I read a very interesting – and contrarian – article in Reuters today. The article argues that it is possible – and given that those with a vested interest like Trulia and Bankrate hesitatingly agree, it is probably more likely than possible – that home ownership may be emotionally fulfilling, but it is a poor wealth creator, i.e. real estate is not a great investment.
The article led to my thinking about all investments, and whether real estate, in this respect, is unique. In thinking more deeply, I begin to wonder how any asset class can possibly have a long-term return on investment that is higher than the growth of the economy in general, other than (possibly) equities.
Here is my logic. Let us say that at one point in time, the entire stock of an asset class (e.g. real estate) is worth $1TN. Thus, the people of an economy have poured one trillion dollars into real estate. Over the next decade, the economy grows by 3% a year on average, while the stock of real estate – market value – doubles to $2TN. With a 3% average annual growth rate, compounded over 10 years, the economy has grown by 34.4% (3% annually compounded 10 times). If real estate is part of the economy, then the “natural” (relative to the economy) value of real estate should have grown to $1.34TN. The remaining $640BN must have come from somewhere else; some other asset class, or set of asset classes, must have grown, together, $640BN less than 34.4%. This should lead to arbitrage, although that is somewhat harder to do with fixed assets like real estate, and people in general seeing other assets undervalued. Over a long enough period of time, the ability of real estate to pull from, say, precious metals, should be counterbalanced by precious metals pulling from real estate. In other words, over a long enough run, real estate, and all other asset classes, should grow at no more or less than the rate of the economy, 3% per year in our example.
The more I think about it, though, the more I realize that there is only one asset class that, again over the long run, is truly an asset: equities. All other so-called assets are just stores of value. Gold, FCOJ (Trading Places?), real estate: not one single asset actually creates new value, with the exception of equities, which are investments in companies that exist to create a profit, i.e. to take $5 of inputs, create $6 of outputs, and thus create profits and new growth.
Over the very long run, smoothing out localized bubbles, it makes little sense that all of these asset classes other than equities should grow at anything beyond the rate of inflation. Quite simply, $1TN of real estate today is really worth no more than $1TN in ten years, but defined in today’s dollars, i.e. $1TN plus the rate of inflation. Every other asset class should be the same, except for equities, which are the source of all growth in GDP beyond the rate of inflation. Equities should grow at the rate of GDP growth, all other asset classes should grow at the rate of inflation.