While trying to make a decision on asset allocation, this is one of the most common questions which every investor would have asked their friends, family, advisors and most importantly themselves, in order to achieve long term capital appreciation. Hence, I thought it may be interesting to look at what historical returns can teach us about both of the asset classes.
For real estate, I have used the All-India House Price Index (HPI), which is published by RBI since the beginning of FY2010-11 on a quarterly basis. The index tracks the prices of residential real estate in the 10 largest cities in the country. For equity, I will use Nifty 50 Index, which reflects the stock prices of the 50 largest listed companies in the country.
Based on these indices, the real estate prices have risen 205% over the last 11 years till Q1 FY2021-22 while equities have risen 196% during the same period. This translates into a 10.7% capital appreciation on an annualized basis for real estate, as compared to a 10.4% capital appreciation in case of Nifty 50. Even if I compare the rolling annual returns over 3-year and 5-year periods, the real estate has given slightly higher returns. The results are encapsulated in the table below:
So, based on this data, one may think that real estate is a better asset class to invest in, as compared to equities. However, this assessment will be incomplete due to two reasons (i) volatility (which refers to the risk associated with the size of changes in returns and is typically measured by standard deviation) of returns for both asset classes is not captured, and (ii) a third option for investing has been overlooked, which is investing in BOTH real estate and equity.
The results are quite interesting, once both of these factors are incorporated. A portfolio spread equally between real estate and equity has slightly lower returns as compared to real estate but has much lower volatility, over both 3-year and 5-year time periods. This leads to a much superior risk adjusted return as compared to portfolios which are invested only in real estate or equities. The comparison is given in the table below:
Therefore, the key takeaway from this analysis is that the investors should look to invest in both equity AND real estate rather than investing only in real estate OR equity.
PS - There are certain limitations of this analysis, which an investor should keep in mind. Some of them are listed below:
- Individual investments in real estate and equity in one particular property or stock can have much different returns.
- The analysis just factors in the capital appreciation. Regular income in the form of rental yield for residential real estate and dividend yield for stocks has not been included.
- It ignores any costs related to buying, selling or management of the asset.
- A real estate portfolio based on HPI, is practically difficult to replicate.
- To keep the analysis simple, only a portfolio which is invested equally in both asset classes has been looked at. A portfolio can have both asset classes in any proportion.
- Property price rise and fall cycles are longer as compared to equity.
- Historical returns may not be a good indicator of future returns.