As I’ve mentioned previously I think the real estate market is in a price bubble. I tend to have more respect for people who thought stocks had reached a permanently high plateau in 2000 (and could only rise from there) than I have for people who now think similarly about real estate. The former could at least point out a fundamental change in the economy–the internet–that one could at least imagine as a mechanism for permanently shifting returns. From the latter I’ve never heard a putative fundamental change–they weren’t building new land ten years ago, either, and there have been periods of low interest rates before.

So, I’m delighted to see that Chris Hibbert, who I believe to be a skeptic and one who appreciates history (as opposed to believing that current trends must continue, increasingly), writing in favor of real estate investing. There are a few things in Hibbert’s post that I don’t follow:

Real Estate investors expect returns of 12% per year, minimum, not counting serious calamities, and not accounting for (often expected) supernormal returns due to rapid appreciation. Unlike stock market investments, you can investigate the recent performance of an investment, and then expect to reach that metric reliably.
…
real estate returns exceed other investments

If real estate returns are more reliable than stock market returns, you’d expect the former to be lower than the latter. In the Long Run, Sleep at Home and Invest in the Stock Market (NYT, August 19) shows that 1980-2005, the S&P 500 has handily beat even the frothiest real estate markets. I cannot find a reference quickly, but I understand that stocks also beat housing over much longer periods of time as well (e.g, 1900-2005), though they haven’t 2000-2005.

It just doesn’t make sense that real estate investments could offer both lower risk and higher returns over a long term. Even if something (i.e., restrictions on builing new housing) made it hard to shift investment into new housing, I’d expect extraordinary returns to go to existing owners and political entrepreneurs (i.e., developers), not to new investors.

In addition, the government insists that you account for your property as if it’s losing value every year, and gives you a tax deduction for the depreciation even though the value is usually increasing.

Everyone knows this. Is there any reason to believe tax advantages aren’t completely factored into real estate prices?

The worst historical cases that I know of were times when housing prices dropped 10 or 20 percent.

Hong Kong and Japan are down 50 and 25 percent from 1997 respectively, and Japan is down over 50 percent from its peak circa 1990. However, apart from a few small markets that suffered major employment declines, drops of 10 to 20 percent seem to be the maximum in the U.S., at least since the great depression, so far.

The renters who funded the run-up still need a place to live, so prices and investment income don’t fall by much.

Or people might consume less housing. Today’s monster homes certainly have room for multiple generations.

It looks like Hibbert plans to write a series on related topics. Hopefully he can disabuse me of my real estate investing skepticism. “Bubble Babble, and why it doesn’t bother investors” sounds like a promising future entry.

Addendum 20050929: Peter McCluskey also comments on Hibbert’s post and this one in Housing Bubble Peaking?