Maybe real estate isn't such a good investment

Posted at 12:42 on Wednesday August 24, 2005 | Filed Under Investing

One of my favorite things is reading an article that takes some fundamental assumption we all make, calmly demolishes it with data and statistics, and then handily concludes like Jackie Chan would after beating someone's ass.

Last week, the NYTimes ran such an article.

The housing boom of the last five years has made many homeowners feel like very, very smart investors...
As the value of real estate has skyrocketed, owners have become enamored of the wealth their homes are creating, with many concluding that real estate is now a safer and better investment than stocks. It turns out, though, that the last five years - when homes in some hot markets like Manhattan and Las Vegas have outperformed stocks - has been a highly unusual period.

In fact, by a wide margin over time, stock prices have risen more quickly than home values, even on the East and West Coasts, where home values have appreciated most.

In social psychology, one of the cognitive errors we make is called the availability heuristic--basically, if something is more recent or prominent in your mind, you will weigh it more heavily in your decision-making.

I really like the NYTimes article. It doesn't dumb down the debate by saying that real estate is "good" or "bad," but instead shows how a bunch of factors--inflation, spending on home improvement, the recent housing boom, and the value of having a place to live--affect our impressions of real estate vs. stocks as investments.

I need to look into the data to understand it better, but my gut feel is that this is an excellent analysis because it takes a long-term perspective and discards the stupid emotions that cause us to mistakenly overvalue certain investments ("Everyone is making $200,000 on their home!! We have to buy now!!!").

So do I think real-estate is a bad investment? Of course not. But I want to look into the data so I can answer the question I am getting more and more these days: "What about real estate?"

Read the full article: In the Long Run, Sleep at Home and Invest in the Stock Market

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Comments (6)

1.: The key to real estate has already been mentioned in another of your blog entries... leverage and cash flow production. If you learn these two principles well you'll be hard pressed to find another investment vehicle that compares.

Posted by Freelove at January 11, 2006 09:37 AM

2.: Investing in real estate does not include buying the house that you live in! That is your residence, and you don't gamble with that...

Real estate investing involves a lot more than "buying while the market is hot" and is definately not for amateurs!

Posted by The Donald at February 14, 2006 05:29 PM

3.: Discussing this article with a friend raised a question: Clearly it is better to own stocks than real-estate, but what about using real-estate holdings to generate income (e.g. as rental properties) and investing the proceeds in the stock market? My initial guess is that this hedges against the risk of real-estate depreciating , and allows money to be dripped into investments to take advantage of dollar-cost-averaging, so this may be a fairly reasonable strategy. Any advice or other opinions?

Posted by Wesley at May 10, 2006 08:51 PM

4.: One of the major differences between the two is taxes. Stock gains are taxted at the federal tax rate, while real estate gains (if owned for over a year) are taxed at the capital gains rate which is significantly lower than stock gains. Over the long haul this can tip the scale heavily in real estate's favor.

Posted by stephen at August 22, 2006 05:14 AM

5.: I am the vice president of sales at a mortgage bank so I have a pretty good understanding o the real estate market and exactly how you can make money from it.

What many people seem to overlook is that you can buy a house on margin. You haven't been able to do that with stocks since the great depression.

So basically I can buy a house for $1,000 of my own money using 100% financing. If I do my homework and pick a property in a booming area in the state of california I'll see an average rate of 12% return each year.

But the thing is...I'm seeing 12% return on the VALUE OF THE PROPERTY. So if I put down $1,000 on a $400,000 property and it goes up 12% I'm getting $48,000 in equity based off $1,000 investment.

HOWEVER, there are other factors to consider. Repairs, maintenance, property taxes and a mortgage payment are all a factor. Each of these will take a chunk of my equity, but even after you factor in all of them I'm likely making at least 20k a year in equity.

If this house is my primary residence I am also writing off 100% of the interest I pay each year. You cannot do that with stocks.

So what's the best way to get rich? Own both stocks and real estate. Watch for safe bets with good rates of return in both areas, and you're golden.

Just like too many people jump into the stock market with no education many do the same with real estate. There's money to be made there, but only if you know what you are doing.

Posted by Chris Fox at December 8, 2006 02:57 PM

6.: I don't understand how anyone can say "Clearly it's better to own stocks than real estate", as Wesley says above in Comment #3. On my blog, Money Mindset, I discuss the main reasons people invest in "income properties".

Chris has it more correct in Comment #5, but I don't think stocks offer as many advantages (see my link), other than it is "easy to get in and out of stocks",. But it's also easy to shoot yourself; doesn't always make it a good thing to do.

Let me know what you think.

Posted by Scott at January 19, 2007 04:51 AM

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