Mansions as an investment don’t make sense

Published Dec 10, 2016

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I almost

let an article about how great luxury real estate has performed sneak by

without comment until I saw a dubious comparison to the stock market. Here's

what caught my eye: Adjusted for inflation, that’s a compound annual growth

rate of 8.7 percent.

The S&P

500 stock-market index averaged an inflation-adjusted annualized return of just

4.1 percent.

This makes

for a good teachable moment about how to analyse investments, in much the same

way as the presidential election or March Madness or the saving habits of a janitor.

I say this while reminding you that I am not a housing basher, unlike some. I

have been positive on residential real estate for a long while.

Let's dive right in:

Don’t use

outliers to prove your point: Yes, the estate of newspaper magnate William Randolph

Hearst is a formidable and impressive home. But it hardly makes for a good

sample to use when describing the advantages of real estate in general, or even

luxury real estate in particular.

Just how

many 50 000-square-foot, five-acre properties in one of the most-expensive zip

codes in America

are there? Like Picassos and rare Ferraris, it is a one-off, not representative

of residential real estate as an asset class.

Use actual

transactions, not aspirational pricing: Owners of illiquid assets have to come

up with credible ways to price their holdings. Wishful thinking doesn't count.

The market hasn't improved enough to justify lofty asking prices for seller who

hope to flip a property. Homes that don’t sell experience price declines, not

increases.

Include all

costs and fees: As an investor, I have spent the past few decades watching my

costs go down. As a homeowner, I have spent the past few decades watching my

costs go up.

As for that

that Standard & Poor's 500 Index 4.1 percent annualised inflation-adjusted

return. Yes, that may be accurate, but only if you omit dividends. Include them

and the return jumps to 7.4 percent.  That’s pretty close to the fictional

8.7 percent return cited above.

Taxes, mortgage interest, insurance,

maintenance, utilities?

Although

mortgage rates may be near historical lows, that probably is temporary.

Meanwhile, the cost of almost everything else has gone up. Yale economist

Robert Shiller pegs annual inflation-adjusted residential real estate returns,

after costs, at 0.2 percent. 

 Don’t

compare an outlier in one asset class to a broad index in another: Imagine if I

cited Amazon.com or Apple to demonstrate the relative underperformance of bonds

or commodities. You would rightly criticize me for cherry-picking.  Use

median returns of different asset classes to make appropriate comparisons.

Pay attention to date ranges and

exceptional factors:

The article

in question cites a property purchased in 1978 in Sagaponack,

New York, in the Hamptons for $140 000 and now listed for

$5.75 million. The article reports that this is a 6.61 percent annual return.

But note that this is a calculation based on the asking price.

That's like

saying I'm calculating the return on my Apple stock based on a price of $125 a

share - which it may reach again someday - even though it trades for $110

today. What's more, the Hamptons aren't exactly

representative of anything other than the fact that in the past 40 years the

financial industry was on a tear and the Hamptons

became Wall Street’s summer playground.

The bottom

line is that you have to live somewhere, and owning is often better than

renting - especially during the past few years, when the cost of capital has

been so inexpensive. But try making the case that residential real estate, even

luxury real estate, has done better than equities during the past 30 or 40

year? The data just doesn't support that conclusion.

This column does not

necessarily reflect the opinion of the editorial board or Bloomberg LP and its

owners.

BLOOMBERG

 

 

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