Home Sweet Home

In my post about basic investment options, I purposely did not mention a huge one, real estate. Besides the fact that it's a post in itself, I left it out because I don't think real estate should be a major financial goal for professionals who are just starting out. Here is why.

Recently, there has been much debate about whether home ownership is a right or privilege. Today, 68% of US households own their home, which is the highest in history. To give you some perspective, 50 years ago, the number was around 55%. Now why the increase? Sure, there's no doubt the nation and its citizens have become more prosperous. The gross domestic product, the ultimate measure of the economy, has tripled in the last 30 years. The median household income has increased 20% during that time (hmmm...why hasn't it tripled?...a topic perhaps for later.). But I argue that the main reason more people own homes these days is because homeownership is more accessible. We really have Franklin Roosevelt to thank for that. When FDR created the institutions Fannie Mae and the Federal Housing Administration, increasing home ownership was precisely his intent. Props for Franky. Anyway, as a result, owning a home is as close to being a right as it's ever been. It's the American dream. But just because everyone has a home, does it mean you should include it in your financial planning? Is it always the right financial decision?

Before we answer this question, let's go over some of the benefits and disadvantages of buying a home. In my book, the biggest benefit is just the fact that you get to say you own the house you live in. You can have as many people as you want living in it, have as many dogs or even kimono dragons if you like, change a bedroom into a pilates gym, another one into a recording studio...you get the point. It's yours and you can do whatever the heck you want. I guess if you were financially inclined, you could also rent part of it out to make some money.

Another benefit of homeownership is that your mortgage interest and property tax payments are tax deductible, which means for every dollar you spend on those payments, you get anywhere between 20-35 cents back from the government, depending on your income tax rate. This is a great benefit, because remember the concept, "Not negative is positive." This tax deduction means you're essentially getting a 20-35% yield on the money you put into your mortgage interest and property taxes. As you may then conclude, this benefits the wealthiest more, because they are in the highest income tax brackets.

Still another benefit is home equity, which is the value of the home minus the debt. Let's say one of my friends bought his house for about $175K in 1998, and now it's worth $450K. He still owes about $50K, so he has $400K of equity. He can either sell his house today for that amount (good luck with that in these difficult times), or take out an equity loan to use for whatever he wants. For instance, he could renovate to add more value to a home, use the sum to live on (not recommended since it's like living off a credit card), use it in an emergency situation (e.g. medical bills), or use it to invest in a business venture like starting a restaurant. Be aware that equity is really only a good thing if your house appreciates. If your house value stayed the same or depreciated, sure you'd still get equity, but it'd be just the money you've paid. It'll be like putting money under your pillow (plus paying the interest as well), and we know we don't want to do that.

But then you ask me, don't houses ALWAYS appreciate? This is a good segway to the downsides of real estate. I know that in the past 10 years, people have made a killing investing in homes. But take a look at this chart by Robert Shiller, one of our most preeminent modern economists, who did a study examining average home prices adjusted for inflation from 1890-2006. http://www.1stmillionat33.com/posts/06-09-12/house_his.gif

As you can see, the appreciation in home prices historically has just been a bit better than inflation, with the exception of the years 2000-2006 when, for lack of a better phrase, they just went nuts. Ummm...I am going out on a limb and saying this period is an outlier, a bubble for which we are currently going through the corrective phase. I've seen people on TV recommending now is the time to snap up "bargain homes." I would argue against that, because the current median home price is still over $200K, and if you believe in Shiller's chart, there clearly is more room for prices to decline. (I am generalizing somewhat, because real estate is regional, and there are some parts of the country where housing prices have indeed bottomed already.) You don't want to buy a place, have it rapidly depreciate, and consequently have to stick with it for 10-20 years, waiting to generate some meaningful equity. Compounding this predicament is that homes are not as liquid as, say stocks. If one of your stocks tanks, you can easily sell shares whenever you want, but finding a buyer for a depreciating house and then going through all the logistics of a sale are far more difficult.

If you remember in my first post, I mentioned that I almost bought a house last year. I was fresh out of residency, had just landed a nice job, and was caught up with the idea that every semi-successful person should own a house. I found a property close to work. The selling price was $480K, my offer was $450K, and the owners rejected it. After 6 months, I was curious and looked up the house again, and to my relief, it was worth $370K. Adding to my relief was that I had left my job and moved like 100 miles away! Thank baby Jesus, with his fleece diapers and all. (Name that movie reference!) If I had bought that house, I would've been left with a huge debt, on a rapidly depreciating property, in a location where I didn't want to be. So you see, buying a house is not meant for those who are still unsettled and unsure about their career specifics, people who don't know for sure where they want to be and how the next good chunk of their life is going to turn out. Hey, isn't that the majority of professionals who are just starting out?

Now you see why I don't recommend real estate as a major investment goal for beginning professionals. It is a huge investment, requiring not only enormous capital but deep life commitments as well. In addition, the return you'll get, even with the tax deductions, is inferior over the long run compared to stocks. And if you are unlucky enough to run into a housing downturn, a house would be more difficult to unload. I'm not saying never think about real estate, but it should be at a later point where you are more sure of your life situation, and are ready to own where you live. When you are at that point, you can make financial goals to save more money for a down payment, and the money in your savings account should be a good start towards that.

A side advantage I haven't mentioned is that real estate does diversify your investments, making sure that you'll still be ok, say if the stock market crashes. But this is a small benefit, because the stock market will recover over the long run, and you are already diversified through your savings accounts and your bonds.

And what about the money you'll save or would otherwise "give away" to your landlord if you rent? Well, unless you're living in a luxury apartment, you'll always have to pay more in the long term for a house than if you rented. So really, think of homeownership as more of a life upgrade.

I know that there will be some people who'll disagree with my perspective on real estate investing. I have friends who have done really well buying properties, selling them a couple of years later, and earning handsome profits. I don't know about you, but that sounds like Donald Trump. Just like we shouldn't try to be bankers and take on every great loan that comes our way, I don't think we should be real estate businessmen when we're not. Especially given how housing has declined in the last 2 years, you could potentially lose a lot of money trying to be the Donald...and he probably can afford to lose more money than you.

Until next time, may you make some moolah, just not on real estate...at least not yet.