This article by James Dunn in The Australian today is worth a read. I am quoted as follows:
"Christopher Joye, chief executive of real estate research and advisory firm Rismark, says his firm's figures show residential real estate has generated total net return of about 10.8 per cent a year over the period June 1982 to December 2009, with a volatility of 3 to 4 per cent a year. But he says the biggest mistake property investors make is extrapolating index volatility to their own home.
"If you own a home, you have one large asset in one specific location, with very high 'idiosyncratic risk'. We estimate that the volatility of a single family home is between 15 and 25 per cent a year. This is akin to the risk of holding a single security listed on the ASX, relative to the much lower volatility of the well-diversified All Ordinaries index."
A house price index is not a volatile index, says Joye, because it captures thousands of house sales a month. "It's simple portfolio theory: the larger the sample size, the better the diversification, the lower the risk. A house price index is a proxy for literally millions of homes worth billions or trillions of dollars. An index is, therefore, an incredibly well diversified portfolio. In contrast, an individual home owner is making an economic commitment to one highly idiosyncratic asset. This is, by definition, a poorly diversified investment with a much larger prospect of loss."
He gives the example of the All Capital Cities House Price Index, compared with a family home in Leichhardt. "The index captures 30,000 home sales a month. The home in Leichhardt is an individual property with unique characteristics: what direction does it face, how old is it, what is the build quality, how many bedrooms and bathrooms does it have, what is the size of the block, does it have a garage, what is the street like, what is the local economy like, what is the zoning risk? It's exactly the same as comparing the volatility of Fortescue, or a microcap, with the volatility of the All Ordinaries index. You can't extrapolate the characteristics of the index to each of its components."
If the residential property investment is considered as a national portfolio of established residential real estate, Joye says the investment gives you a low-risk, strong long-term performer that gives significant diversification benefits, through low correlation to the other main asset classes -- in fact, negative correlation to the sharemarket. Statistically, this means residential real estate rises when the sharemarket is falling.
For these reasons, portfolio investment in residential real estate makes sense for superannuation funds, he says, because residential real estate is Australia's "largest investable asset class", worth more than $3.4 trillion -- or 2.5 times the value of the stocks listed on the ASX. But he says the super funds need to have access to the required investment vehicles.
Retail investors who own homes also need the ability to diversify their highly localised residential real estate exposures through a broader portfolio holding, says Joye. "I think this is the next step after we come to grips with the very high idiosyncratic risk and volatility of a single property.
"We're working with the ASX to list a security that covers an index of Sydney housing, which will give investors exposure to the performance of residential real estate but, more importantly, will give them the low volatility of the index.
"Whether people want to hedge their own exposure, or start their kids investing in an index that will keep up with property prices, it would work the same, " he says. Joye says this listed product should arrive on the ASX next year."
