Jim Mora: The Federal Reserve Bank of San Francisco and the Department of Economics at the University of California have released a much-discussed paper, in the short time since its release, called the Rate of Return on Everything.
Every asset class across– every main asset class across 16 advanced countries since 1870, a period of 150 years pretty much. Stocks, housing, bonds and bills worldwide. I don’t think they looked at art or collections of stamps or anything.
Barry, what wouldn’t you invest in that people do invest in? I mean, we’ve all made these kinds of decisions even if they’re quite small sometimes. What would you tend to favour?
Barry: Well I tend to favour property although I got burnt once with a scheme on the Gold Coast. Buy into a hotel development over there, certainly got burnt on that. But I think property is one because let’s face it, you can actually live in a house, you can’t live in a share portfolio.
Jim Mora: No, true. But I think we have always been told that shares beat property as a long-term investment and this research is suggesting otherwise. Dominick Stephens is joining us, the chief economist at Westpac. Good afternoon, Dominick.
Dominick Stephens: Good afternoon, Jim. How are you?
Full Audio Interview (transcription below):
Jim Mora: Well, thank you, and nice to have you on. Are you happy that this is a comprehensive survey? It certainly looks comprehensive.
Dominick Stephens: It is. I’ve only had a few moments to look at the paper this afternoon. I’d start by saying their conclusion wasn’t really that housing has outperformed equities.
What they’re saying is that actually they’ve had about the same return since 1870, and that’s about 7.5% on average which is pretty high. They said things like, “Well before World War One, housing outperformed equities and since World War Two, it’s underperformed equities.”
So we’re dealing with some pretty long, in fact life long periods here of difference. But really what they were saying is they’re about the same. One of the things, I think one of the conclusions in the NBR article I saw was well, they said housing might be a better investment because at a national level, it’s less volatile than equities.
So you get these sort of, you more frequently get big changes where equity markets all move down or up at once. The thing is, one of the things that the authors pointed out is that actually housing investors only get to invest in one or two houses at a time, so they have much less diversification.
Actually, I mean the two panelists actually brought up a brilliant example of exactly this. You can get really lucky or really unlucky because you can only invest in one or two houses. Whereas equity investors get to diversify a whole load.
So yeah, basically it was a very comprehensive and high quality article as far as I could tell but it wasn’t really saying that housing is outperforming equity.
Jim Mora: Right. Okay. Residential real estate as rental investment has, as Dominick’s saying, gone stride for stride and slightly outperformed global stocks since 1870 but part of the reason that they favour housing is, as Dominick says, it’s markably less volatile. What about houses, Dominick, you don’t rent out but hang on to?
Dominick Stephens: Yeah. Well in this article, that was one of the investments they were looking at, so owner-occupied housing and I would just point out that they only came to their conclusions based on their estimates on the value of the rent that you would have otherwise had to pay, and the cost of maintaining the house.
And those estimates are really subject to a bit of uncertainty. I’d say in New Zealand, of course, if you’ve got a bit of spare cash, the best place to put it is into your own home or paying off your own mortgage and that’s because it’s a massively tax-advantaged investment.
So we do have a lot of people who think they’re geniuses because they made a lot of money on their own home but it’s a massive, massively tax-advantaged investment relative to others, so it’s not particularly surprising that since 1990 when these tax advantages came into play, that the people investing in that asset class have done well.
Jim Mora: Can you explain this for us? I’ve just plucked a sentence out of it. One interesting finding was then was then when risk premiums are low like today, financial crises become more likely. Is that just a calm before the storm thing?
Dominick Stephens: I think, I’ve only had a few moments to look at it but I think that what they’re talking about is when you’re down at very low inflation and all the rest, there’s a greater likelihood of hitting the zero bound on interest rates.
So interest rates can’t go below zero but they might need to. They can’t fall very far but they might need to and then you might end up in a crisis situation.
Jim Mora: There have been interesting theories, Dominick, about this online. And one is that the housing bubble might not be a bubble after all but simply the bidding up of an asset to drive down its future expected returns to bring it in line with other assets, i.e. housing was underpriced for 130 years and is now correctly priced.
That is an interesting point of view. I don’t know if you agree with it or not.
Dominick Stephens: I’d say it’s a valid point of view. It’s certainly possible. I’ve done lots of work on fundamental valuations of housing and one of the things I’ve found, for example, was in the mid-2000s, I was arguing that housing was undervalued going into 2002 and 2003, and the big run up in New Zealand house prices over ’04, ’05, and ’06 was probably sort of catch up.
So that’s a reasonable point of view. That does raise a really good point though about this type of work and that’s that the time periods you study really matter.
I mean, I could just imagine someone in Japan, a researcher in 1990, researching house prices in Japan and concluding that they outperformed every single asset ever in all of history over whatever time period you measure.
But of course, since 1990, Japanese house prices have fallen to 40% of their previous value and they’ve fallen in almost every single year since then so that’s, what’s that? 27 years.
So time periods really matter and these guys have studied all the way back to 1870, but during a lifetime or a lifetime of investing, you could easily exist during a one-off period of lift in house prices, which I think what’s happened in New Zealand due to the change in the tax system.
You could easily live through a period where house prices fall every year of your investing life like they did in Japan.
Jim Mora: Yeah. You make a really good point.
Barry: Is the house bubble though, the falling price of houses, is that as bad as a share market crash? And we’ve had quite a few of those over the years, haven’t we? The ’20s, ’90s.
Dominick Stephens: It’s not as bad. I mean yes, I think it’s– if by social harm, if that’s your question then I would say it’s much worse. And that’s because home ownership, A, is often held over debt so you end up with negative equity whereas you don’t get negative equity so often in share market crashes.
And secondly, it’s very widespread. So a lot of people own houses and therefore you can get very widespread negative equity. That’s where you owe more than the value of your house which has subsequently fallen. And it does create, it really gums up an economy.
Whereas share market crashes tend to be bigger, at a national level, much bigger, there’s much more volatility when you’re measuring a whole country’s house prices or equity prices, but they’re less widespread in the holding and there’s less debt over the holding so it’s less likely to cause a really big issue in the economy.
Jim Mora: Very good to have your expertise. Thank you, Dominick. Dominick Stephens, the chief economist at Westpac, and the research and the conclusion of many does seem to violate the accepted tenet that higher risk assets have higher returns.
But I think Dominick explained that quite well. It depends where you are and at what time.
Barry: I just remember a number of friends in 1987 who had borrowed a lot of money to buy shares and what it did to them. And so I’ve always been very careful around the shares because of that. Just remembering what had happened then.
Jim Mora: I know many of us have never forgotten 1987 and the shock that was.
Source: Radio New Zealand
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