Contrasting Real Estate with Comparable Investments, 1978 to 2008

Abstract

The authors study the annual returns of U.S. real estate over the 31-year period starting in 1978. With aggregate private real estate worth over $30 trillion and representing 60% of U.S. acreage, residential real estate—consisting primarily of single-owner-occupied houses—has by far the largest dollar value of any category of real estate. For the study period, business (commercial) real estate was the best-performing sector with a 9.99% average annual return. In comparison, farm real estate and residential real estate had average annual returns of 8.76% and 5.68%, respectively. All real estate sectors, as well as stock, bond, and commodity markets outperformed the average annual inflation rate of 4.01% over the period. Because physical real estate is not liquid and valuations are often based on appraisals rather than trades, its annual return can be hard to measure precisely and may be difficult to achieve. All physical real estate sectors are correlated with inflation, but equity REITs are more correlated with stock markets. Equity REITs substantially outperformed physical real estate over the sample period, and mortgage REITs and hybrid REITs suffered badly from the subprime mortgage crisis. All categories of real estate performed well during the two periods 1978–1979 and 2000–2005, but after enjoying decades of subsidized returns, residential real estate crashed during the subprime mortgage crisis, opening the door to the eventual fall of the commercial (business) real estate market.