There is a huge contrast between the returns on investable real estate and homes. Since their introduction in the early 1970s, REITS have delivered returns somewhat higher than those on the S&P 500 with a higher Sharpe ratio. The relative returns on REITS and stocks have varied over time, but the long-run performance of REITS has been impressive. Direct ownership of real estate has delivered lower returns than REITS, but that’s only because the series used to describe returns on institutional ownership of real estate has been de-leveraged. Both sets of returns show that real estate is an attractive means to diversify an investment portfolio.
Home ownership is another story. The returns on home ownership are disappointing in most periods compared with investment in REITS or stocks. It’s true that with high leverage, home ownership can deliver spectacular returns when house prices are rising (as they did in the 10 years through 2006). But that same leverage can lead to spectacular losses when home prices fall. Fortunately, when house prices fall, investors do not mark their homes to market (unless they are in the unfortunate position of having to sell). So they can ignore price trends knowing that there is no investment statement coming in the mail to jolt them back to reality. They simply sit in their houses waiting for the next boom to occur.