Should Millennials invest in real estate? Robert Shiller says no because real estate does not seem to provide long-term returns.
We hear bloggers write how they have doubled their property value in the last decade. It also makes sense if a millennial in her 30s wants to have a family in a big house.
But is it the smartest investment decision to buy real estate? There is substantial empirical evidence that renting is a far superior decision.
Millennials: look beyond the cyclical nature of the real estate market:
Real estate prices are always cyclical because it takes a few years to build houses. Construction cannot keep up with demand, creating a shortage. Then, when all the construction catches up, there is undoubtedly an oversupply. If you want to look at real estate returns, you have to look beyond these short-term cycles.
It takes 2-3 years for construction to build new buildings. But when supply does eventually flood the market, it can cause over-saturation and crash because it’s hard to estimate demand so far out accurately. But over time, demand slowly catches up, and a new cycle of pent-up demand and then over-supply begins.
Opportunity cost of buying real estate versus buying stock
Just because real estate investment has doubled in value doesn’t mean it’s the best option. Let’s say a house that cost $100 to buy in 2010 doubled in 6 years to $200 to buy in 2016. The table below shows that this shift translates to an annual growth rate of 12%. But during the same period, the S&P 500 has grown a lot too, such that an $100 deposit into the S&P 500 in 2010 would’ve become $207 by 2016, $7 more than the house!
Robert Shiller says real index does not indicate long-run returns
Some people argue that because land is limited, but the population is growing, investing in real estate will never lose. The authoritative voice on the housing market, Robert Shiller disagrees.
Assuming a house price is $100 in 1880, by April 2016, that same house is estimated at $161.93 in real terms. The growth translates into an annualized real growth rate of 0%. Real estate growth varies across the country, so an investment in Manhattan is different from one in Detroit. But overall, historical evidence shows buying a house does not produce real returns.
There are many reasons behind why real estate produced 0 true returns. One of which is technology. We can build thinner, taller buildings at more cost-efficient prices. Just think what we can do tomorrow.
But look at the S&P (also adjusted for inflation) returns in the table below. A $100 investment in 1870 becomes $1,000 in real terms by 2010. Using this calculator, an investment from Jan 1880 to April 2016 produces an annualized real growth rate of 2.099%. Investment in the stock market creates real value over the long-run.
Millennials have the patience and the confidence should wait out the business cycles. Investing in the U.S. stock market is one of the best bets in the world.
Bottomline: Millenials should not invest in real estate because buying a house does not provide real returns in the long run. But if you want to raise a child in a suburb, by all means, make that purchase.