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My friend was about to buy a million-dollar house with no research

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Note: I’ve created a new category called “Real estate” (see the other categories on the right side of the blog).

One of my friends is 28 and she’s looking to buy a house in San Francisco pretty soon. Now, as you know, I’m not a big fan of real estate for investment reasons, but because I’m not an expert, I’ve been researching it more and more (see my links here). So when she mentioned wanting to buy a house, I asked one question: “Why?”

This is where things fell apart.

Her responses included things like:

“I don’t want to waste money paying rent.” I’m convinced this awful phrase was invented by Realtors BECAUSE IT’S SIMPLY NOT TRUE FOR EVERYONE. YOU ARE NOT WASTING RENT IF YOU LIVE IN AN EXPENSIVE AREA. Here’s a good article with more details.

I asked what she thought about the real-estate market right now, considering many of the ARM resets are still coming. One response: “The market is already bad, so there’s upside potential when I sell? what do you think of that logic? Prices are supposedly lower right now as a result.” I don’t think logic is enough to justify the biggest purchase of your life.

I also pasted a couple of the best articles on real estate: This one (Yahoo Finance) and this one (New York Times).

The result was interesting. She hadn’t seen these, so she asked me what I would do with my money. At this point, I was at a coffee shop and one of them lived near me, so she came over to talk about this in-person. I looked over her finances and realized she had tens of thousands of dollars just sitting around, earning hardly any interest. Even putting it in a Capital One 360 (formerly ING) savings account would have gotten her hundreds of dollars a month (open a Capital One 360 savings account in 10 minutes).

The first thing I did was suggest three books to her on investing (more books I recommend). We talked for a while, and I suggested some things she could do to improve her finances and start earning more. After about 20 minutes of back-and-forth, I asked her what she was going to do for her next steps. “I’m going to be honest,” she said. “I’m not going to read those books.”

I thought this was really fascinating. Here’s someone who has tens of thousands of dollars earning 0.5% interest and she’s so resistant to the idea of reading investment books that she almost bought a million-dollar house instead. Five years ago, she had a significant amount of money. What if she had invested it in the stock market?

And five years from now, wouldn’t she be happy that she spent 5-10 hours reading a few books to get her finances in order?

Why young people still think of real-estate as an investment
One of the best things to happen from the real-estate bust that we’re undergoing is to make people think twice about real estate as an investment. That’s right — to actually consciously think about why they’re making the biggest purchase of their lives, rather than just buying a house because “it’s the next thing to do.”

And yet, I’m still stunned when I hear about my friends “investing” in real estate, especially in the Bay Area. (Yes, real estate can be profitable and great, but in some areas of the country there are far better investments).

I thought about it over the weekend, and I think there are a few reasons why real estate still seems to appealing to my friends:

1. They have some money lying around and know they should be doing something
2. They don’t know anything about investing, and the barriers to knowledge seem high
3. Real estate represents something tangible — and something their parents probably keep reminding them about
4. Society still explicitly and implicitly rewards homeowners (just think about a young friend who owns a home — are others impressed?)
5. THEY HAVE BEEN IGNORING EVERYTHING IN THE NEWS EVERY DAY FOR THE LAST 1 YEAR ABOUT REAL ESTATE (???)
6. It’s easier to do new things than to look back at old things, like reading books or handpicked articles about real-estate (Seriously, how many people will click and read through those links?)

Research for gargantuan purchases = good
Here’s the point: Buying a house is the biggest purchase you’ll ever make. When you do it, you need to understand exactly why. That means an extensive amount of research. When I bought a car, for example, I spent months learning about every trick under the sun. I had 17 dealers negotiating with each other to get my business. And that was to save a few thousand dollars! Now, I’m Indian and I’m weird, but I did that for buying a car. When I buy a house, I expect to enlist the help of several third-world researchers for months of research and, when I walk into the final negotiation, I will be accompanied by a large hairy man, a metal baton, and a chimp. IT’S THE BIGGEST PURCHASE OF YOUR LIFE. WHY WOULDN’T YOU SPEND TIME UNDERSTANDING THE PROS AND CONS OF IT?

You know, on one hand, much of this site is about getting started and not spending too much time doing endless research. But there’s a balance, as I describe in my article on conscious spending — you need to know the basics, and you need to know much more for real estate, which you can’t just sell the next day if you decide you don’t like it. When I pointed out sites like Patrick.net to my friend, she had never heard of them.

As usual, there are lots of ads and media influences to buy, but ultimately we make the decision on how much to research our real-estate purchases. I’m not saying it’s a bad decision — although my real-estate colors are clearly showing — but when I read a real-estate blog like SocketSite, I realize I’m not nearly as knowledgeable about real estate as others.

The 3-Book Solution
For many, what seems like an intimidating amount of research can be broken down by buying 3 books and reading them. Instead of coming in with a blank slate, you go to Amazon, find the highest-rated books in your area, and read them in a couple of weeks. I’ve done this with books on marketing, venture capital, and psychology. I keep a notepad and write down my questions. After 3 books, you’ll have very targeted and specific questions to ask someone. (Instead of “what should I do???” you might say, “Should I choose a Roth IRA or Roth 401(k)?”)

In July, I wrote about how asking targeted questions can get you targeted answers. To get the right answers about investing, pick up a few books — whether these ones or other ones — and get started by asking the right questions. Here are the three best books to get started investing.

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97 Comments

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  1. A possible limitation of this approach is that you have to be aware of MLS rules about advertising other peoples’ listings if you use this formula, so you may want to talk it over with your broker first. On the other hand, most listing agents would undoubtedly give you permission if you call them.

  2. Hey Ramit
    First, The area I live in (Waterloo, Ontario Canada) has housing prices that are about, say 25% of prices in the San Fran area, and I understand what you’re saying about really expensive housing.

    I agree that people should research before they do any sort of investing, or a large purchase. As Buffet has said, education mitigates risk significantly.

    Personally, I strongly favour real estate over stocks or mutual funds as an investment vehicle. Here in my area I can invest in a condo for $130K that has steadily appreciated year after year, and rents at a rate that covers my cost. Doing this I can easily turn a 100K initial equity investment into 650K in 10 years – an opportunity the stock market hasn’t yet afforded me (and I can show you how I do it if you are curious).

    Also, this is an investment that I can live in if I have to, and in fact my first investment was a condo that I lived in.

    I used to be a big proponent of the stock market, back when I worked at a large national investment brokerage. History has shown me that it’s just not as powerful a tool for wealth creation for most people as rel estate can be.

    Ben

    (PS – I’m a real estate investment broker)

  3. Hi Ramit,

    What do you think about buying a place with the specific purpose of renting? I am in New Orleans, where a large amount of properties are doubles. I am currently renting 1/2 of one in a more expensive neighborhood (my rent and water is $900/month), and have been thinking of buying one down the street from me — my thought is to live on one side, and then rent out the other. I would love to hear your opinion on this — my money smarts are non-existent.

  4. Hey Ramit,
    I also think another reason why people are into real estate is probably Kiyosaki’s influence. His get rich books are very real estate focused so I would assume he had some sort of influence.

    Also, real estate is a very traditional thinking. Most of our parents probably groomed us that way. A lot of the older generation people I talked to had the same thoughts such as, “renting is a waste of money,” “home is the best ‘investment’ you can make because of equity and tax deductions,” and so on. So those types of thinking is part of our society.

    Maybe it’s because back in the old days a home was a decent investment. And that’s what people believed ever since. Who knows.

    • JC, did you ever consider those old people know from seeing and doing what you don’t understand? Instead of a lengthy post of explaining all the misconception by people that don’t own, I’ll just say everyone buys a house, it’s just a matter of who they are buying for.

  5. Hi Ramit,

    There are three reasons why real estate might also be a good investment:

    1. It allows you to leverage yourself in a way very few other assets can. Thus even a small gain relative to stocks is multiplied by the leverage of your mortgage.
    2. It has attractive tax benefits.
    3. Many people feel more secure and happier in their own home given that they cannot be forced to move and can alter it as they please.

    Note: I don’t think these imply that it is a good investment. I am grappling with this problem now myself with the prospect of buying my first home in the Bay Area. What I would emphasize is that you take your liquidity requirements into account. As an actuarial student it was emphasized that one needs to take one’s liquidity needs (defined by your liabilities) into account. Moral: don’t buy now if you even think you are going to have to move in less than 3 years. You could realize a loss that will be multiplied by your mortgage.

  6. Great post! In spite of all the news, I’m actually thinking about getting a house in the next year and will probably be considering sub-prime mortgages – I have a good credit but haven’t had time to save up a 20% down payment. I’ve run a few scenarios in excel and the cashflow doesn’t look like a problem – just the down payment. The biggest reason I’m considering it is that my rent is going up very fast, and will probably be more than a mortgage on a small house in a nice area. Between payments lower than my rent (and with a fixed value while my earnings go up) and a few extra principal payments here and there I think there’s a good chance it would be the better value despite the fact that I seem to be in the risky category of borrowers. House prices here also went up quite a bit last year so there’s a risk of short-term depreciation but with a fixed mortgage I wouldn’t be worrying about remortgaging to stay in the house.

    It looks like this is a solid decision for me (although it may not give me the absolute best return numerically), but it’s always hard to be sure with something like this… what do you recommend for researching your first house purchase?

    Apart from that I fully agree on the investment value of houses. Too many people are generalizing a few cases into the whole market and thinking there’s easy money. If making half a million dollars was as easy as living in the same place for 10 years you’d think there would be a lot more rich people.

  7. Ramit,
    The major point that you are missing about Real Estate is that it is not likethe stock market. Real Estate is very regionally oriented. Thus, the broad strokes that the news paints may apply in San Fran, Miami, etc. but may not apply in Minot, North Dakota!
    In addition, Real estate has more power to compound wealth due to the simple fact that it offers leverage to the average person.
    Sure, many stock investors may have the opportunity to go on margin or become a Prop trader to increase thier leverage for investment. However, the average person has no access to large amounts of leverage (even 100% financing) except for Real Estate.
    Yes, highly leveraged mortgages are what got us into trouble – but they also made a lot of people a lot of money. This is wealth that these people could not have compouned without the assistance of financial leverage (ie mortgages).
    Feel free to e-mail me if you would like to discuss these points further. I would be glad to be of assistance to you.
    Regards,
    Tyler

  8. Here’s a different way to look at it. I purchased a house for my family moving from an apartment. Our expenses are a lot higher now (if you include the basement, our new place is near 3.5 times the size of the apt).

    Over the past two days I’ve been in my back yard shoveling all the snow from the grass in to a 7 foot sloping pile right beside my deck. It probably took me around 6 hours work total. Last night, my family (kids 6 and 3) spent the evening sliding from the deck, in to my back yard. Not the safest thing on the planet, but darn fun. My 6 year old commented that the apartment was always inside and boring, and now we have a house we have way more fun. Who cares about money when you hear things like that?

    Heres the catch though, we live in an area where we got a great home for a small family (4 person) for under 2 times our annual family income. You can walk to a grocery store, a library, and the schools all the way up to grade 8. We would be renting if we had to pay 4-5 times our annual income for something as nice as what we have.

  9. I came across your blog through blog hopping and loved your book recommendations. I am putting in an order in to Amazon as soon as my salary comes out. I’ve just started thinking about saving money seriously and haven’t got the first clue when it comes to investing.

  10. I *REALLY* don’t like Suze Orman, but I do think her book is a good starting point.. although she does grate on my nerves.

    For me, the book that changed my life was The Millionaire Next Door. The path to life, is smart spending (frugality), and smart investing (not buying into the hype)… so I hope she takes some kernel of your advice and puts it in an interest account earning 4% a month.. at the very least.

    I’ve since come around from the idea of buying a house too. I’m saving up for one just in case, but I’m happy renting (or not really renting) instead. I think I’d buy a house if I had a family. Then it might have some value to me.

    • Suze and Dave are OK to help people that are a total train wreck fix the obvious, but aren’t really strong advising people beyond that. If you are staying in the same place, why not lock into low fixed rates that won’t go up as rents will and continue to go up. The next great depression will be this generation not only saving enough for retirement like previous generations, but also worrying about how to quit their job and still pay the rent

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