I’m an avid reader of my Google News feed. I tend to believe that Google has collected enough information about me that I get served relevant news articles (naive, right?). Google also knows that I follow the same 3 stocks, and everyday I check on the status of those stocks. Given the rollercoaster that the stock market has been on in past few months, Google News decided to serve me an article about alternative asset investing. Of course I took the bait and spent days reading about different asset types outside of the traditional stock market (side note check out Rally Rd. if you want to invest in collectible cars).
As I spent time reading, I started studying residential real estate in California. Purchasing a home is a huge decision and for most homeowners it is the largest asset that they will posses in their lifetime. Given that we mostly think about homes satisfying the basic need of shelter and not as assets, we tend to overlook the investment side. Surprisingly, residential real estate is an extremely large asset class for Americans. Did you know that the US residential real estate market is slightly greater in value that the US stock markets?
The total value of the US residential real estate market was $33.3 trillion at the end of 2019. The overall value of the US stock market was $30.4 trillion. For being a multi-trillion dollar market, we typically do not talk about homes like we do stocks at investment dinner table conversations (Or however you might discuss investing and saving for retirement).
One more surprising tidbit about US residential real estate market — California is responsible for roughly 25% of the overall value ($7.1 trillion). On top of it, the past decade has performed extremely well for Californian home values. Since 2010, the Golden State has added $3.1 trillion in value. Roughly 2/3 of this growth can be found concentrated in the Bay Area (San Francisco and San Jose Metros).
If you are still with me, this was a roundabout way to say that there is a ton money tied up in US homes and a large chunk is found in California. You are probably still thinking — “Great, but is it a good investment?” Let’s get into that question now by breaking down US residential real estate market.
First of all, comparing investments is difficult. Without getting into the nuances and differences, I simply want to know if I put $1 into a Californian home would it perform less, equal, or greater than the average performance of the US stock market. For this post, a ‘good investment’ is simply tied to current convention that investing in the stock market is a ‘good investment’ longterm (read about mutual funds ). In order to compare my $1 growth potential, I decided to look at the Compound Annual Growth Rate(CAGR) of US residential real estate market vs US Stock Market. Basically, CAGR will tell me how much my $1 will grow on an average per year. It’s a more true assessment of growth overtime (Read more about CAGR).
For my residential real estate data, I used Zillow’s normalized data to perform my analysis. The data only goes back to 1996, but I think that will be sufficient to answer our question. To establish a baseline CAGR of the stock market, I used an online tool to determine that the CAGR from Jan. 1, 1996 — Dec 31, 2019. The 24 year CAGR was 7.14%.
Instead of diving directly into California, I wanted to pull up a mile high and look down on the country. If you looked at all the states in the past 24 years, California clearly stands, but all states fall short of my estimated 7.14% US Stock Market CAGR . However, a state is a sum of its parts. Let’s dive deeper.
Next, I created a snapshot of the hottest real estate area within California — The SF Bay Area. Surprisingly, most people tend to separate San Francisco Metro and San Jose Metro. However, they very much run into each other, and I like to treat them as one Metro area. If I calculate the CAGR of the ten counties in the Bay Area and compare them on a map, the rankings look like Figure 3 and Figure 3 table below.
Looking at all ten counties in Bay Area, San Francisco County is the only one to outperform our 7.14% US Stock Market CAGR. Alameda and Santa Clara Counties are not too far off. Now let’s go deeper.
Let’s dive into the neighborhoods of Menlo Park in San Mateo County. Menlo Park is home to Facebook and has seen its neighborhoods change dramatically in the past 20 yrs. I calculated the CAGR since 1996 for all 16 neighborhoods. I dropped Belle Haven from my results because it lacked sufficient data from Zillow, and I graphed the remaining 15 neighborhoods in Figure 4 below.
To my surprise, many of the neighborhoods outperformed our 7.14% US Stock Market CAGR. The Willows neighborhood had an impressive 9.89% CAGR since 1996 (13.2% CAGR in the past 10yrs). Technically, we could probably go deeper by looking only at homes in prime locations on streets, but I’ll stop here.
So what do you think? Are Californian homes a good investment? Your answer probably depends on your investment strategy, but maybe this post has helped shape your perspective.
