Housing versus REIT's

Real Estate is a unique class of investment. For many, Real Estate is both the largest asset and the largest liability in their financial life. We have classic personal finance dichotomies such as "own versus rent" related to Real Estate. Even the sages of the Talmud weighed in on the topic of Real Estate investment, with Rebbe Yitzchak remarking "A person should always divide his money into three: one third in land, one third in commerce, and one third at hand."1  For our purposes, we won't be looking at how much land to own, but which way. Specifically, housing vs REIT's.

We'll be looking at the numbers on how individual housing vs REIT's perform. Now that multiple methods of owning Real Estate are readily available, we can look at how these different means of investing in the same asset have done historically. While various tax efficiencies (and inefficiencies) exist for either way of owning Real Estate- investing in REIT's or investing in individual housing. Further, considerations such as the fact that not all would-be-landowners are suited to being a landlord make for a much more complicated debate. That's why it's still being had. For our part, we're going to focus on the numbers-side, shining a light on a critical dimension of all investing: returns.

The Federal Housing Finance Agency (FHFA) is a Regulatory Agency with that regulates housing such as Fannie Mae and Freddie Mac

A Real Estate Investment Trust (REIT) is a company that invests in Real Estate with a unique tax structure and ability to trade on an exchange

Home Ownership, By the Numbers

Historically, the fact of the matter is that individual home ownership has performed very poorly relative to other investments. According to ground-breaking research into the real rate of return for housing ownership by the Harvard Business Institute in 2011, it was concluded that the real rate of return for housing is negative. To be specific, researchers Wenli Li and Fang Yang found that the rate of return for home ownership was -0.6% per year. 2 

To be clear, before important tax and financing adjustments that actual owners will generally experience, the real rate of return was a positive 1.7%. Your average home owner will indeed pay most if not all of these taxes and costs every year, and that did not account for commissions, fees, and capital gains taxes that would happen during the sale of a property. By comparison, Robert Shiller determined in his book "Irrational Exuberance" that the average real return of U.S. Treasury Bonds was 1.7%. You can, however, shelter bonds from taxes easily and avoid mortgage, upkeep, etc. with a lot less stress. 3

Real Estate Investment Trusts (REIT's)

In 1960, Congress created the legal framework for the Real Estate Investment Trust (REIT)- a company that invests in Real Estate. 4 Their rationale for creating the REIT was to give all investors the opportunity to invest in large-scale, diversified portfolios of income-producing real estate. It also made Real Estate ownership much more efficient for investors. For example, the standard deviation of real annual house price changes between 1975 and 2008 was 3.4 for the nation, 1.5 percent or less in Cleveland, Indianapolis, and Louisville, but 11.6 percent in Boston, 9.9 percent in Honolulu, and 9.7 percent in San Jose, according to Li & Yang. The ability to gain exposure to more diverse portfolios of national (and now, international) portfolios brought smaller investors closer to that 3.4% volatility across the board.

REIT's can be traded on an exchange just like a stock. This means investors pay a transparent, reliable price for their investment (Scottrade, Vanguard, and Schwab all charge less than $7 a trade at the moment, to name a few). The liquidity of REIT's versus home ownership will be readily apparent to anyone who's ever both placed a stock trade and tried to sell a house.

The Data

Now that we've introduced the main players, let's get into the data. The following is from the Federal Housing Finance Agency (FHFA)- they regulate Federal Housing agencies such as Fannie Mae as well as report on housing index data- and MSCI's REIT index returns. MSCI maintains an index popular among investors as a broad basket of REITs. It's the index that underlies such popular Exchange traded funds as the Vanguard REIT Index (Ticker: VNQ), which has nearly $63 Billion in assets to date.

Year

FHFA (Housing) Index

REIT Index

REITs > Homes

1997
4.6%
20.3%
1998
5.00%
-17.5%
1999
4.9%
-4.6%
2000
7.2%
26.4%
2001
7.3%
13.9%
2002
6.9%
3.8%
2003
7.0%
37.1%
2004
10.4%
31.6%
2005
11.1%
12.2%
2006
4.7%
35.1%
2007
-0.4%
-15.7%
2008
-4.9%
-37.7%
2009
-4.3%
28%
2010
-1.3%
28%
2011
-2.4%
8.3%
2012
-4.0%
19.7%
2013
3.9%
2.47%
2014
5.3%
30.4%
2015
5.4%
2.5%
2016
5.6%
8.6%

Conclusion

Real Estate is no longer an investment that requires finding a property, managing it, collecting incomes, finding a buyer, and selling for a sizable commission and realized capital gains taxes. REIT investing is an alternative worth considering for those looking to build long term wealth with Real Estate. Additionally, REIT investing can be done inside an IRA, 401(k), 403(b), or Variable Annuity, just to name a few of the available tax shelters for passive Real Estate investing. Add to that the ability to invest in Commercial, Residential, Hotel, Industrial, Self-Storage, Health Care, etc. sectors for diversification of risk and exposure to a wide range of opportunities, and REIT's stack up quite well against traditional Real Estate investing.

Thanks for joining us in our discussion of the Housing vs REIT's. This is just a first step in discussing Real Estate- we hope to write about Real Estate at more length over time. We commonly cover Oregon's Case Shiller Index, and we will continue doing so.

All information in this article from the MSCI, the FHFA, the Harvard Business Institute, and Morningstar.

Meet the Author & Portfolio Manager

Victor Schramm is a Certified Fund Specialist (CFS®), with expertise in Mutual Funds & Variable Annuity Separate Accounts. He focuses on long term investing geared toward our annuity clients as a Fee Only Investment Advisor. He lives in Portland, OR.

Victor Schramm, CFS®Analyst & Portfolio Manager

Disclaimer:

This information is solely a representation of publicly available facts intended for educational use only. This is not a solicitation to buy or sell any public or private Security, in any city named in the article or elsewhere. No information provided here about Housing, Real Estate, or Real Estate Investment Trusts (REITs) is to be used as a market timing tool for buying or selling any security. Real Estate Investments are very complex investments that require a high degree of due diligence- this article is not investment diligence or investment advice in any form.

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