1

Someone asked me how well a property investment performs relative to ETFs over the course of 10+ years. My financial literacy is extremely low, and I just became aware of the concept of ETF last week. I tried to analyze the scenario posed to me. Can you guys tell me if my approach below is correct? And if I've overlooked important considerations?

First thing I did was find this formula in Google:

CurrentValue = Principal*(1+Rate)^Years

I want to compare different scenarios based on the Rate of growth. So I re-worked the formula to this:

Rate = (CurrentValue/Principal)^(1/Years) - 1

Now I want to crunch some numbers for property investment. The value of my house today is $600k. I bought it for $250k in 2007. I could have bought it for $200k in 2008 after the market crash. The rates for these two conditions look like this:

House2007 = (600/250)^(1/12) - 1 = 7.57%
House2008 = (600/200)^(1/11) - 1 = 10.50%

Next, I'll compare with a passive investment approach where I consider investing in an ETF that mirrors the Dow Jones. I see that in 2007, the stock value was as high as $13408, and in 2008 it was as low as 7062. Today it is $24388. That gives me:

DJI2007 = (24388/13408)^(1/12) - 1 = 5.11%
DJI2008 = (24388/7062)^(1/11) - 1 = 11.93%

Doing the same for S&P500, I get these

SP2007 = (2633/1526)^(1/12) - 1 = 4.65%
SP2008 = (2633/797)^(1/11) - 1 = 11.48%

Seems the rates for property vs ETF are comparable. Is this the correct way to look at these scenarios from idealized performance criteria? Are there substantial considerations I've omitted? Does this mean that it is quite common for people to expect real estate investment and ETF investments to be comparable?

Side note: I guess with a property investment, your principal capital is not fluid. But with a passive ETF investment, your principal capital is fluid. A property gives you opportunity to generate rental income. Passive ETF investments don't generate income comparable to rental income?

  • Your real estate example is very good. For the period 2004 to 2018, some parts of the country have basically had 0% return or worse. – Peter K. Dec 9 '18 at 0:02
2

There are aspects of your approach that are fine, but others that aren't.

I'm happy for you that your house has had the gain that it did in this time frame. That result was unique to you, or at least unique to certain areas of the country. When you say "a property investment", do you mean this particular one, or were you attempting to compare it, in general?

What you ignored, in the case of stocks, was reinvested dividends. The failure of the DOW and S&P indexes, is that they don't give any hint as to what total return was. You would need to get the data for this by another method. Easy to find.

In the case of the property, increase in property value is the lesser of the property's ongoing worth. Rent, in a well chosen area, is going to be about 1% of the property value each month, e.g. an investor is going to be interested in buying a house for $200K if he can get $2,000/mo in rent. The other large issue you ignored was ongoing expenses. A house has property tax, insurance, repairs, and other upkeep.

Last, I recommend you look at the Case Shiller Home Price Index which shows that long term, home prices track inflation and little more. Long term, home prices tend to track in between general inflation and wage inflation. In other words, near the increase of real wages over time. On the other hand, stocks have risen by an inflation adjusted 7% or so over the long term, and there's no logical reason that trend wouldn't continue. (Keeping in mind, that any short term housing rise above wage increases literally cannot continue indefinitely, as such a level of increase would make homes unaffordable pretty quickly. Supply and demand can't be ignored)

Your Answer

By clicking "Post Your Answer", you acknowledge that you have read our updated terms of service, privacy policy and cookie policy, and that your continued use of the website is subject to these policies.

Not the answer you're looking for? Browse other questions tagged or ask your own question.