The real return on real estate

Marian Ross

Sunday, February 04, 2018

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Twenty years ago, a patty cost $20. Today, a patty costs $120. Therefore, I should be able to buy six patties today with the same funds I used to buy one in 1998.

It's obvious that this doesn't make any sense. However, we hear it every day from investors.

Buyer 1: “I bought a property in 1975 for $150,000. I sold it in 2016 for $14 million. How amazing is that?” Or Buyer 2: “I bought my house for $12 million in 1990, it's now worth $124 million. Best investment I ever made.”

Think again. Have you taken inflation or devaluation into account?

Let's look at Buyer 1's transaction: $150,000 in 1975 was worth approximately US$164,835.16. In 2014, J$14 million was worth US$122,100; 26 per cent less than the original investment.

Similarly, if Buyer 2 bought a property for $12 million in 1990, she spent the approximate equivalent of US$1.468 million in 1990. If this same property was valued at $124 million in 2018 or US$992,000, she would have lost roughly 32 per cent of her investment in US dollar terms.

Even ignoring the effect of devaluation, it's difficult to keep up with inflation.

If you spent $40 million in 2001 to buy a house that was worth $60 million in 2018, you have lost more than 66 per cent of your investment through inflation. After accounting for inflation of 9.3 per cent per year, $60 million in 2018 was worth $13.2 million in 2001. This equates to an approximate annual return of -4.2 per cent.

Inflation in recent years has been lower. However, even at a lower inflation rate of 5.7 per cent (observed over the past 6 years), $40 million in 2018 dollars is equal to $28.68 million in 2012 dollars.

In other words, if you bought a property for $28.68 million in 2012 and it was worth $40 million in 2018, your investment has retained its value.

The original investment should be compared to the discounted value of the sale price. Inflation is a useful benchmark or hurdle rate to apply to your investment decisions. In other words, your investment's return should exceed inflation.

Of course, this is not to say that real estate investments are generally unprofitable. It simply means that investments must be evaluated while taking the time value of money and local currency volatility into account. Certainly, real estate in desirable areas with limited land space can be preservers of value.

Similarly, in times of economic growth and expansion, gentrification is often a catalyst for capital appreciation.

Returns on real estate also depend on the amount of leverage being used and the cost of it. In developed economies with stable access to low-cost funding, real estate ownership can be an attractive proposition.

In contrast, stock and bond markets can provide investors with outsized returns.

In fact, an investment of US$10,000 in a US dollar bond fund in 2003 was worth US$58,579 in 2018. Discounting the 2018 value for two per cent inflation (10-year average in USA), the ending value of the investment is US$43,525.21 in 2003 dollars – more than four times the original investment.

Investors indicate that they are willing to accept lower returns on real estate for a number of reasons. For example, the perceived comfort of owning a physical asset that you can feel and touch – instead of a stock or bond that is captured on a piece of paper. Investors also perceive the asset class as “easier to understand”. Some investors genuinely enjoy the process of managing a real estate portfolio, and the utility they derive from the experience outweighs the lower financial return they receive.

Like any investment portfolio, diversification is important. While some real estate can preserve value, the asset class is highly illiquid. To get into and out of the real estate market can take several months and can cost a lot in terms of fees and taxes.

In contrast, it takes two days to liquidate a bond or stock investment in the global markets.

It is easy to see the price or market value of a stock or bond; there is very little room for disagreement between buyers and sellers. However, buyers and sellers often negotiate extensively to reach an agreed price for a piece of real estate.

While each asset class has its pros and cons, we encourage investors to evaluate all their investments net of inflation and in terms of a hard currency.

Marian Ross is an assistant vice-president of Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at:

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