Can Owning Real Estate Increase Your Income?

Real Estate is recovering from its worst decline since the Great Depression, and, in some markets, institutional investors are giving the sector a lift. I read an article, Housing vs. Stocks, where Rob Brown, Ph.D., CFA, Chief Investment Strategist at United Capital Financial Advisers LLC, cautions investors about following a trend The Wall Street Journal recently reported on. That is, large institutions are purchasing single-family dwellings in beaten-up markets and converting them into rental properties to generate a higher income stream. In fact, in December Silver Bay Realty Trust Corp. became the first U.S.-based single-family rental company to go public as a REIT.

Is this a solution to your quest for income in a low yield environment? Not so fast, says Brown. According to Karl Case/Robert Shiller housing price data he quotes in the article, the returns on equities typically beat the returns on housing. “Unless the investor has an unusual and rare ability to pick the right period favoring housing, he or she is likely to be disadvantaged,” he writes. In fact, Brown points put that “even when one identifies the absolute best-performing time windows for housing, equities still performed better!” He shows how, dating back to 1945, the only exception to this rule was the exceptional housing environment that ended in early 2006: The after-inflation return to housing for the nine years ended December 31, 2005, was 7.01%, and it was only 5.08% for U.S. stocks.

Why are housing’s returns lower than equities’? Brown notes that stock ownership signifies ownership of a portion of a corporation’s earnings and their future growth. Housing, on the other hand, is a unique combination of two assets: the structure itself which is “continuously depreciating” and the land which holds some appreciation potential. He writes, “Given that the structure has an inherent negative return and the land a positive return driven mostly by favorable population growth, it is natural to expect a low return to housing.”

In closing, however, Brown introduces a caveat. There may be a difference, he says, in the returns for people who buy single-family dwellings to live in and those who purchase and then operate houses as rental units.  That is he acknowledges that the “operational business” of acquiring a house at a good price and managing it as a rental could hold potential for more attractive returns. In my view, becoming a landlord requires both a careful examination of financial data and lifestyle considerations.

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