Startling Real Estate Advice! (Part 2)

So have we got your attention?  Here's more surprising perspective from banker Brent:

The drawback to home ownership as an investment is that (1) buying a house is expensive, maintaining a house is expensive and selling a house is expensive and (2) even if you sell it at a “profit,” (sic) you still have to find a place to live. And, guess what? While your house was going up in value, so were all the others, including the next one you are going to buy!




Beyond the cost of the home and the requisite downpayment, buying a home with a mortgage carries what the industry refers to as “Closing Costs.” These can range from a few hundred dollars up to as much as 5% of the purchase price (remember, the down payment is not included here). Then you have to maintain the home, an expense that has a bit of sticker shock for most first time buyers. There is insurance, utilities, real estate taxes, upgrades, maintenance—no, you can’t call the landlord anymore to fix the leaky pipes—and, eventually, the replacement of most of the major components of the home.


There’s also interest on your loan. Now, yes, we know it’s deductible. But what does that really mean? For sure, it does not mean you reduce your tax bill by the amount of the interest you pay. It only reduces your taxable income dollar for dollar. But, for a lot of first time homeowners, particularly with families, the rate at which their income is being taxed may be less than 20% (your “marginal” tax rate). At the 15% tax rate (think family of four with income of $70,000), every $1,000 you spend on interest only saves you $150. Same goes for real estate taxes. And you thought you were “wasting” that $1,150 a month you were paying for that 2 bedroom apartment.


But the fun really starts when you go to sell. Unless you are clueless enough to believe you can sell your home yourself without taking a big discount in price, you will engage a realtor, and he/she will charge you 6.0% of your selling price. Not to be outdone, the State will get another 2.0% out of you in transfer taxes, recordings, title insurance, etc. Oh, and did we mention the realtor insisted you REPLACE that old roof of yours ($26,769) or they couldn’t sell your house without a big-time disclosure to the buyer. And, about those old carpets in the living room. . . .


So, forgetting about the cost of maintaining the home (hey, you did a lot of the work yourself!) and even ignoring the cost of the new roof, you paid about 2% getting into the home in closing costs and about 8% selling it. So, you needed to have the actual sales price of your home be 10% higher than what you originally paid for it just to BREAK EVEN. (Here’s a good time to go read Rule # 3 again)


By analogy, compare “investing” in a home and “investing” in a company like, say, Boeing. If I spend $10,000 on Boeing common stock, that’s all I ever have to spend. No maintenance, no insurance, no roof! In fact, in good times, they might even send me a dividend. If Boeing stock goes up 10%, I pay a small commission and keep the rest. If it goes down 10%, I can sell and keep 90% of what I started with. But most importantly, I don’t have to own Boeing stock. When I sell, I can put the money in my pocket. If I had to buy the stock back—like I have to buy a house to live in when I sell the one I was living in—I have gained nothing from an investment standpoint.


Compare that to your house purchase. If you put 10% down to buy a home, and it doesn’t go up in value so that you sell it for what you paid, after your 10% selling costs, you lose your entire investment. And we already described what happens when it goes up 10% in value.


So why aren’t houses GREAT investments? While the great social commentator, Will Rogers, was correct in advising his audience to “buy real estate: they aren’t making any more of it!”, the reality is that a home—except in cases of substantial (read: Expensive) additions and improvements—is a static asset. A three bedroom, 2 bath, 2 car attached garage home will always be a three bedroom, 2 bath, 2 car attached garage home. It will just be older! In fact, without all that maintenance stuff we discussed, it eventually will be a three bedroom, 2 bath, abandoned home, with a 2 car attached garage. By comparison, a company, like Boeing, if successful, is a dynamic asset that grows and changes. It can increase its market share, improve its profit margin, add product lines and generally increase its total value. A home, conversely, incurs a change in value primarily through population growth (more people, no more Earth) and the nominal inflation of the value of the currency.


“But,” cries conventional wisdom, “THERE IS ALWAYS INFLATION!”


Actually, that’s not true nor even close to true. If you study a chart of inflation rates in the US going back to the first condo at Jamestown, you will find that, though periodically broken by short term inflationary periods, and, for that matter, short term deflationary—read DEPRESSION--periods, usually resulting from banking panics in the pre-Federal Reserve days, inflation has been the exception, not the rule. Unfortunately for most of today’s observers, one of the most egregious exceptions to the Rule occurred in the 1970’s during the OPEC crisis. Inflation rose to double digits for half a decade, adjustable rate mortgages reached rates in the 20’s, and wage and price controls were effected by none other than your United States, we of the free market system, of America. This was an event that tainted the perspective of many considered to be financial “experts” today.


The crisis also led to the deregulation of oil prices, airlines and the banking system (interest rates on savings accounts used to be regulated by the government). The effect of these deregulations was to begin the wringing out of the inflationary structure that had been created in the US by years of war, social engineering and cold war fears. Since that time, sustained periods of inflation have not existed, culminating in an environment today where “inflation-indexed” benefits from the government are actually scheduled to decline due to deflation (but, don’t bet on it. Congress isn’t very good at letting its constituents whine!)


“Hey, but housing prices did rise during the early 2000’s, in some cases doubling and tripling in value! What about that, smart guy?”

We will give you time to ponder that abrasive question...until next post...