Key Post What return should I expect for property

Marc

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My wife and I have recently sold the house she purchased in Dublin 13 years ago – for €5000 less than she paid for it.

Although she bought it as a home and not as an investment it made me wonder; what risk and return characteristics Financial Planners should really assume for a property investment.

I’ve read several posts recently stating that property prices will “probably” increase by x% over the next few years, but with little evidence to support the expectations.

I have therefore collected the following historic data:


 Irish Residential Property since 1970

 Irish Commercial Property since 1975

 UK Residential Property since 1983


I have presented the data from the perspective of an Irish Financial Planner who may have clients investing in both the UK and Ireland taking account of currency fluctuations as well as movements in the underlying asset.

Irish residential property


Between January 1970 and the end of December 2015 the annual growth in Irish Residential Property has averaged 8.66%pa Nationally and 9.25%pa in Dublin.

However, over the same period inflation has averaged 5.86%pa suggesting that the real return for residential property has been around 2.8%pa Nationally and 3.39% in Dublin which is slightly higher
than my findings for average residential property in the UK since 1983 (2.5%pa real return).

Equally, this extra real return above inflation wasn't the norm.

For example, during the 1970s and 1980s, real house prices nationally lagged behind the cost of living up to the end of 1987.

Thereafter, Ireland experienced a property boom, bust and subsequent recovery which bear no relation to the experience of the previous decade.


From a risk/return perspective, National Average Property in Ireland increased by approximately the same amount as Global Developed equities over the full period growing nearly 55 times. However, we know that the 1970s were a particularly bad time for equities and it wasn͛t until 1988 that an equity investment caught up with the average National Property.


An analysis of the quarterly data allows us to calculate the maximum drawdown in order to obtain an impression of how risky Irish Residential Property is relative to, say, an investment in equities.

I conclude that the maximum drawdown for Irish Property is of the order of magnitude of that of Global Equities. In other words, there is no free lunch in investing. The equity-like returns of Irish property are associated with similar equity-like drawdowns.

I intend to publish the complete findings in my forthcoming book but hopefully readers of ask about money will find this initial snippet interesting.

Sources: CSO, halifax house price index UK CPI, MSCI
 
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Very interesting stuff...thank you Marc

What about the income yield?

The old axiom of dividend yield plus dividend growth equalling total return springs to mind.
 
I'm also looking at historic rental yields on both sides of the Irish Sea on a Gross (before costs and tax) and net basis.

Again, one of the issues I'm looking at is what is a reasonable cost to assign to a rental property. Effectively landlords should depreciate their property each year in the same way that any other business depreciates its assets.
 
Very interesting work.

Can you explain what you mean by maximum drawdown.

Conflating "residential property" with "residential property suitable for letting" is a simplification. While this may not matter in terms of changes in property values, it is hugely significant in terms of rental yield. The price of a property suitable for letting may move in tandem with a property suitable for owner occupation, the rental yield is very different.
 
I agree that rental income needs to be considered separately to the capital value and I thought long and hard about this.

However, I concluded that current rental income is always known with 100% confidence. Equally current costs, mortgage interest, rates, insurance etc are all known facts. Whereas, current valuation is always a matter of opinion until contracts are signed.

So current rental income is actually the easy part of the puzzle.

We can talk about “potential rental yield” but not with the same confidence that we can talk about the yield of a stock or a bond.

This is because property transactions tend to be relatively infrequent and each property is a “relatively” unique transaction and that means that we really only know the rental yield of a property twice with confidence - when we buy it and when we sell it.


Maximum drawdown is defined as the peak-to-trough decline of an investment during a specific period and is usually quoted as a percentage of the peak value.

The max drawdown for Dublin property based on quarterly data is -46% for example.

More frequent data eg monthly might yield a higher result since it could capture more of the peak and trough.

This is why people often think stocks are more risky than houses. A price that is quoted every millisecond is inherently more volatile than one quoted every 20 or 30 years.

Just imagine if your home had a stock ticker above the front door showing any bids for your house in real time.

I think I’d unplug it!

When we sold our house it was confidentially valued by the estate agent 8.5% higher than it eventually sold.
 
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If comparing against other investments you also need to consider the cost of ownership, including the additional costs of buying and selling the property, property tax, maintenance etc.
 
Very interesting - thanks for sharing and gathering the numbers.


suggesting that the real return for residential property has been around 2.8%pa Nationally and 3.39% in Dublin .

From a risk/return perspective, National Average Property in Ireland increased by approximately the same amount as Global Developed equities over the full period growing nearly 55 times.

These are both a bit misleading as these don't give any value to living in the house/renting it out, or allow any costs for taxes, maintenance etc., (I assume dividends were included for equities and re-invested).
 
from http://www.thepropertypin.com/viewtopic.php?f=10&t=66475 a very interesting related paper!

Dublin house prices: A history of booms and busts from 1708-1949

Presented by Karl Deeter, David Duffy and Frank Quinn at the the Statistical and Social Inquiry Society of Ireland on 20 October 2016

http://www.tara.tcd.ie/bitstream/handle/2262/82167/1deeter.pdf?sequence=1&isAllowed=y

An excerpt from the paper

Table 1. Annual Growth Rates, Nominal and Real

Years, Nominal, Real (Annual average change %)
1708-1949 4.3 4.5
1708-1799 4.5 4.4
1800-1899 1.3 3.2
1900-1949 9.8 7.4
 
One of the best things about investing in the public markets is that the data is so clean.

Measuring performance is easy and there is no place to hide.

By contrast, the gap between the average asking price calculated by @Rightmove for the UK and the average sale price totted up by @ONS is 26% or £79k

A person with a new idea is a crank, until that idea succeeds - Mark Twain

No statue was ever put up for a critic

Here is a link to my analysis

 
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Congratulations Marc on producing this detailed analysis, and thanks for posting it here. I would like to comment on a number of points.


Familiarity bias.

You consider familiarity bias so important that you address it as your first point, yet I fail to understand what you are saying about it. The apartment I can see out my window, doesn't appear on the radar of an investor in New York. To me this says that the market in that apartment is likely to be less efficient than the market in a widely traded share, and so there is a greater chance that it is mispriced. Possibly underpriced, possibly overpriced. To me this gives more opportunity to well informed property investor to find a bargain than would be found in a widely traded share.

Liquidity

You say that property is not liquid. That is true. You say that therefore an investor should seek an illiquidity premium. I disagree. If an investor has funds that are not suitable to be tied up long term in an illiquid investment then they should not be invested in property. If an investors funds can confidently be tied up for the long term then because short term investors are out, the investor may expect to gain a better return. This is not the same as a liquidity premium, anyone who needs their return in 5 years, but invests in property because he gets an “illiquidity premium” is a fool. Anyone who is confident he can tie his money up for 25 years should invest in the asset with the best expected return over that period.

Starting Valuations

You say “Starting Valuations clearly matter when forming a view about expected future returns in both equity and real estate investments” Absolutely. Although I believe that this is more relevant for property investments, because the market is shallower.

Residential properties vs Rental properties.

On page 24 you compare the rental yield on properties in Dublin 6 with those in Ballyfermot. I would suggest that including properties in D6 or other similar areas distorts the analysis of the returns to property investing. While every share is bought with a view to profit, not every property is. The price of property in D6 is not driven by its investment potential, its driven by social chachet, which has no place in investing. Including such properties in an analysis of property as an investment makes the returns look very much worse than the actual returns experienced by those who buy property as an investment rather than as a home. Of course I realise that it would be difficult to exclude these type of properties.


This is my most important disagreement with your analysis. I suggest that an analysis of an investment case based on properties many (the large majority ?) of which were not bought for investment purposes, is futile.


Bias


There are a number of hints that this research is seeking to come to a predetermined conclusion rather that being open to finding among a number of possible conclusions.

The quotation from Schiller at the beginning for a start.

In your conclusion Section 3.4 page 25 you say that the expected real return for Irish residential property nationally is around 2%,. It is only in 3.4.1 that we see that this refers to capital appreciation only. I don't think that you add this anywhere to the rental income to obtain a total return. A curious omission.

Your assumed Rental Income for Irish Residential property is 3% to 4.5% Gross. Page 25. You really need to get out more Marc. That is even contradicted by the details on page 24 where you tell us that the yield in D6 is the lowest in the country at 3.6%. I suggest that yields in excess of 8% gross are widely available in the market.

As a by the way calculating an expected return based on historical performance is not something I see as a valid exercise, you give some reasons for this yourself on the bottom of page 22.


Two small points

It seems that in your graphs you compare equity returns net of dividend with property price returns. I suggest that this is less than compelling. Obviously it is total returns that matter in both cases. The split between capital and yield in each asset category is not necessarily comparable.

Page 22. I think the labelling of the X axis is a typo.

Thanks again for sharing your work, comparing my opinions with your work has helped me clarify me ideas about property investing.
 
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