Real Estate's Performance Over Time

The risk and reward profile of an investment differs significantly by asset category. Research performed by Ibbotson Associates indicates that the overall rate of return varied widely among different investment categories between 1975 and 1995. During this period, large company stocks were the top performing asset, with a compounded annual rate of return of 14.6 percent. Although large company stocks had the highest overall long-term rate of return, the considerable yearly fluctuations in the rate of return indicates a high level of risk for short-term investors.

The return on long-term Treasuries was higher than business real estate, in part because of the long-term maturity period. However, another factor was in play that caused long-term Treasuries to have a higher return than business real estate. It was the severe downturn in investment real estate from 1991 to mid-1994 that resulted in long-term Treasuries outperforming business real estate during this period.

Thus, a short-term anomaly produced an overall stronger performance for long-term Treasuries. Yet, beginning in mid-1994 and continuing into 1995, commercial real estate has shown substantial improvement-which should allow commercial investment real estate returns to close the investment return gap with long-term Treasuries. In fact, commercial real estate actually outperformed long-term Treasuries for 15 years out of the 20-year period.

Although some investors view real estate as a risky investment because of its limited liquidity, the investment returns on commercial real estate over the 1975 to 1995 period demonstrated the lowest level of fluctuation from year to year. This pattern contrasts greatly with other forms of investment that showed great year-to-year volatility in returns. This low level of fluctuation indicates that commercial real estate has less volatility risk when compared to other assets.

Over the last 20 years, commercial real estate outperformed short-term Treasuries, 9.1 percent versus 7.3 percent. This outcome is not surprising because short-term Treasuries represent the lowest risk level of any investment. However, commercial real estate also outperformed commodities from 1975 to 1995. This outcome is somewhat surprising because of the high-risk profile of commodities, as indicated by the wide fluctuations of commodity returns from year to year.

Real Estate's Impact on the National Economy
A study performed by Ibbotson in 1985 indicated that U.S. real estate accounted for 18 percent of the world's total wealth. This statistic demonstrates that real estate is an essential element not only of the U.S. economy but of the world economy. With U.S. real estate valued at $10 trillion to $15 trillion, it represents the largest single component of the national economy. Given the enormous size of the market, real estate can have a profound impact on the overall health of the economy.

The importance of real estate to the national economy is illustrated by the fact that property taxes are primary sources of revenue for federal, state, and local governments. Taxes collected on real estate represent 14 percent of all federal tax revenue, and 10 percent of state tax revenue. More significantly, real estate taxes account for 70 percent of taxes collected by local governments, where they must provide for education, fire, police, trash collection, and other essential local services.

Real estate construction employment also is a significant contributor to the national economy. During 1995, construction employed 5.1 million people. This workforce is larger than the U.S. military and automotive-related employment sectors combined.

Dollars spent on real estate construction are also a major contributor to the economy. Total real estate construction spending from 1990 through 1995 is estimated at $1.6 trillion. To put real estate construction spending in perspective, the level of construction spending during 1995 will exceed national defense spending.

Construction spending serves as an important barometer of the health of the nation's economy. For example, construction spending during the recession of 1991 to 1992 was 20.3 percent lower than during the economic expansion from 1994 to 1995. Construction spending also creates an important multiplier effect, amplifying the total impact of construction spending by recycling dollars throughout the economy-creating wealth and jobs. Overall, real estate has been and will remain one of the primary driving forces of the national economy and a generator of national wealth.

George Green

George Green is a policy representative/senior economist for investment real estate at the National Association of Realtors in Washington, D.C.