Which is the asset class that delivers the highest long-run returns? This is one of the fundamental questions that have preoccupied modern economic thoughts.
According to a new research, residential real estate, not equity, has been the best long-run investment over the course of modern history. In the paper, titled ‘The Rate of Return on Everything, 1870-2015’, economists Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick and Alan Taylor compare stocks, bonds and housing across 16 advanced economies over the past century and a half to arrive at an emphatic conclusion: The return on residential real estate has been as high as or higher than the return on equity.
It bases this on a comprehensive dataset for all major asset classes, including total returns to the largest, but often ignored, component of household wealth, housing. The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015, reinforces a clear pattern: Stocks and real estate dominate in terms of returns. While housing is by far the hardest asset to measure — given that its price change sharply from unit to unit and city to city — the research tried to overcome these data deficiencies and create a long-term database of housing prices in advanced economies. Between the two top asset classes, even as residential real estate comes through as the best long-run investment over the course of modern history, housing trumps stocks largely on account of the fact that the returns were less than half as volatile. On aggregate, returns on the two asset classes are in the same ballpark (7.9 per cent for housing and 7 per cent for equities), but the standard deviation of housing returns — denoting the volatility — is substantially smaller than that of equities (10 per cent for housing versus 22 per cent for equities).
According to the study, during the late 19th and 20th century, real returns on safe assets have been low — on average 1 per cent for bills and 2.5 per cent for bonds — relative to alternative investments. Although the return volatility — measured as annual standard deviation — is lower than that of housing and equities, these assets clearly offered little protection during high-inflation eras and during the two world wars, both periods of low consumption growth.
Data are pooled and equally-weighted — they are raw rather than portfolio returns. The study includes wars so that results are not impacted by omitted disasters, even though it excludes phases of hyperinflations in order to focus on the underlying trends in returns, rather than inflation.
There are countries that buck the broader trend. The UK is one of the few countries featured in the survey where stocks have significantly outperformed housing over the long run. In most countries, the returns are comparable, and in some places such as France and Japan, housing has done much better. It’s much less volatile than stocks, too.
When it comes to country-specific safe asset returns for three samples: All years, post–1950, and post–1980, the experiences of a few countries stand out. In France, real bill returns have been negative when averaged over the full sample while in Portugal and Spain, they have been approximately zero. In Norway, the average return on bills has been negative for the post-1950 sample. However, most other countries have experienced reasonably similar returns on safe assets, in the ballpark of 1 per cent — 3 per cent.
Investment and returns across countries
The study shows that at the end of 2015, the five leading developed economies — the US, the UK, Germany, Japan and France — had their highest component of investable assets in equities. The average for the five countries stood at 25.9 per cent. While housing accounted for an average of 19.4 per cent of the investable assets of these five nations, the average share of investable assets into deposits was 12.3 per cent.
The US comes on top among the five nations in terms of equity investment as 39.1 per cent of the investable assets of US were parked in equities. France comes next with 28 per cent of assets into equities. When it comes to real estate, the UK came on top with 27.5 per cent of the investable assets in real estate.
Japanese investors are seen to be the most conservative among the five nations as only 13.4 per cent were in equities and housing and deposits accounted for 10.9 and 18.9 per cent.
When it comes to real rates of return on equities and housing, data show that after 1980, Finland, Sweden, Denmark and Norway come on top in terms of equity returns. While Finland generated a return of 16.17 per cent, Sweden posted a return of 15.74 per cent. Returns in the US and the UK stood at 9.09 per cent and 9.34 per cent, respectively. In the case of housing also, Norway, Finland and Sweden come on top with return of over nine per cent. The US and the UK saw returns of 5.6 per cent and 6.8 per cent, respectively.
The report, however, points out that over the last two decades, equity returns have become highly correlated across countries and therefore a well-diversified global equity portfolio has become less of a hedge against country-specific risk. On the contrary, real estate offers better hedge against country specific risk. “In contrast to equities, cross-country housing returns have remained relatively uncorrelated, perhaps because housing assets remain less globally tradable than equities or are exposed more to idiosyncratic country-level shocks,” the report said.
According to the report, even if the performance of the fundamentals driving the housing and equity returns is similar, investor returns on the two asset classes may differ on account of various factors including transaction costs, taxes and differences in the liquidity and financial structure of the investment claim.