Keynes and Houses
It looks like Keynes was right. Before that comment inspires a chunk of the readership to fire off angry emails about macroeconomic policy, I should say that I am not talking about John Maynard Keynes’s influential ideas about how to stimulate the economy. Rather, I am talking about his role as a trail-blazing investor and the father of modern endowment management.
Between the wars, Keynes was bursar of King’s College, Cambridge, one of the richest in England, and had the freedom to deploy the considerable assets in its portfolio. Until then, Oxbridge endowments had been invested almost entirely in real estate, but Keynes decided it was worthwhile moving into other assets, because property was riskier than it looked. He made this prescient comment:
“One must not allow one’s attitude to securities which have a daily market quotation to be disturbed by this fact or lose one’s sense of proportion. Some Bursars will buy without a tremor unquoted and unmarketable investments in real estate which, if they had a selling quotation for immediate cash available at each Audit, would turn their hair gray. The fact that you do not [know] how much its ready money quotation fluctuates does not, as is commonly supposed, make an investment a safe one.”
Whatever you think about his ideas on macroeconomics, this point is very true. And he was prepared to put his money where his mouth was. This shows up clearly in a new paper called The Rate of Return on Real Estate, by David Chambers of the University of Cambridge’s Judge Business School, Christophe Spaenjers of HEC Paris and Eva Steiner of Penn State University’s Smeal College of Business, which is based on data throughout the 20th century for the endowments of four colleges: New College and Christ Church, Oxford; and Trinity and King’s Colleges, Cambridge. This cast light on the sharp difference between the King’s property portfolio under Keynes, and the real estate holdings of neighboring Trinity. Both owned roughly the same number of properties at the beginning of the last century. It is easy to see in the chart on the left when Keynes took over at King’s. Meanwhile, Trinity doubled down on property, becoming a major landowner, as it is to this day:
Keynes’s adventures in the stock market in the 1930s proved spectacularly successful. In many ways he did for the U.K. what Benjamin Graham was doing in the U.S. But Trinity’s management of its property portfolio was superb, aided in part by luck. For example, in the 1930s it bought farmland that would become the Felixstowe container port, the largest in the U.K., long before container shipping had been invented. Between them, the two colleges showed that there was a case for more modern asset allocation, but also one for a traditional actively managed property portfolio:
But while this is all very interesting, the meat of the report is devoted to details gleaned from a century’s worth of housing returns. All the four endowments owned a lot of homes throughout the period, and kept records of their capital gains, rental income and costs. This gave the academics an unusually “clean” set of data to look at how much money really can be made out of residential real estate.
The issue is important because it tends to conflict with a hugely influential study published in 2017, called The Rate of Return on Everything, by Oscar Jorda, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. This was a mightily ambitious piece of financial archaeology covering 17 countries, and it rendered the startling result that housing performed virtually as well as equities over time, but with much less volatility. The result held true for every country that Jorda and his colleagues examined:
This remarkable outcome suggested the cult of equity that took over in the second half of the 20th century was a big misjudgment; we should have been in housing for the long run instead. The research by Chambers and his team indicate otherwise. This is how their numbers for capital appreciation and total return compared with the Jorda team’s data:
The real returns from housing largely depend on the rents that can be derived from them, and the Oxbridge colleges’ real-world experience suggests that being a landlord is nowhere near as profitable as the earlier study made it appear.
There are plenty of caveats. The Jorda study was based on broad national data. The Oxbridge colleges are all large landlords, but they probably aren't representative of the country as a whole. That said, they had the advantages that go with scale and talented employees. They were also actively managing their portfolio for profit, which isn't necessarily true of the housing stock as a whole. So if there were a discrepancy, you would expect the Oxbridgeans to come out on top.
Why are the results different? Chambers suggests first that the Oxbridge “micro-study” involved taking both rents and prices from the same data. The earlier study unavoidably took price and rent information from different sources, rather than identifying the total return from a specific sample of houses. He also argues that it is necessary to control for quality; a four-bedroom semi-detached house built in 1980 will be much higher quality than one built a century earlier. Without adjusting for this, he argues that you can overestimate the returns from older housing. That leads to the critical issue of costs; landlords often discover that their business is much more expensive than they had expected. The costs of holding and renting a portfolio of housing will inevitably be higher than the equivalent costs generated by a portfolio of stocks and bonds, and the endowments’ books capture this.
The bottom line is that housing is restored to the position we might expect, with returns ranking between bonds and equities. Housing is lower risk than equities but, as Keynes surmised, once you look under the hood at volatility and expenses, it’s not the free lunch it may appear.
For now, as in other areas of life, the Keynesians have it. But, as in those other areas of life, I’m guessing there will be a strong intellectual counter-punch before long.
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