March 29, 2007

Real Estate: Information Overload and How to Think For Yourself

Is it me or has it been just about impossible for the past several years now to go through a day without hearing or reading something about the housing market? At first, it was all about how everyone was making boatloads of money in real estate (with the implicit message that anyone not in on the action, read: renters, would get passed by in the great economic rat race), and more recently, everything has centered around the fear of housing bubbles, rising interest rates and the subprime mortgage market. Truisms that seemed to make so much sense a couple years ago (e.g. "real estate is never a bad investment because prices always go up!") have been replaced by others (e.g. "there's a giant housing bubble in our country caused by an overheated run-up in housing prices!"). With so much information overload out there, how do you separate the wheat from the chaff to figure out what is and isn't important when you're looking to buy or sell property? Some thoughts below:
  1. Reject all the truisms - personal finance is by nature "personal" which means that no one truism applies to all inviduals. So, no matter how many times you hear a pundit repeat mantras like "renting is for losers", just because the message is loud and persistent, it doesn't mean that it's necessarily true for you. Remember, there's no help like self-help, and by thinking about issues actively and critically rather than letting others tell you what to do, you're more likely to make better informed decisions.

  2. Don't be afraid to do the math - a lot of truisms that you'll hear on the news or read about on the Internet can be verified (or disproved) by doing a little math. For those of you who are math-phobic, there are a bunch of tools and calculators on the Internet that can help you crunch numbers. Caveat: the only problem is that some of these calculators are more reliable than others, and I could dedicate entire posts to this topic.
So, all I've told you so far is to reject everything you read and hear along with some vague notion that you should be dusting off your old Algebra books to do some math. How is that supposed to help you? Well, I admit that I certainly haven't provided any magic answers, and that's partly on purpose - I don't think there are quick and easy answers. However, I do believe that popular notions about the real estate market are rife with unjustified and oftentimes incorrect myths, mantras and exaggerations, some of which I have tried to address here and here. For now, I'll leave you with this article "What Happens When the Boom Goes Bust" from the Motley Fool, one of the rare articles about housing that I have found to be informative and well thought out:
According to the National Association of Home Builders, the average price for a new home in 1980 was $76,400. In 2005, the average was $295,100.

That's incredible! $218,700 in caaash ...
Before you get too excited thinking about investing in real estate and flipping houses, ponder this: Over a 25-year period, that $218,700 gain comes out to a 5.6% annualized return.

Think about that. If your stock investments had grown at just 5.6% annually over the past 25 years, you'd be kicking yourself. And with good reason -- during that time, the S&P 500 earned 10.3% annually -- almost double the average gains in housing....

Treat investing like you treat homeownership
During the past eight years, home prices have grown at a much faster clip, so some of you are probably accusing us of cheating. We aren't.

Instead, we're taking a long-term view -- because that's the only view that can make you super-rich.

What's a mere million
Consider that cocktail-party story about Sal from Asbury Park who made a million a few years ago flipping condos in Miami. It's a great story, and we'll go ahead and bet that bits and pieces of it are true. In fact, it might all be true.

But for every Sal from Asbury Park, there was a Jimmy from Hackensack who got in over his head and lost everything. Yeah, that happened too. That's why the subprime lending market is collapsing around HSBC (NYSE: HBC), Washington Mutual (NYSE: WM), and New Century Financial (NYSE: NEW), among others.

And even if Sal did make a million in 2003, is he set for life? Certainly not. In order to make that nest egg last, Sal can only withdraw about $40,000 per year. Our guess is that Sal wants to live better than that. So he probably kept flipping houses. Flipping and flipping until the Miami condo market came down around him. Or, if he's still holding properties, the real estate boom cycle has ended, and Sal will be lucky to eke out 5% returns over the next decade or more -- all the while servicing the debt he needed to buy those condos in the first place.

A cautionary tale
Of course, Sal's a figment of our imagination, but we invented him to make a point. One great year will not set you up for life. Even a short-lived real estate boom won't make that happen. To set yourself up for life, you need decades of good years. And the stock market is the wealth-building enterprise that has demonstrated the ability to return 10% per year for decades. In other words, buy a house for the comfort, but buy stocks for the profits.


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May 23, 2013 at 6:22 AM  

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