The standard advice for those who desire a long-term, positive return on their investment is to turn to the stock market while being prepared to weather its inevitable ups and downs. Historically, though, real estate has outperformed equities, according to a major study called “The Return on Everything” that spanned more than 140 years. When each asset was adjusted for inflation, and when all returns where included — instead of simply focusing on appreciation — residential real estate was the clear winner. In fact, it averaged more than seven percent per year with half from appreciation and a half from rental income.
Real Estate Outperforms Equities Every Time
The general public has this skewed perception regarding the health of equities as a long-term investment compared to other options. In fact, a Harris Poll survey of 2,198 adults found that a full 40 percent didn’t know which investment type had demonstrated the best performance since 2000. When pressed, though, 25 percent thought the answer was equities while 16 percent thought it was real estate.
It’s likely that the poll respondents were influenced in their decision by the advantages the S&P stock market had recently demonstrated. In reality, during the six-year period from December 31, 2000, through December 30, 2016, real estate returns outperformed equities — and not by a paltry amount either. While the S&P Index showed a 5.43 percent total return during that time period, real estate demonstrated a 10.71 percent annual return.
Real Estate Thwarts the Risk to Returns Ratio
Traditional investment thinking equates high risk with the potential for higher returns. Treasury bonds, backed by the federal government, are considered to be low risk and their low returns reflect that. Equities are assumed to be high risk — and for good reason. Some years they finish off with double-digit gains while the next year they are tumbling downward. Real estate is a low-risk investment that outperforms higher-risk equities.
The Sharpe Ratio
There’s even a risk-reward ratio called the Sharpe ratio that measures an investment’s risk against its potential return. Using a complex formula devised by William Sharpe, this ratio divides an investment’s risk premium by its average annual standard deviation. Treasury bonds have a Sharpe ratio of about 2 while equities’ Sharpe ratio is about 27. Though their returns are often strong, an equity’s risk lowers its Sharpe rate. Since 1950, real estate’s Sharpe ratio has averaged 8.
Historically, real estate has demonstrated that it offers lower overall risk for investors and it helps smooth out the volatility that’s associated with equities. By doing so, real estate provides investors with the ability to enjoy true diversification across their portfolio.