Real Estate
Appreciation of New Home Values is Cyclical and Relatively Low
For much of the last ten years, a house seemed to be not just a home, but a sure path to wealth. Home values rose steadily, and many people began to believe that their retirement was secure as long as they owned a home. Beginning in mid-2006, this rosy retirement picture changed, and the housing market continues to experience a significant correction.
The purpose of this article is to put these recent events in the housing market in historical perspective and to offer insight as to how this historical perspective might be of value to you as you plan for and live in retirement.
The previous decade of rising home values and the recent decline in home values reminds us that residential real estate is vulnerable to market cycles similar to other asset classes. From 1963-2005, the remarkable climb in residential real estate values has been punctuated by three sharp market downturns coming at roughly ten-year intervals – the early 70's, the early 80's, the early 90's. The severity and duration of the current downturn is still uncertain, but we do know that the median price of a new home has fallen significantly off its high.
Many recent investors in new homes did not study the history of cycles in which new home values can both rise and fall. When we take into account both types of cycles, how do returns on new home values compare to asset classes such as stocks, bonds, and cash? To answer that question, we first look at real returns (price appreciation adjusted for inflation) averaged over 1963-2005. Over that long period the median price of new homes in the United States rose at an average real compounded rate of 1.35%. During that same period, stocks had an average real return of 5.95%, and bonds returned 2.74%. The appreciation of new home values, adjusted for inflation, has barely outpaced the real return rate for U.S. Treasury bills.
Additional insight into the attractiveness of various types of assets in relation to new home values comes from examination of average returns over rolling ten-year time frames. ("Rolling" refers to the procedure of compiling returns over periods like 1963-1972, 1964-1973, and continuing to 1996-2005 and then averaging the compiled returns.) Ten years is a typical holding period for new homes and is appropriate in estimates of the total return on a new-home investment.
The table below provides real (inflation adjusted) returns for stocks, bonds, Treasury bills, and real estate (new home values) from 1963-2005 in rolling ten-year time frames. From the row showing the worst returns over a ten-year period, we see that all assets have had periods of declining value after adjustment for inflation. New homes are similar to Treasury bills in their average return and in the variation of returns between the best and worst periods. Stocks are much more rewarding than other assets in most periods, but they have had ten-year stretches where returns were below those of Treasury bills and new homes.
Based on this information, what insights can we glean regarding retirement planning?
| Real Returns 1963-2005 over Rolling Ten-Year Time Frames* | ||||
|---|---|---|---|---|
| Statistic (Annualized) | New Home Values | Stocks | Bonds | Treasury Bills |
| Average 10-Year Return | 1.62% | 6.47% | 3.33% | 1.50% |
| Worst 10-Year Return | -1.11% | -2.90% | -4.60% | -0.42% |
| Best 10-Year Return | 4.64% | 15.29% | 10.78% | 3.46% |
| *Data compiled by Fidelity Research Institute | ||||
History suggests there are good reasons to be wary of thinking about your home as a primary source of retirement income. Long-term inflation adjusted returns in stocks and bonds have been higher than in new home values. When considering long time horizons, such as planning for and living in retirement, a portfolio that is allocated across the major asset classes and well-diversified within each asset class can provide you with a higher certainty of meeting your retirement goals.
A key difference in housing as an investment class compared to other assets (stocks, bonds, and cash) is that a home is a relatively illiquid asset. A liquid asset can be sold in part or in full to raise cash to meet current obligations. When owners of relatively illiquid assets need to raise cash quickly, they often have to sell their assets at discount prices.
One common mistake people tend to make is to over-invest in a home. For example, they may stretch to make mortgage payments at the expense of fully investing in employer retirement plans. The opportunity cost of not maximizing tax-deferred retirement saving options can have a significant negative long-term effect on your retirement nest egg.