Passive Investor Series Part 3: Stock Market vs Real Estate Returns
A well-known multifamily real estate investor spoke at a meeting I recently attended. During the meeting, he discussed the stock market versus real estate and made an interesting statement. He said if you paid someone 4% to invest in real estate for the last 20 years up to 2020, it would return more than what the stock market would have. That statement stuck out to me. Having thought many times about this statement and not finding any statistics or others mentioning this, I decided to answer the question myself through good old-fashioned analysis.
So let’s go back to the statement made by this guru. How has the S&P 500 done in the last 20 years? Let’s take a look:
Before comparing the graphs, let’s define each of the columns so we are all under the same understanding.
Year - The year of the return
Annual Return - The return that investment reached in a given year
Balance - Results of invested capital in the given year plus all gains/losses from prior years
Total Return - Return on investment on your invested capital
Annualized Return - The average annual performance of your invested capital by dividing the Total Return from the number of years invested.
At first glance, the stock market had a handful of down years (in red). In early 2000, you have the dotcom bubble that tanked the stock market. Then the market started to recover and then in 2008 we entered the Great Recession. These two events were not kind to investors. However, you then came to the decade of recovery and saw stocks at all-time highs. If you invested after 2009, then you likely have seen amazing returns on your investment.
You may be asking if the stock market has gone up double-digits in multiple years, how is it possible it does not outperform a 4% return? If you had an investment that lost 10% in one year, then went up 10% the following year, are you back at the same amount you started with? No.
Let’s do the math:
As can be seen, in year 1, the investment went from $100,000 to $90,000 with the -10% return. In year 2, the $90,000 returned 10%, so your balance is now $99,000. The balance in year 2 does not go back to the original balance, $100,000, even with a 10% return and would need an 11.11% return in year 2 to get your investment back to $100,000.
Looking back at the stock market returns, it had multiple years of losses from 2000-2002 before multiple years of recovery, even gaining over 20%+ in returns in one year that would have brought the investment close to breaking even by 2007. Then in 2008 came the crash that tanked the investments nearly 40% in one year. It isn’t until five years later before stocks finally break even again with multiple years of gains over 20%.
Although the 20-year period in question was unique with two major crashes in the stock market, it is not unique to have different events that can tank the market. For this reason, the historic stock market returns in the last 50 years have been 6.8%. This implies there were years of positive double digit returns along with years of negative double-digit returns. However, the stock market only steadily increased.
So, was this real estate investor correct in his statement? Sort of. At the end of 2019, the S&P 500 had an annualized return of 5.99%, which is higher than the 4% return the guru mentioned. If referencing the end of 2018, then the 4% would return be higher than investing in the stock market.
The point is clear with what this investor was trying to get across, which is that the stock market is not necessarily the best place to put all of your hard-earned savings. While the stock market has had large swings up in recent years, there is an expectation that things will always balance itself out through the law of averages.
What does this all mean?
The common saying, “past performance is not a guarantee of future results” holds true here. Even though the 4% return outperformed the stock market through 2018, the stock market has now started to outperform the former. However, even with this outperformance, it should be expected the stock market will continue its historical trend and average around a 7%-8% return.
On the other hand, it is possible to find real estate investments averaging returns of more than 4%, which is considered very conservative. It is also fairly easy to find returns matching the average stock market returns (7%-8%) or higher, no matter if you invest actively or passively. For example, a syndicated passive investment can average returns between 14%-16%, if you look in the right places.