Residential real estate in major cities is considered to be particularly profitable. However, the returns over the past 150 years have been lower on average than for properties in smaller cities. This is shown in a study by the team of economist Prof. Dr. Moritz Schularick, member of the Cluster of Excellence ECONtribute: Markets & Public Policy at the University of Bonn. The study is the first of its kind to provide historical comparisons of long-term total returns on residential portfolios, linking house price data and rental yields. It was published in advance as “ECONtribute Discussion Paper”.
The researchers evaluated data on house prices and rents from 27 selected major cities in 15 countries. In the first step, the team calculated the average total return on urban residential properties over the past 150 years, which comprises house price growth and rental income. In addition to existing databases, the researchers used municipal yearbooks, newspaper advertisements, tax and notary records as a baseline. The economists then compared returns in major cities with average returns in the rest of the country. In addition to international metropolises such as London, New York and Tokyo, the team also looked at German cities such as Berlin, Frankfurt and Hamburg.
The result: Residential real estate in the major cities studied generated an average of about one percent less total return annually over the past 150 years compared to the rest of the country. This effect is also evident when looking at shorter periods of time, such as the past 70 or 30 years. “If you had invested in a national portfolio of residential real estate in 1950, it would be worth twice as much today as an equivalent big-city portfolio,” says Moritz Schularick, professor of economics at ECONtribute at the University of Bonn – given one had always reinvested the rental income.
Rental income crucial for high estate returns
The study concludes that the key factor for high returns is rental income, which has remained relatively constant. “House prices did rise more at times, but they also fluctuated more,” Schularick says. Overall, rental income accounted for almost 70 percent of the total return on residential real estate over the past 150 years. In relation to the purchase price, rents are higher on average outside the metropolitan areas.
Risk premium on rural residential real estate
The researchers also explain the fact that residential real estate outside the major cities yields higher returns in the long term with the increased risk that investors take in smaller towns. Real estate in major cities is more liquid, meaning that it has a greater likelihood of being sold at any given time. Meanwhile, in smaller towns, it can be more difficult to sell property quickly.
The study dispels the prejudice that real estate investment is most attractive in major cities. “Even large investors are shifting towards investing in rental properties in smaller cities,” said Leibniz Prize winner Schularick.
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Prof. Dr. Moritz Schularick
ECONtribute, Universität Bonn
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