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7.0 REAL ESTATE
The average return on a real estate investment compared to stocks, bonds, and other investments
such as precious metals, art, etc. is tabulated and published by the Wall Street Journal on the first
business day of each year. Annual appreciation of real estate is usually below 10%.
The historical percentage
of increase in home values
is shown in the tabulation
on the right.
They are derived from Yale
economist Robert J. Shiller's
Irrational Exuberance:
1890's: 0.53%
1900's: 1.40%
1910's: 3.30%
1920's: (-0.70%)
1930's: (-0.45%)
1940's: 8.16%
1950's: 2.67%
1960's: 2.57%
1970's: 8.12%
1980's: 5.86%
1990's: 2.84%
2000's: 9.27%
A chart of real estate values in the past 17 years from Jan 1998 to Mar 2005 was published in the
SanFrancisco Chronicle on April 15, 2005. This was before the financial crisis of 2008 where real
estate values were increasing at a fairly high rate. However, if we use the compound interest
formula to calculate the average annual rate of appreciation over 17 years, here are the results:
In the San Francisco Bay Area where the average real estate price went from $170k to $605k
(an increase of 3.56 times) over 17 years. The annual rate of increase for this perriod was 7.75%
Nationally, the average real estate price went from $76k to $173k over 17 years,
which is an annual rate of increase of 4.96%.
7.1 RULE OF 72
There is a simple way to determine the number of years it takes money to double with compound interest. This is called the “Rule of 72”.
By dividing the interest rate into 72, you will get the number of years it takes to double.
As an example:
At 7.2%/year, money will double in 10 years. At 10%/year, money will double in 7.2 years.
7.2 ZERO NET GAIN IN REAL ESTATE
To illustrate that real estate is a Zero net gain investment, let us examine a hypothetical home worth $100,000.
To simplify the math, let’s assume the home will appreciate at 7.2%/year where it’s value would have doubled
after 10 years. To purchase this home, assume we are able to obtain a loan for the full amount (zero down
payment) at 7.2% with NO principal payment, (interest only).
After 10 years, we would have made loan payments of around $100,000 (7.2%/year for 10 years)
Meanwhile the value of the home has doubled to $200,000. We sell the home and pay off the $100,000 principal
of the loan. We now have $100,000. Zero Net Gain!.
Of course there were income tax deductions, besides the cost of property taxes, insurance, repairs, etc. If we
consider all of the associated costs (real estate commission, maintainence, etc.) during the 10 years, The result
may not be far from a Zero Net Gain.
