There hasn't been much discussion of taxes, which is surprising to me. The authors themselves note:
Next, when calculating equity and housing returns, we do not account for taxes. From an
investor’s perspective accounting for taxes is clearly important. Equity capital gains and, for some
countries and periods, dividend income, are typically subject to a capital gains tax. When dividends
are not taxed as capital gains, they are typically taxed as income. In some countries, housing
capital gains are subject to capital gains taxes, but particularly owner-occupied houses have been
granted exemptions in many cases. Additionally, housing tends to be subject to further asset-specific
levies in the form of property taxes, documented extensively in Appendix K. For both equities
and housing, the level and applicability of taxes has varied over time. For housing, this variation
in treatment also extends to the assessment rules, valuations, and tax band specifications. As a
ballpark estimate, the impact of property taxes would lower the real estate returns by less than
one percentage point per year relative to equity (see Appendix K for further detail). The various
exemptions for homeowners make the impact of capital gains taxes on real estate returns even
harder to quantify but also imply that differential tax treatment is unlikely to play an important role
in explaining the return differentials between equities and housing. Since quantifying the time- and
country-varying effect of taxes on returns with precision is beyond the scope of this study, we focus
on pre-tax returns throughout the paper.
They bury country-specific taxation in Appendix K as beyond the scope of their work, especially as due to compounding issues with changes-in-legislation. However I think it's premature to make conclusions from this data, with that caveat. Consider: if one is pricing real estate for after-tax returns surely there should be some pre-tax premium demanded over assets with the same risk profile for the extra tax hit (at least, for some investors, so to the extent these investors marginally make decisions -- if that makes sense), reducing post-tax returns.
Consider current U.S. taxes (currently -- obviously this varied over time):
- On traditional stock investments: (1) income tax rate on non-qualified portion (with care this can be 0%) of dividends (2) qualified dividend rate, max of 23.8% (for most individual investors 15%) on most income (2) long-term capital gains rate on capital appreciation.
- On real estate: (1) ordinary income tax rate on all rental income (2) long-term capital gains rate on appreciation.
Looking at this ex ante I would definitely expect higher pre-tax returns for real estate than for stocks. This is especially true because I expect the wealthier individuals disproportionately own real estate as investments versus a higher proportion of lower-income people who may rent (and may have tax-sheltered investments, possibly through a pension). I also note that the capital gain portion of total return was slightly higher for equity (52%) as compared to housing (45%).
The authors are quite right that for homeowners there are various exemptions carved out, but they're not everyone. It's also true that property tax rates may affect housing returns by less than a percentage point, but what about the differential tax treatment of income? The geometric rental income return was 6.41%. At present rates that is 2.53% of return lost to tax.
Hard to determine exactly what the net effect on pre-tax CAGR this should amount to, but I am suspicious of making the easy conclusion from the top-line results of this data.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."