Investment Performance: Common Stocks Versus Apartment Houses*

Abstract

SURPRISINGLY LITTLE IS KNOWN about the comparative realized yields of rental property and common stocks, although they are by far the most popular forms of equity investment. In seeking to evaluate their ex post results over a common time period, previous studies have been beset by two formidable obstacles: dearth of data, and lack of a good yardstick to measure rate of return. Now, with theorists and practitioners generally agreed on the "discounted cash flow" method as the correct tool for measuring investment performance, the latter problem is partially solved.In this article, covering the period 1952-1962, the discounted cash flow method is used to compare the investment experience of 20 FHA-financed (Section 608) residential projects with that of 76 randomly chosen industrial stocks.The five sections of this paper include, in order: a brief review of the discounted cash flow method; an examination of the investment performance of the 20 rental properties; the findings for stock investments; a comparison of the two investment forms and explanations for their yield differentials; and finally, the conclusions and implications of the study. I. THE DISCOUNTED CASH FLOW METHODAs background for the empirical findings presented below, it may be advisable to present a brief review of the discounted cash flow method itself, as well as the theory behind it. A form of the present value formula, the discounted cash flow method calculates the rate of return on an investment project by finding that rate of compound discount which equates the net cash inflow stream attributable to a project to its initial cash outlays. This method is based upon the traditional economic concept that the economic worth of any capital good equals the present value of its expected income stream.Since the object of this study is to find ex post rates of returns on stocks and real estate, problems of risk and forecasting do not exist. The laborious task of computation is delegated to the computer.The general formula used in this study follows: n C=Z t T-ot

Diversification in the Real Estate Portfolio

“…The quality of the data has severely limited the study of the characteristics of real estate returns. Even when relatively good data are available, these assets are traded so infrequently that researchers are either forced to ignore price appreciation or make unpalatable assumptions about the rate of increase in appreciation (Friedman, 1970, Wendt and Wong, 1965). Recently, a large commingled real estate fund (over 300 properties) provided the authors individual property information on quarterly cash flows and market values.…”

Superior Real Estate Investment Performance: Enigma or Illusion? A Critical Review of the Literature

“…The combined impact of taxes and leverage do not adequately account for superior real estate returns. Wendt and Wong (1965) find that the return on apartments relative to common stock is almost identical when cash flows are adjusted for taxes and financing.…”

“…The Wendt and Wong (1965) study is representative of research using the internal rate of return criterion to evaluate one type of real estate relative to common stock. This criterion is not adjusted for risk.…”

“…The studies of Coyne, Goulet, and Piconni (1980), Kaplan (1985), and Robichek, Cohn, and Pringle (1972), in contrast to Wendt and Wong (1965), use risk-adjusted holding period returns rather than the internal rate of return .2 Like Wendt and Wong however, these studies examine one property type relative to one or more alternative investments. Coyne, Goulet, and Picconi (1980) demonstrate that residential real estate exhibits higher risk-adjusted returns relative to stocks and bonds.…”

“…Webb and Sirmans (1980) also find that leverage partly accounts for higher rates of return to different property types. In contrast to Ricks (1969) and Wendt and Wong (1965) however, risk is explicitly considered with cap rates used in lieu of IRR as the measure of return. Higher risk-adjusted real estate returns are found to exist regardless of the leverage effect.…”