Maybe not

This is going to be a kind of short post that may prove me to be a dumbass, but I’ve been thinking about real estate and I wanted to talk about it.

For background, I had a friend at work who had to quit her job and move back to her hometown because she could no longer afford rent in the city. She had a steady job at a big research university but it just didn’t pay her rent and so she moved away. I was saddened by both her loss (since she could no longer do the job she loved) and the loss to science, how many other bright minds have been pushed away by low pay and the cost of living crisis?

But it also got me thinking. I’ve talked before about how dividends are supposed to help cure inflation. The housing crisis is caused by a lack of housing supply, and this should mean that housing investors are making bank (much like oil investors). While we think of housing investors as just the individuals who own their own home, the landlords who own most of America’s rental stock are often incorporated and can be invested in. A common investment vehicle for investing in these companies are REITs (real estate investment trusts), which are often publicly traded just like stocks and ETFs. So if landlords are making bank, then REITs should be making bank, so people investing in REITs should also make bank, right? Maaaaaaaybe not.

I did a quick scan of popular REITs and for whatever reason almost all of them seem like strong underperformers. A REIT invests in the real estate market much like an ETF invests in the stock market, and you can grade how well a REIT or ETF is doing by a few metrics, such as alpha, beta, and Sharpe ratio. Note that all REITs and ETFs will be graded relative to a chosen index, $VOO is an ETF that seeks to track the performance of the S&P 500 so it is graded relative to that index. REITs track the performance of the housing market and so will be graded according to a housing market index. Anyway let’s start with alpha, this tells us how much better or worse the fund is doing than it’s chosen index. If $VOO goes up more than the S&P 500, then it has a positive alpha, if it goes down more than the S&P 500 then it has a negative alpha. Beta is a measurement of volatility, $VOO may track the S&P over time, but if it swings wildly up and down (moreso than the S&P) then it will have a higher beta. The Sharpe ratio then is a measurement of reward relative to risk. A higher Sharpe ratio means the ETF or REIT has over-performed on a risk-reward basis, and a lower Sharpe ratio means it has underperformed.

What does this all mean for REITs? They all seem to underperform. The most popular REITs I could find online all had negative alpha (meaning they underperformed their index) and surprisingly low Sharpe ratios of below 0.2 (meaning they weren’t stellar on a risk-reward basis either). Compare that with the most popular ETFs out there, $VOO (mentioned above) has about 0 alpha and a Sharpe ratio of 0.5, meaning it tracks its index almost exactly and is at least OK on a risk/reward basis. $QQQ (another popular ETF, this one tracking the NASDAQ) has a positive alpha (overperforms its index) and a Sharpe ratio of 0.6. Add to this that the stock market has higher expected returns than real estate (meaning you’d expect $VOO and $QQQ to do better than REITs anyway) and it doesn’t look like REITs are a good investment. Past performance does not determine future performance and all that, but the real estate market would have to moon while the stock market tanked for me to expect these REITs to overperform the most popular ETFs.

So it seems that despite skyrocketing housing costs, it’s hard for a retail investor to make money on real estate. I’m not sure who exactly is making money on real estate, if the landlords are making money then it isn’t coming back to the investors, and if the builders/maintainers are making money then it isn’t coming back to their investors either. It seems at this point that the housing market is hurting us all in ways we can’t even make money off of.