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March 19, 2021, 2:15 p.m. EDT

How real estate has performed during the pandemic

The place of real estate in retirees’ portfolios

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By Mark Hulbert, MarketWatch

Getty Images

Residential real estate has performed surprisingly well over the last year, not only during last February-March’s stock market plunge, but subsequently as well.

Is it unusual for this asset class to perform this well? It’s an important question that deserves being asked this month, the one-year anniversary of the pandemic-induced economic lockdown and bear market.

It’s important for another reason as well: Real estate represents one of the biggest chunks of U.S. households’ net worth, if not the biggest. It’s therefore of crucial relevance how residential real estate performs when the stock market plunges.

During the first quarter of last year, during which the S&P 500 /zigman2/quotes/210599714/realtime SPX -0.84%  lost more than 20%, the Case-Shiller U.S. National Home Price Index rose 1.4%. Unlike bonds, which also rose during that bear market but which have struggled ever since, the Case-Shiller Index has continued to rise. Its latest reading is 8.9% higher than where it stood at the end of last year’s first quarter.

The index’s slow-and-steady march higher over the last decade is plotted in the accompanying chart. The S&P 500’s volatility is nearly six times greater than that of the Case-Shiller index (as measured by the standard deviations of their monthly returns). To be sure, part of this greater volatility is due to how the Case-Shiller index is constructed; each month’s reading reflects a three-month moving average of the raw index values. If I were to calculate the S&P 500’s volatility using the same moving-average approach, its volatility would be “only” three times greater than that of the Case-Shiller index.

Even better, from an asset allocation perspective, is that the correlation coefficient between the Case-Shiller index and the S&P 500 is close to zero.

To find out how unusual the last decade’s experience has been, I analyzed the Case-Shiller U.S. National Home Price index as far back as monthly data are available (in the early 1950s). I measured this index’s performance in each U.S. equity bear market since then that appears in the calendar maintained by Ned Davis Research. If we ignore one bear market in which the index fell by a tiny amount (0.4%), it gained in every one of those bear markets—but one.

That one exception was a doozy, however: I’m referring, of course, to the 2007-2009 Great Recession. From its 2006 high to its 2012 low, the Case-Shiller index fell by 27%.

The $64,000 question, given this history, is whether real estate’s performance in the Great Recession is the exception rather than the rule. Robert Shiller, the Yale finance professor and Nobel laureate who is co-creator of this housing price index, believes it is.

In an interview in the wake of the financial crisis, Shiller told me that he thought real estate’s poor performance in the 2007-2009 was an anomalous event, since historically “there is surprisingly little relation” between home prices and the stock market. He therefore did not expect that “in the next bear stock market there [will] be anything unusual happening in the housing market.”

His prediction was certainly true in last year’s bear market. A recent email to Shiller to get his current thoughts was not immediately answered.

History therefore suggests that residential real estate will be a good hedge during the next equity bear market. Chances are that you nevertheless aren’t putting this lesson into practice in your retirement portfolio, however. That’s because we tend to pay inordinate attention to the recent past, a tendency known as “recency bias.” And this tendency is especially strong when that recent past is as traumatic as the 2007-2009 downturn.

Unless you believe that the world has changed in a fundamental way making the 2007-2009 experience the rule rather than the exception, however, you shouldn’t be underweighting real estate in your retirement portfolio.

If you decide to increase your allocation to real estate, your next challenge is figuring out how to do so. In most cases, of course, our real-estate investments are in our residence or other individual house, and their performance will be a function of a host of idiosyncratic factors in addition to a national price average like the Case-Shiller index.

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Dec. 3, 2021 5:35p
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