wning real estate has produced impressive returns for investors, but how does this investment compare to the stock market?
You may choose to invest in real estate for good for diversification, but what about returns? Which asset class has produced better returns over long periods of time -- real estate or investing in stocks?
This question of real estate vs. stocks is tough to answer. There’s no way to reliably gauge individual investment property returns on a wide scale. Having said that, here’s a rundown of how the two asset classes compare as long-term portfolio investments.
First, it’s important to note that stocks tend to increase in value more quickly than real estate. Over long periods of time, an S&P 500 index fund has historically produced total returns in the 9–10% range. Meanwhile, real estate prices tend to outpace inflation, but not by much.
Since 1940, the median home value in the United States has increased at an annualized rate of 5.5%. But this is misleading. Homes are significantly larger today, on average, than they were back then. The average home in 1940 was 1,246 square feet, roughly half of the 2,430 average of 2010. Adjusting for home size, the annualized increase on a per-square-foot basis drops to 4.6%. After accounting for inflation, the average home value has risen by just 1.5% per year.
Compare this to stock returns. Stocks have generated roughly 7% per year over the long run after accounting for inflation. In other words, the stock market has generated returns at more than four times the rate of real estate appreciation. If you’ve ever heard someone tell you that “your home isn’t an investment,” this is probably why.
Real estate values tend to barely outpace inflation. However, there are a few reasons why real estate investing tends to do better.
The first reason is leverage. Unlike investing in stocks, where it’s irresponsible to invest with borrowed money, you can use significant amounts of financing when investing in real estate without adding a ton of risk.