Do durable assets make sense as investments?

Gold Roman Aureus. Source: Wikipedia

Some things have been around a long time: silver and gold were currencies and a store of value for millennia; fine jewelry has always been a sign of status; and housing and land are always in demand—everyone has to live and world somewhere.

But do they make sense in an investment portfolio? A little perspective is important. People get very emotional about real investments. We’re naturally attached to our homes. And how folks feel about precious metals is often related to how they feel about government. After all, most governments abandoned the gold standard for money in the ‘70s. I remember reading a World Book article about the international gold repository in New York back then, and how global debts were adjusted by moving a cart-load of bullion from one subterranean vault to another.

But precious metals and real estate have a different function now. Are they good investments? Their long-term returns are interesting. The Dutch have always been meticulous record-keepers, especially about financial matters. By indexing and recording series of real-estate transactions along the Herengracht, or “Gentleman’s Canal,” a couple of Dutch researchers documented four centuries of real-estate returns in a truly world-class city. The Herengracht has always been prime real estate—where the power brokers first chose to live, then locate their businesses.

View of the Herengracht. Gerrit Adriaenszoon Berckheyde. Source: Riiksmuseum

Their study shows that while real estate does hold its inflation-adjusted value over time, it isn’t much of a source of return. That is, when stocks were soaring, land was just doing a little better than holding its own. And there were times—like the late 18th century—when land values dropped dramatically. In Amsterdam, that might have had something to do with the Napoleonic Wars and the fate of the Dutch East India Company.

Central Amsterdam land values, 1628-1974. Source: Eichholz and Geltner, 2002

Please note that this index only covers transactions, not income. The income from real estate is an important—perhaps the most important part—of its value as an investment. Rents and leases cover what can be considered the economic value of land, and we don’t have all those records. But it’s reasonable to assume that lease payments kept up with the cost of living, if only because they are part of the cost of living.

By contrast, the transactional value of any property follows the fortunes of its underlying geography. So, New York and London values soared in the late 20th and early 21st centuries as the financial economy blossomed. Silicon Valley, Berlin, and Mumbai seem to be central to the emerging tech economy. And what’s happening to real estate there?

When it comes to long-term returns on real estate, there are two simple rules. The first is well known: location, location, location. The other factor is equally relevant: volatility happens. Unpredictable events happen unpredictably.

Douglas R. Tengdin, CFA