Maybe real estate isn’t such a good investment

13 Comments

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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13 Comments

 
  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.

  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!

  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?

  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.

  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.

  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.

  7. I also agree that you can’t make the generalization “clearly it’s better to own stocks than real estate.” It really depends on the person and depends on their goals. For most people that are willing to put in some time, owning both is probably the best decision.

    For the “buy it and hold forever” type of investor (like me) in real estate, there really isn’t a good or bad time to buy. There are only good and bad properties to buy. Figure it this way: if you buy today with as little as you can, and still breakeven on a fixed loan after expenses, then you’re doing ok. Don’t consider appreciation as a buying factor, because you’re not buying to sell or 1031 it.

    So, if you buy a house for $100k with $10k down (about the most financing a newbie will get is 90% on an investment prop.), and you are breaking even at the end of the year after taxes, expenses, etc. from rent – then it’s a good deal.

    When you look long term and don’t consider selling, you are buying yourself an income stream… better yet, someone is buying it for you monthly. I’m a real estate broker and know that this is not the only or “right” way to do it… but it certainly is one way to do it.. andit’s better than doing nothing!

    Rent will go up over time (and taxes, expenses marginally in comparison)… so your month to month picture will look better. Also, when your 20 fixed or 30 fixed is done, your income stream will become much more significant. And anytime before that, if you find the right apartment complexes to invest in, you have the option to 1031 it.

    Simple stuff like real estate, e-bonds, i-bonds, etc…. at least consider it!

  8. Great post ramit.

    If you haven’t seen these they are pretty good and provided some more nuance to the housing market and to what is going on in SF.

    1. Is from SF Chronicle and does a really good job showing the nuance of the stats and why the high value locations aren’t weak compared to the surrounding areas and how those outer SF regions areas skew the data because they significantly overweight the metrics that are based on single family homes. The closer you get to the heart of the city (the less single family homes).

    http://www.sfgate.com/flat/archive/2008/01/04/g/a/2008/01/04/carollloyd.html

    2. The second one does a great job turning purchase price and rents into the equivalent of the P/E ratio – Price / Rents Ratio. Showing that while prices in SF are slated to fall in the next 5 years 25% – Rents will increase 15% making the true adjustment ~ 10%. Anyhow more importantly it gives historic P/R values. i.e. in SF the P/R ratio is something like 25. So if you rent a place for $4k/month ($48,000 / year). The value of the home should be 48000*25=$1,250,000

    http://money.cnn.com/2007/11/06/real_estate/home_prices.fortune/index.htm?postversion=2007110711

  9. Yo Stephen, stock market gains are taxed at the capital gains rate as well as long as you hold them for some minimum amount of time (I believe it’s one year, although I could be mistaken).

    Also, interest payments being tax deductible shouldn’t be considered a feather in real estate’s cap. You are still paying interest. You just don’t have to pay taxes on the money you pay for interest. WIth stocks, you pay 0 interest.

    And that leads me to the crux of my argument…mainly that I am highly skeptical of an investment that requires me to pay more than the entire principal of the investment in interest charges. i.e. interest on a 15 year loan adds up to more than the principal. And on a 30 year loan it’s even worse. I don’t understand how you can pay some guy $200,000 in interest over the life of the mortgage for a property that sells for $150,000 and call it a good investment.

    Add in maintenance costs, taxes, closing fees, and the hassle of finding well-behaved tenants, and I just don’t see how real estate can be the premier investment vehicle that many would have you believe.

    It takes 15 minutes to open an IRA and pop some money in a total market index fund. Is all that extra time & money worth it?

  10. What makes something a “good” investment depends on your current goals — life goals as well as financial goals. It is possible to lose a great deal of money in real estate — and take on a lot of work, legal liability, and hassle. And, there’s timing — At a particular time in life, it might make more sense to, say, invest in a business venture rather than in real estate.

  11. Great topic! This is a difficult question — one I used to get all the time as a real estate reporter: Is now a good time to buy? If you look at the data patterns for home values you quickly see that the market moves in cycles, rotating from buyers to sellers markets every 10 years or so. But even this is just a general look. I think the most important things to keep in mind when considering a real estate purchase are your local market (local as in.. your neighborhood, similar homes, and the job market, not just your overall city or county data), and your specific individual situation. It might be a great investment for one person but not the next, depending on your lifestyle, career path and where you see yourself in 5 years. There are benefits to owning: building equity, tax breaks, sense of accomplishment and financial security. But there are downsides too. It’s much more expensive than renting in some markets, and you could build your future wealth more effectively with other investments.

  12. Ramit, although I’m not surprised that a NY Times reporter is so uneducated as to try and compare stocks and real estate as alternate investments without discussing margin, I’m shocked that you purport to be able to teach me how to be rich, and you did not point out his obvious error. Because of the ability to purchase real estate with only a small percentage of the purchase price, simply comparing the rate of growth in stocks to the rate of growth of real estate is highly misleading.

    Of course, any discussion of leverage in investing requires some discussion of risk also, so a serious treatment of this subject must be more involved than just a paragraph or two.

    “The Donald” comments that “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.” However, he misses the point made by NY Times reporter, that rising real estate prices create wealth for homeowners, whether they intended it as an investment or not.

    Ramit, I’m sorry to say that your comment that the NY Times article takes a fundamental assumption we all make (“real estate is a good investment”) and “calmly demolishes it with data and statistics” reveals to me that you are indeed a financial lightweight and that although I might glean some occasional nuggets from your blog, I’d better be extremely careful about following your advice. I no longer believe you will teach me to be rich.

  13. All my life I heard about how real estate was a rock solid investment so I finally bought with cash in 2006. I have now lost $150,000.00 in just under 3 years and it continues to sink. It may take 20 years to recoup the money if I do at all. So much for common wisdom.