February 22, 2007

Real Estate: Myths and Exaggerations II

Myth: Buying a home is a great investment.
Reality: Maybe

One of the most common reasons given for buying a home is that owning property is a great investment. The correlations don't lie - the average net worth of a homeowner in our country is much higher than the average net worth of a renter. But, is correlation equal to causation here? Should we put all of our money into real estate?

Let's compare real estate with another asset class - stocks. According the U.S. Census Bureau, in 1990, the median price of a home in the U.S. was $122,900. By 2006, the median price was $245,300, an impressive gain of $122,400 or 99.6%. Contrast that with the S&P 500, which on January of 1990 was at 329.08 and by June 1, 2006 was at 1285.71. That's a 291% gain. Or put it another way, invest that same $245, 300 in the S&P 500 in January 1990, and your investment would be worth $713,083. What if we go back further in time? Thirty-one years ago in 1976, the median price of a home in the U.S. was $44,200, the equivalent of a 455% gain by 2006. The S&P 500 was at 90.9 on January 1, 1976. That's a 1314% gain.

Some of you will say - hey, wait a minute. Most homeowners didn't pay for their homes outright - most people make a down payment and take out a mortgage. When housing prices increase, their return on investment is much higher because they're using the bank's money to fund the purchase of the home. If I put a $10,000 down payment on a $100,000 home and the price of my home appreciates to $150,000, I've made $50K just off a $10K investment. Those suckers who invested in stock had to spend $100K of his (because suckers are usually men) own money to buy the stock, and when the value of his holdings go to $150K, he's made the same $50K but had to put up $100K to get there! Perhaps, but how is this really different than buying stock on margin?

Others of you will say - hey, what about all those people who made a killing off of real estate in California, Boston, Manhattan and DC - even better than stock market index returns? More power to anyone who can figure out which markets are hot and can time the market (or maybe they're just lucky that they picked the *right* place to live), but if you've really got those Nostradamus skills, why not use those prescient powers and pick some great stocks (and let me know your picks, please). Sure, you could have doubled, tripled, quadrupled or quintupled your money in your Bay Area condo over the past ten years, but you also could have put your money in Yahoo ten years ago and 20x your investment.

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