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Strategies & Market Trends : The Residential Real Estate Crash Index
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To: GraceZ who wrote (3770)7/31/2002 4:29:27 PM
From: Elroy JetsonRead Replies (1) of 306849
 
When comparing the returns on different type of assets, the factor that needs to be controlled is RISK. When the level of risk is adjusted, all asset classes should provide the same long term return.

If you buy a security whether a REIT or a stock, the company behind this security may use no leverage, excessive leverage, or something in between. A typical real estate purchase employs debt 4x the amount of capital. A bank, by contrast, employs leverage 19x their capital. Would this suggest that banks are more than 4x riskier than real estate? As we all know, as leverage increases so does risk. But risk comes from other sources as well.

Many macroeconomic studies have shown that the risk free return in the US economy is the interest rate on long term treasury bonds. Higher returns can be achieved by taking on more risk.

Twenty years ago I reviewed investments for Chevron in many non-oil industries. Whether real estate development, mining, geothermal, agriculture - the amazing thing is how consistent the returns were from industry to industry. Different levels of leverage were applied based on the standard in that industry, but the resulting return on capital was the same.

There are some few exceptions. Notably the drug industry which has managed to manipulate the government into creating a very protected monopolies for their business. But an investor in drug stocks will not realize this higher return as the p/e they pay for a share in the company is dramatically higher, thus bringing the return lower. The market is remarkably efficient in providing a neutral return to all businesses.
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