation-corrected values and on the economics behind them.

And he discusses his thoughts on housing in comparison to stocks as an investment:

Here is a harsh truth about homeownership: Over the long haul, it’s hard for homes to compete with the stock market in real appreciation. That’s because companies whose shares are traded on a stock exchange retain a good share of their earnings to plow back into the business. The business should grow and its real stock price should also grow through time — unless the company makes poor decisions, as some certainly do.

By contrast, real home prices should decline with time, except to the extent that households shell out some money and plow back some of their incomes into maintenance and improvements, because homes wear out and go out of style.

These variables alone suggest how tricky it is to forecast your home’s value when the time comes to sell. Prices can go down as well as up. That is also true for investments in general, of course, and is why generations of portfolio analysts have advocated assessment of risks, and not just extrapolation of recent trends, as the key to intelligent investing.

It’s good to hear to an expert in any field and Robert Shiller is an expert on real estate (the Case-Shiller Home Price Index bears his name). Interesting thoughts on what some refer to as their biggest investment. Remember to consider all variables when making an investment. Real estate can be a good investment but for most people it remains a lifestyle choice (as opposed to renting) that gives you flexibility once you pay off your mortgage.

Now onto what I’ve been reading this week:

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  1. Wholesale investor properties Luling commented on May 17

    The data for home prices has been pretty good in the past year and it has led some to believe that we having a nice comeback in the real estate market from the depths of the housing bubble. Here’s Schiller take on this phenomenon.

  2. Absolute PRC commented on Jun 05

    We often hear it enough that real estate is a good investment and we have realized in the past few years that it is not true. However, those who have the time to wait can see some grain of truth in the positive outcome of real estate investment,