Rental Real Estate vs Equity Returns: An Extended Correlation Analysis
Presented by Andrew Gaines
I was really struck by this chart when I saw it recently. This was published in a research paper that was produced by the Federal Reserve Bank of San Francisco in 2017. I found it to be very illuminating. It represents the longest data series ever compiled demonstrating the relationship between real returns on equities as compared to housing real estate. The analysis was performed across 16 advanced economies spanning a period of 150 years.
Here are my observations and interpretations.
1. Observation: Returns for both equities and housing (owner occupied and rental housing) are cyclical but are generally positive over long time horizons.
A. Interpretation: Equity and real estate investments should be good long-term investment options because they reliably produce positive returns.
2. Observation: Average real returns for equities and housing are similar in the long run, but the volatility of housing over time is much lower than that of equities.
B. Interpretation: For every dollar invested in housing real estate, I should receive a similar return to that of equities, but with less risk. Additionally, I would need to remain invested in equities over a longer time horizon to achieve the average return due to volatility effects.
3. Observation: Since the end of WW2 real returns on equities and housing have been noncorrelated.
C. Interpretation: If this relationship persists, investing in real estate will continue to provide a robust diversification benefit. From the authors of the paper: “The low covariance of equity and housing returns over the long run reveals attractive gains from diversification across these two asset classes that economists, up to now, have been unable to measure or analyze.”
4. Observation: The authors also demonstrate that “equity returns have also become highly correlated across countries” and therefore “a well-diversified global equity portfolio has become less of a hedge against country-specific risk…In contrast…cross-country housing returns have remained relatively uncorrelated.”
D. Interpretation: Investing a percentage of my investment portfolio in housing real estate may be a more helpful diversifier than global equity exposure.
I will be adding this paper to my resource folder for future reference. It clearly shows the benefit of having housing real estate as part of a well-constructed investment portfolio.