Isn't Real Estate Really A Lousy Investment?

Discussion in 'Financial Planning' started by Amy McCall, Jul 17, 2004.

  1. Amy McCall

    Amy McCall Guest

    Hi--Everyone is crowing about how their houses are such great
    investments because they've appreciated in value the past several
    years, but they never talk about the interest they're paying over the
    years. When you buy a stock or bond, you're not paying interest, so
    how can real estate be such a great investment, unless you're paying
    Amy McCall, Jul 17, 2004
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  2. How do you plan to handle the repair/upkeep etc. on the great
    investment? You know - those pesky plumbers, roofers, electricians,
    yard people, pest control, painters (they just left my house with a
    nice check), carpenters, cleaners, heater/AC people, etc.

    -HW "Skip" Weldon
    Columbia, SC
    HW \Skip\ Weldon, Jul 17, 2004
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  3. There are two parts to owning a home. First is shelter. Everyone
    needs to have it. The second is the investment part. Lets assume
    someone has a $1500 house payment. They are the typical family of
    2.3 kids and dog and a cat. Lets assume it would cost $1100 for
    them to rent a place to live. That means tht of the $1500 per
    month that they spend on the house, $1100 goes to shelter, and
    $400 goes to the investment. Over 30 years, this $400 per month
    buys them a $200,000 home that might be worth $500,000 at the
    end of 30 years. That is actually a pretty good investment.

    If you don't need the shelter part of real estate, and you have
    to earn a reasonable rate of return, then it gets much more
    challenging to find properties that make sense. But they are
    out there.

    John A. Weeks III, Jul 17, 2004
  4. Lets assume
    Gosh, John, this is WAY more house than anyone actually needs. Why do you
    want to spend so much on housing? The cost to upkeep such a house is
    expensive. That's just a heck of a lot of interest to send to the bank. Why
    wouldn't you want to keep it for yourself?

    Elizabeth Richardson
    whose message is more tongue-in-cheek because John thinks you shouldn't
    spend money on cars. This is a perfect example of spending your money on
    what you like and can afford.
    Elizabeth Richardson, Jul 17, 2004
  5. Well, actually in a true investment (and I'll get into why I don't
    see a home as that), the debt can improve your return if you get one
    little detail right--that the underlying investment will return more
    than the interest being paid. It's the concept known as
    leverage--by using debt, you get a larger investment than you would
    otherwise. You get the full return on the larger investment, even
    though you only put up a fraction of that amount. Of course, the
    problem is that leverage works in both directions <grin>, so you do
    need to be right.

    That said, I think a personal residence should be looked at first
    and foremost as more of a consumption item that just might happen to
    give you a return <grin>. That is, I don't believe in making
    yourself "house poor" with the theory that you buy the absolutely
    most expensive house that someone will lend you the money to buy, on
    the theory that the appreciation will bail you out before the home
    manages to break you.

    But reality is that you *do* have to live somewhere and that need
    will continue as long as you continue <grin>, so buying is a way to
    control the expense of housing over the long term. From that
    perspective I think it's a very good move generally to buy a
    reasonable house that replaces a comparable property you'd rent
    anyway. While you increase short term risk (the pipe bursts, it's
    your problem <grin>), you remove long term exposure to increases in
    the cost of housing if you have a fixed rate mortgage on a property
    you'd like to live in for a long period of time. Rents can and do
    go up--but you aren't exposed to that, just to the ancillary costs
    that, over time, will be reflected in rent prices as well.

    That said, it's important to remember that real estate comes with
    high transaction costs both getting in and getting out. As such, I
    think you need to be sure and buy something that you aren't going to
    want to replace in the short term. While in many places in recent
    years people have been able to do that buoyed by rapid appreciation,
    that looks to me like a quirk similar to what happened to tech
    stocks--I wouldn't bet on it on continuing forever.

    Why I don't see it as an investment is because I find most people
    simply find they purchase a similarly or higher priced property when
    they sell. With the stock you are talking about, when you sell it
    there's no personal taste issue that pushes you to buy a similar
    security--nor do you face the problem of *having* to either "buy or
    rent" a security of some sort to fill the need for shelter.
    Ed Zollars, CPA, Jul 17, 2004
  6. I couldn't agree more with you, Elizabeth. I just picked these
    numbers out of thin air as an example.
    I don't have a problem with people buying exclusive real estate or
    luxury cars if they can afford them. But if you have to get a loan
    to buy a luxury car, or a mortgage to buy a mansion, then you
    obviously cannot afford them, and should resort to using John's
    laws until you can pay cash. If one cannot afford the mythical
    $1500 used above, it doesn't matter how good the investment is.

    John A. Weeks III, Jul 18, 2004
  7. The above paragraphs is pure unadulterated hogwash.

    Large ticket items are invariably financed, even by those who can afford to
    pay cash. Why? They have better uses for their capital.

    I work with mortgage brokers and loan officers on a daily basis, primarily
    making sure the lender is protected from various catastrophic risks. Several
    of my key contacts specialize in mortgages with face amounts in excess of
    seven figures, as do many of the ag/business loan officers I work with. One
    of them hands off all loans for less than eight figures to one of his

    One of my peers works in an affluent neighborhood near the coast. He works
    with banks, just like I do. His experience is similar to mine. The
    $10,000,000 estate without a mortgage or otherwise secured loan is
    relatively rare.

    Plus, there are margin loans, especially for those with significant
    holdings. People who do not have significant holdings aren't aware of the
    various alternative uses of self-financing.

    Several of my clients own car dealerships, including dealers that sell
    pricier makes such as Mercedes Benz, Jaguar, Lexus, BMW, Porsche, Range
    Rover, and Hummer. Their F&I guys make a really good living, because people
    who can afford to pay cash can also afford to keep their cash AND the car,
    by financing it or leasing it. Advertisements in airline in-flight
    magazines, Robb Report, the WSJ with quotes lease rates in the thousand
    dollar per month range aren't targeting Ma and Pa Kettle, and those ads
    aren't cheap. The reason they are run is they work on their target market
    just like the ads for a Ford F-150 with a $269 lease payment work on factory

    The difference between rich people and everone else is the rich have more
    money. Their problems aren't any different from everyone elses, they just
    differ by orders of magnitude. People who aren't rich often succumb to myth
    and urban legend, such as "paying cash" for large ticket items. What this
    proves is that people who subscribe to these myths and urban legends just
    don't move in the affluent social circles.

    Brent D. Gardner, ChFC
    Chartered Financial Consultant

    "Be ever questioning. Ignorance is not bliss. It is oblivion. You don't go
    to heaven if you die dumb. Become better informed. Learn from other's
    mistakes. You could not live long enough to make them all yourself." - Hyman
    George Rickover (1900-86), Admiral, US Navy, advocated development of
    nuclear subs & ships

    The Chartered Life Underwriter (CLU) and Chartered Financial Consultant
    (ChFC), designations owned and exclusively offered by The American College,
    signify the highest standards of academic study and professional excellence
    in the financial services industry.
    Brent D. Gardner, ChFC, Jul 19, 2004
  8. Brent...I think you may have read more into what I wrote than what
    is there. My point is that if you HAVE to get a loan, then you
    cannot afford it. In the examples you gave, the people already
    have the money, and are using loans as a finance tool, not as a
    way to borrow themselves rich. For example, you mention margin
    loans. In order to get a margin loan, you have to have securities
    that you own on deposit with a broker.

    If you have cash as an option, then a loan is OK. But if you cannot
    pay cash, then you have no business buying a luxury item with a loan.

    I suspect that I could have written that more clearly up front. I
    didn't intend to imply that you have to pay cash.

    John A. Weeks III, Jul 19, 2004
  9. Most people cannot afford to pay cash for a new car. If they stopped
    borrowing to buy new ones, the economy in the USA would stagnate in ways you
    cannot possibly fathom. In all but the most urban of environments, a car is
    generally a necessity, not a luxury. The attorney who can afford the $2,236
    per month lease on a SL 600 is no different from the sheet metal journeyman
    who can swing $269 per month for a Ford F-150, they ONLY differ by orders of

    FYI, there are MANY high income business ownrs and professionals who can't
    write a check for $130,000 to buy the Mercedes, but they can make those
    payments, no problem. Why should they drive a F-150 when they can cruise in
    style, IF THEY SO CHOOSE? Because somebody on the internet thinks they
    shouldn't drive a luxury car unless they can pay cash? That's just Dumb,
    with a capital D.

    Economic freedom is probably one of the single most important freedoms we
    have, because without it, the others are all but worthless.
    I disagree, and I work with HI/HNW people on a daily basis. Some of the
    wealthiest people I know are asset rich and cash poor. They finance damn
    near everything, because to pay cash creates tax problems that you would not
    understand. They have plenty of cash flow, but invariably it is earmarked
    for something, including the lease on the SL 600 in the garage and the 15
    year note on the Cobalt 360 moored on Grand Lake.
    What you promote, John, is egalitarianism, and that dog won't hunt in these
    woods. This is The United States of America, and if someone wants to spend
    THEIR money as THEY see fit, SO BE IT. It's none of your business. If you
    had the kind of money they did, you'd laugh when somebody spouted off about
    how one should spend their money.

    If someone wants to buy something, and they do not have enough cash, they
    can do one of three things:

    1. Buy something else.
    2. Save up over time, and buy later.
    3. Buy now, and pay over time.

    The latter two choices benefit the lender, in one way or another. The
    difference between interest earned on short term savings and the interest
    charged on short term loans is the cost of doing business TODAY versus
    waiting until a tomorrow that may never come. If someone wants to pay that
    extra cost to enjoy some luxuries in life today, SO BE IT. They may not live
    to enjoy them tomorrow.

    A frugal lifestyle isn't for everone, thank God. The economy is driven by
    SPENDING. The lifestyle of a pauper sucks. Anyone that wants to disagree, I
    will ask: "Why aren't you living like one, then?" but I've already heard the
    silence or the "hamana-hamana-hamanas" reminescent of Jackie Gleason on the

    The problem virtually ALL amateur arm-chair wannabe planners/advisors suffer
    from is the singular inability to give objective advice without clouding it
    with personal judgements and irrelevant opinions, making whatever advice
    offered worthless. One who has no experience dealing with HI/HNW people has
    no place giving advice in that arena, nor does their undereducated and
    inexperienced opinion carry any weight.

    Brent D. Gardner, ChFC
    Chartered Financial Consultant

    "Be ever questioning. Ignorance is not bliss. It is oblivion. You don't go
    to heaven if you die dumb. Become better informed. Learn from other's
    mistakes. You could not live long enough to make them all yourself." - Hyman
    George Rickover (1900-86), Admiral, US Navy, advocated development of
    nuclear subs & ships

    The Chartered Life Underwriter (CLU) and Chartered Financial Consultant
    (ChFC), designations owned and exclusively offered by The American College,
    signify the highest standards of academic study and professional excellence
    in the financial services industry.
    Brent D. Gardner, ChFC, Jul 19, 2004
  10. [ 89 lines in ]
    I remember your definitions of HNW in an earlier post. Back then, you
    This was completely untrue, and puts some doubts on your ability to give
    general financial advice in this newsgroup. Clearly, you are very
    successful and have lots of HI/HNW clients. Congratulations. On the other
    hand, your clientele might be quite a bit better-off than many wage
    earners. You have once stated that the median net worth of american
    households was $220k -- remember that "UAW/PAW"-discussion? Do you still
    believe the median net worth of households in the US is $220k?

    This thread states interesting questions about how much debt a person can
    and should take on. You are correct that HI/HNW-people are often well
    advised to use leverage to finance their style of living. Indeed, most of
    the times HI/HNW got there in the first place by mortgaging their homes and
    investing in their own business, thereby getting a far better return on
    their investment than most people can dream of. However, this is not for
    everyone, and it also is not a very safe option for those with little or no
    net worth.

    Perhaps you should be a bit more modest in your posts. Unlike what you
    believe, most people do not have a six-figure net worth.
    Joakim Persson, Jul 19, 2004
  11. [ 63 lines in ]
    Very true. However, you're overlooking the point that the affluent are
    usually more risk-tolerant than people with less net worth. Financing large
    investments, and even lesser investments, can be good as long as you have
    better uses for the saved cash flow. A moderately priced lease can be a
    great deal if you can deduct it as an expense in your own business.

    However, the picture becomes a bit more complicated if your expected return
    and risk tolerance is lower. I'm sure you would agree CC debt can destroy
    the household economy of poor households with little or no net worth. There
    is a similar risk when consuming big-ticket items -- poor households can
    easily overstretch themselves and damage their cash flow for a long time.
    This is not to say that it's always best to pay cash, far from it. But
    looking at it from a long-term perspective, consumer and mortage debt are
    rising at paces which are not sustainable. This means that there can
    clearly be trouble ahead for low-income, low-net-worth households
    overextending themselves.
    Joakim Persson, Jul 19, 2004
  12. [a screed full of personal judgements and ad hominems]
    Unlike the pure-as-the-driven snow "objective" advice someone who
    only makes money when he convinces a client to buy whatever he's
    pushing gives, of course...
    Rich Carreiro, Jul 19, 2004
  13. I'll put it this way--I see very few clients who are debt free and
    are in the poor house for doing so. And for many people, debt is a
    narcotic--it solves the problem today and puts off dealing with
    financial reality until sometime "later." It also allows them to
    put up the *appearance* of more financial success than they have
    actually achieved, which helps feed the ego.

    It's one thing to be a risk taker and actually make successful use
    of leverage, but that's not what most people do. Rather, they
    borrow primarily to support their desire to have objects today
    rather than later. That group would likely be very well served by
    the discipline enforced by paying cash for consumption items--even
    "big ticket" ones.

    First, it might cause them to evaluate whether that "more expensive"
    option is really worth the extra cost. Second, when it comes times
    to buy there actually would be assets to "leave in the market" even
    if they decided to borrow based on the leverage concept.
    Ed Zollars, CPA, Jul 19, 2004
  14. Amy McCall

    Tad Borek Guest

    Whether you're talking about real estate, stocks, gold or pork bellies -
    in a booming market all these things look like great investments. And
    they are - by definition.

    But if you're figuring out where to put a dollar (or thousands of them)
    today you need to consider the risks that go along with the investment,
    and what you might see out of it.

    Over the long haul real estate (residential) has been essentially an
    inflation-matching investment. That's begging the question, in a way,
    because the cost of housing is part of what is figured into defining the
    inflation rate. But still, until recently anyway, homes went up at close
    to the basic inflation rate in the US. For a chart showing this, and how
    alarmingly odd the recent market is, check Business Week June 14, 2004,
    page 89.

    In contrast other investments have returned quite a bit more than the
    basic inflation rate - stocks as the obvious example. The US stock
    market returned 7% above the inflation rate, if you're tallying the long
    term returns through 2004. A mix of mutual funds could have gotten you
    close to those kind of returns if left alone. So if that's the criteria
    you're using, then homes haven't been very good "investments". In
    general anyway - of course there are specific properties that have done
    really well, and specific stocks that went to $0.

    Some things complicate this though, leverage being a big one. When you
    put a little money down and borrow the rest, your net returns can be
    really big, as long as the market goes up of course. In 1994 you could
    have put $20,000 down on a $100,000 condo in one of the dicier areas
    here in San Francisco, and it would sell for maybe $600,000 today if
    you're willing to spend $10 on a can of paint to get the tags off the
    front door. Over the 10 years you would have paid maybe $60,000 in
    interest. So ignoring details like taxes, you might say you netted
    $500,000 in gains on an $80,000 investment over ten years, which is
    great. That's enough to retire on in parts of the country where - based
    on other posts - $1500/month buys a insultingly large luxury home. That
    came from leverage - it wasn't a $100k investment, it was a $20k
    investment plus the willingness to pay interest on the $80k in debt. And
    the trick is, the condo price went through the roof, so you ended up way
    ahead of the cost of the mortgage.

    These days there aren't any good $100k (or $400k) condos left in SF but
    people are still thinking in the same terms...putting little down and
    buying that crappy condo for $600k. I know this is a unique market, but
    I've seen it repeated lots of places because of the low interest rates
    and the constant lowering of the bar for home purchase.

    I see a lot of risk in that, and I don't think residential real estate
    is a very good investment at this point, at least not unless you're
    planning on holding onto it a very long time. The leverage that nets you
    $500k on a $20k investment can just as well leave you with $100k in
    losses on a $600k condo with a second to cover the down payment. That's
    not the case with other types of investments. Not many people with $50k
    invested in stocks would borrow another $200k to invest in stocks (even
    if they could) to get the extra returns. But that's basically what the
    home-investor is doing. The ability to borrow for cheap, and for a long
    time (30 years) certainly helps but still, it's borrowed money, and the
    interest clock is ticking on the full purchase price.

    Also: real estate, as an investment, is unique in that it requires
    regular care & feeding. You can buy a mutual fund and stare at it for 15
    years without adding a dime. That doesn't work with real estate; if you
    can't pony up the cash for mortgage & upkeep, it's going on the block.
    That may be OK, but if prices are down you could easily wipe out a lot
    of your net worth.

    Tad Borek, Jul 20, 2004
  15. Amy McCall

    BMS Guest

    Isn't the question the opportunity costs of housing alternatives? Renting or
    owning and the rewards and the missed opportunities of having a long term
    contractual commitment?
    BMS, Jul 20, 2004
  16. Amy McCall

    MissLivvy Guest

    I have the same skepticism as you. Also, when you point out to them all the
    money they are blowing on interest, they inevitably argue "but it's tax
    deductible!". Yeah, it's deductible, but it's not like the deduction erases
    the amount of interest you pay, as some of them seem to think.
    MissLivvy, Jul 21, 2004
  17. Amy McCall


    Actually, some folks _do_ pay interest when they buy
    stocks (much more rarely will they do that with bonds).
    If they buy more stocks than they have the cash for,
    they take out a loan to pay for it. It's called a
    "margin loan" and it's pretty common, though it's
    not always a good idea.

    The question isn't "is it bad if I pay interest in
    order to buy something" but, rather, "am I getting
    my money's worth and/or a better return on whatever
    I bought such that it's worth paying interest for?"

    There's nothing inherently wrong with paying interest,
    especially for things which go up in value (and in
    the case of the house, even if it doesn't go up in
    value quite as fast as the rate of interest you are

    If you were buying a house to rent out rather than to
    live in yourself, you can calculate whether the investment
    was worth it (and the interest you pay on it) fairly
    staightforwardly - add up all the monthly expenses
    associated with the house (including mortgage interest)
    and subtract them from the rent you get - if it's positive
    and big enough to compensate you for the risks and the
    capital tied up in it (and the time and energy it takes
    to manage it), it's likely a good investment.

    If you are buying a house for yourself to live in,
    you might think of the interest as the rent you pay
    on the money you borrowed for the house and compare
    that to the rent you'd otherwise be paying to rent
    a comparable home. If you'd not otherwise be renting
    a comparable home, think twice about buying that house.

    No matter how you slice it, you need a place to live,
    in which case, you either (a) rent the place itself (from
    someone who's done the calculations I talked about
    earlier!) or (b) rent the money to buy the place itself
    or (c) have the cash to buy it up front - in which case
    you are tying up a huge amount of capital and the rent
    you are paying is what's called "opportunity cost" -
    you lose out on the returns you could have generated
    with that capital had you deployed it otherwise (ie. instead
    of tying all your cash up in the house, you might have
    invested in a diversified portfolio of stocks and/or bonds).

    Real estate may or may not be a "great investment", but
    whether it is or is not depends on a lot of things and
    the simple fact that most real estate transactions involve
    leverage (borrowed money) is mostly irrelevant to that.
    , Jul 21, 2004
  18. I agree that's the fundamental issue with your personal
    residence--it's not as if you don't buy one that somehow you
    eliminate the cost of paying for shelter, at least if you aren't
    keen on sleeping on the street <grin>. And, as you note, if you
    wait until you have enough cash to buy the property for cash, you'll
    still have to pay for shelter during that period.

    That said, it is still useful to remember that the interest tax
    deduction doesn't somehow magically cause you to end up with more
    cash in your pocket than interest paid <grin>. As well, there are
    definitely ways to buy that can create a major financial pinch.

    Remember the thread from the poster that had stretched like mad to
    buy a house much bigger than he needed or would reasonably need for
    years by purchasing the house on an adjustable rate interest only
    mortgage. In that case you had someone who was going to be in world
    of hurt under a number of reasonably possible scenarios.

    But had that same individual instead bought a property that didn't
    stretch his cash flow to the limits on a fixed rate mortgage, while
    he might not have been the happiest camper had the value of his
    property dropped under pressure from higher interest rates, so long
    as his income stayed steady (and that didn't seem to be a
    significant risk in that case) he wouldn't face major financial
    problems. And given how far what he bought seemed removed from what
    he could reasonably *use* (forget need <grin>), it seemed likely he
    could have found both such a property and financed without having to
    push the envelope.

    In that case, the worst that happens is that the buyer ends up
    seeing rents drop dramatically and he/she *could* have had shelter
    for much less, but is now "locked in" to the higher payment.
    However, over time values have tended to move up, along with rents,
    so over time he's still likely to come out ahead even if a *short
    term* advantage might have been gained by renting.
    Ed Zollars, CPA, Jul 22, 2004
  19. Amy McCall

    JD Guest

    If you project back to 1999, my math show homes where valued at about 3.9
    times median household income here in the U.S.. Thanks to today's low
    interest rate environement that ratio is currently 4.7. (with little
    difference in montly payments thanks to interest rates) The average ratio
    dating from to 1967 thru April 2004 is 3.8. You may agree that projecting
    forward from a period of low valuations to one of high valuations and
    expecting the trend to continue is a mistake. Maybe property values will go
    sideways for a few years, or maybe some overheated markets may pull back a
    bit. I don't think this is the best time to invest in a "hot" market or buy
    more house than you need. (jmo)

    Here is a post I posted to another group. Most of the info is I think is
    pertinent, the last paragraph has to do with the overall economy:

    -I was curious if it was just me or are home prices trully very high
    priced by historic standards , and the best analogy I could think for a
    historic comparison was median household income, this is what I got:

    It is important to note that not all real eatate markets are high flying as
    others, in fact many are severly lagging while others are going nuts. This
    is an awesome study by the "Office of Federal Housing Enterprise
    Oversight (OFHEO)" if you jump forward to page 16-17 you'll see the top20
    and bottom 20 highest and lowest rates of apreciation, this is followed by
    most metropolitan areas.

    It is interesting to note Page 33 of this harvard study shows "cost as a %
    of income" 1975 - 2003 that thanks to historically low interest rates
    americans are not *currently feeling the effects of today's home prices.

    Now with intersest rates with nowhere to go but up, you have to wonder what
    the effect will be on real estate prices, and what the effects of a falling
    housing market would be. I thought this was a very intreresting study by
    the IMF. They compare falling prices in equities to that of real estate,
    through careful analysis through many countries data. There data shows tthe
    effect of falling real estate does indeed have a larger negative impact on
    an economy than that of equities. The study is called "when Bubbles burst"


    but they never talk about the interest they're paying over the
    JD, Jul 30, 2004
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