Is Real Estate Really a Bad Investment?

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I read three sites everyday:

  1. Wall Street Journal
  2. Business Insider
  3. BiggerPockets

I encourage everyone to do the same.

BusinessInsider recently ran an article that stated:

Trish Regan: “Then why buy a home? People trap their savings in a home. They’re running an opportunity cost of not having that money liquid to earn a better return in the market. Why do it?”

Robert Shiller: “Absolutely! Housing traditionally is not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. And there’s technical progress in housing. So, new ones are better…

“So, why was it considered an investment? That was a fad. That was an idea that took hold in the early 2000’s. And I don’t expect it to come back. Not with the same force. So people might just decide, “Yeah, I’ll diversify my portfolio. I’ll live in a rental.” That is a very sensible thing for many people to do.

“If you think investing in housing is such a great idea, why not invest in cars? Buy a car, mothball it, and sell it in 20 years. Obviously not a good idea because people won’t want our cars. It’s the same with our houses. So, they’re not really an investment vehicle.”

Homeowners understand that you can’t sell a home with 30-year-old roofing, carpet, and kitchen appliances. Sure, the home price might go up, but investors must adjust prices for years of maintenance and renovations.

Source: BusinessInsider

My first reaction is to scream at the computer (as I’m sure yours is too). However, let’s be honest and look at the facts:

Yes – housing does require maintenance expenses…

well…

…I’ll pretty much stop there because that’s the basis of his argument.

Comparing a house (non-discretionary) with a car (very discretionary) is like comparing apples to oranges.

It’s actually kind-of frightening that a Yale professor would compare something that appreciates (housing) with something that depreciates (cars).

Using this logic, you would have been an idiot to buy the entire island of Manhattan for $1,000 (2006 dollars). Which is what happened when the Native Americans sold Manahaten to Peter Minuit.

Instead of going over mundane facts, it would have been much more intelligent to simply look at both sides – which includes the benefits, like if you own the real estate you have locked in your housing costs for approximately 30 years (protecting yourself from inflation).

But no- they left that out.

So instead, I’ll just repeat a story I heard from a friend of mine that has lived in San Francisco for the past 13 years.

Me: So I hear Twitter is going public?  Real estate prices and rent will probably spike just like when Facebook went public.  Agree?

My friend: Hell yea.  It sucks!  My rent has gone up 350% in 5 years!  It will probably go up 50% next year.  Do you know how hard it is to survive with that kind of rent increase?

So what side of that trade do you want to be on?  The landlord or the renter?

 Another Ridiculous Example

Someone else that I follow closely is Ramit Sethi of Iwillteachyoutoberich.com. He hates real estate and recently wrote an article breaking down basically exactly what Shiller said above.  So why am I repeating this?   Because the comments to his post were fascinating.

ramitII

What do you mean you “agree,” Ramit?  Your own readers have single-handedly dismantled your argument!

Conclusion

In conclusion, I’ll simply leave you with a conversation my wife and I had recently.  Someone offered to buy a rental house we own.  I told my wife and she simply responded: “what would we do with the money, put it in savings and earn 0.01%?”

Why would you sell an investment (and pay capital gains tax) that’s earning you an after-tax yield of 17% to earn 0.01%?

Agree to Disagree. Let me know in the comments

About Author

Jimmy Moncrief is a bank underwriter and real estate investor. He blogs at RealEstateFinanceHQ.com where he talks about all things real estate. He also is the creater of free evernote templates for BiggerPockets members to learn how to better organize and automate their real estate investing.

52 Comments

  1. Hi Jimmy! I have been research on various websites to see whether it would be beneficial for me to make additional payments on my mortgage (which also includes my rental property) to increase my equity at a faster rate. Do you have a website that you recommend for doing some calculations on this?

    Also, how do you feel this affects the depreciation on the rental, either in a positive or negative way?

    • Why do you want to increase equity would be my question? It won’t bring you anymore returns until you sell or pay off your house. I pay off one rental early at a time because I use arms and have 9 mortgages. It’s easier for me to get more loans with less mortgages. Otherwise I would put all my extra money into buying new houses.

      • Hi Mark – the reason is that I am about 10 years from retirement and won’t be doing big time investing in properties such as you do, so I am looking for the best plan of action over the next 10 years.

        • Mark – thanks for chiming in!

          Nancy – thanks for the question!

          I would personally get your house paid-off if you aren’t using excess liquidity to grow your real estate business. Which is what Mark and I are both doing.

        • Nancy,
          I would suggest paying off your mortgage. Hopefully that can be done by making larger monthly payments from your rental income. A free and clear property gives you a competitive advantage in the market.

  2. It appears that Shiller was speaking about folks considering their primary residence as an investment. I actually just moved this spring to a single family home from my first investment (aduplex). By the time we are done remodeling our new home (about this time next year) we would have a hard time selling it for what we have into it. We love the area, love the house and will even more once it is done. Will work long time for us. The justification I have is that I spent more on the garage and deck and moving the kitchen and adding a third bathroom in the basement because I want it not necessarily as an investment. I will enjoy $10,000 spent on the place I live and can use everyday much more than a week vacation or new upgraded vehicle.
    As for investment property and passing the sentiment that owning your home isn’t all its cracked up to be… that doesn’t bother me. My banker and bank account doesn’t care what the news says but whether I am making money or not 🙂

      • Jimmy, I think it is also important to note that the tax benefits are overstated in owning a home. I bought a one bed condo to live in about 13 years ago and never realized any tax benefits. The standard deduction was always more or a benefit. I now own a 3 bed condo that I live in and she’d my exposure in the one bed condo. I also bought this as a place to live in not an investment and I think that is the key point. I also don’t realize any tax benefits from this condo.as my standard deduction is much more beneficial. The tax system is setup so that you take on more debt in order to realize those tax benefits that you speak of. In other words, the higher the property value the more likely you are to see a tax benefit and in my area, that means you have to buy house for $350k +

  3. I love people that are so highly misguided, because they are making my pockets much bigger 🙂
    Personally, when I purchased my primary residence. I purchased it using the same rule set I used to buy an investment property or a flip, that I wouldn’t be living in. I bought way below market and then repaired it. I now have built in Equity that I can tap for other investments (which I do rather aggressively). At the end of the day I have hardly any of my own money trapped in the deal because I have been able to refi it at market value and pull most of it back out. So the idea or premise that one is sitting on equity in their home, only to pass on higher paying investments is beyond absurd, and highly mis-guided.

    • Great point!
      This is pretty much what we did with our primary. Bought a fixer (That was not so bad as to not qualify for a regular mortgage) fixed to our liking then refinanced to get a better rate and have a HELOC to cover a lot of the repairs we did and use that equity to fund lots of our other RE Investments.

      By buying under market and forcing appreciation we could sell today for at least $50K more than are all in cost (Probably closer to $100K) and all that money would be tax free.

      HORRIBLE use of funds…

  4. Great post Jimmy! I saw where one if my blog posts was linked to a corvette forum last week. They were discussing how horrible rental properties were. Some of the people advising against them had owned multiple rentals for many years. One guy had owned rentals for 17 years. He still owned them! Why didn’t he sell them if they were such va bad investment? Other people were throwing out horrible information about taxes and depreciation. I think there is a ton of wrong info out there.

    If the people in your articles compared car dealers or rentals car agencies to housing maybe they’d see the light. There is obviously no profit in leasing a car or renting it out ……..( sarcasm)

  5. Everything is cyclical, there was a time to invest in cars and mothball them. Imagine you had purchased some 60’s muscle cars and done this.

    I’m pretty sure everytime these articles come up they are in reference to large investment portfolios, but im not sure.

    • Hindsight is everything isn’t it and if only we had a crystal ball. When I was 17, my dad brought me to buy my first car (used) and I wanted a Chevy Camaro. The one we looked at was exactly what I wanted, which was a white 1968 Camaro convertible. The reason I didn’t want it, was that it had this ugly black and white interior that I didn’t like and later found out was called houndstooth, so I didn’t buy it. It was $700. No, I never got over this, although I have moved on. If I ever get rich, guess what I will try to find again?

  6. Schiller has been consistently wrong about real estate investing for years. In fact, the international community just conferred the ultimate award of stupidity to him with the Nobel prize, just like Al Gore, our drone bomber in chief, and Arrafat.
    I hope the media keeps quoting him so I can keep buying for a few more years.

  7. Awesome post. My wife and I always question our desire to improve our current home. We won’t realize the money we are putting into our house, however, like @Kyle Hipp says above, we absolutely love the location of our house. It’s a safe neighborhood, walkable distance to the grocery store, two local pools, four parks for kids, Starbucks, and 100’s of acres of woodland (we’re trail runners). It’s less than a ten minute drive to a great brew pub, additional acres of state woodlands, an awesome wood-fired pizza restaurant and the University. Because we live in a college town, rentals that offer anything near what we have in our home cost about 70% more than what we are spending to own our home.

  8. Buying vs renting: 1st grade math. When you buy with a 30 year mortgage you lock in your monthly payments, get tax write offs, appreciation and satisfaction of owning. Renting, the land lord gets ALL these benefits plus increased cash flow.

    Most first time home buyers worry about buying their first home. Learn a long time ago it’s much cheaper to let others buy property for me and they pay for the privilege with positive cash flow. They say that buying your home is NOT an investment, sure beats throwing your money away every month in rent!

      • It does depend on your lifestyle choice. On the higher end scale I believe you can do pretty good renting. You can continue to rent the newest and best amenities. Your freedom to move is so much greater than owning. I am pretty tied down to my home and would have lretty hefty costs if I wanted to move. On a $200,000 house, I’d be looking at roughly $12,000 in commissions alone and that doesn’t include closing costs, price cuts and carrying costs if it doesn’t sell in a month. It ties up a lot of resources where if I am renting I just l pay my lease to the end if I didn’t happen to plan ahead and even if not it would take a while to add up to that cost of selling a home.
        As for 30 year locked in cost, that works if you stay their for the 30 years but people do etendto move more than that on average also even a new home will require a new roof, siding, water heater or two, furnace, windows (maybe). The yard needs to be maintained and above that if you buy in a new neighborhood, 30 years down the road the rest of the homes face the same difficulties. How many folks have kept up their home to preserve value. The rest of the home needs to be modernized as well. How ofter do we walk in to a meticuloisly maintained home from 1983 and think, “wow they took great csre of everything but a lot of this needs to go because no one wa ts to buy a home circa 1983”.
        As others have mentioned the tax benefits as not realized many times as the standard deduction covers interest. In fact I know of many folks that are hurt by the myth that it is smart to keep a mortgage for tax reasons. They pay $2,000 in interest and $3,000 in taxes and it doesn’t matter because their standard deduction covers it so they waste $2,000 in interest to the bank. Even if that was above the standard deduction they pay $2,000 in interest to save $700 in taxes in the highest bracket when the alternative would be to pay $700 in taxes and keep the remaining $1,300. Math has eluded many unfortunately.
        Home ownership provides tools to get ahead but only if used correctly.

      • Actually, it MAY NOT beat the alternative. Jimmy, you need to show a further discussion of cost of home ownership and maintenance in comparison to potential savings of renting.

        • That will come down to how you buy and what your financing is vs. the rental rates in your area.
          For example we bought out place during the dip and got it a bit under market at the time. Started with a good rate but refinanced a couple years in after improving the property a lot.
          Rates were better and the appraisal was so much higher that we got an even better rate then expected.

          We actually wanted to look into moving and cash out all the equity we had tax free to use for other investments. Unfortunately we bought and financed so well that to actually save money month to month the places available do not meet our minimum needs and to find a place that meets our needs (But isn’t anywhere near as nice and updated as ours) would raise out costs at least 40-50%. To get a place that is also of reasonably similar quality too we would be looking at close to double.

  9. Nice article. However, a point to consider. You may be earning 17% as an after tax yield based upon what you put into the property. But if a potential buyer offered you a premium, I would take a moment to stop and consider what your yield is if you consider your equity based upon his offer. Example:

    You have a 200k mortgage on the house, 50k of equity based upon your total money invested. You earn 8500 / year on it for 17% on your equity. If the buyer were to offer you 400k for the house, your 8500 / year now represnts a 4.25% return on your equity. (I’m ignoring transaction costs for simplicity, obviously they matter as well).

    In this case, it may make sense for you to sell this particular property and acquire more with the proceeds. Even if your new investment only nets you a 10% return on your “new” 200k representing 20,000 / year, this is more than double your current profit.

  10. I believe Shiller is referring to primary residence. I also believe most buyers purchase with a long term 30 year fixed product which not only is more expensive in terms of rate being paid, but also in total dollars paid for the property. I believe in purchasing with short-term adjustable rates or short term fixed rates so that he carry cost is smallest.

    I also invest in real estate (commercial and residential), but know full well that I need to be careful in how I purchase, hold, and liquidate my properties as all three are very important and can become costly mistakes. I use only adjustable and short term fixed rates on residential properties and use mixes of equity, commercial and municipal incentives for larger development projects.

    I didn’t buy our primary residence with our money, I built up to a point where the “business” of real estate pays for our homes. Maybe, that is what Shiller really means. Don’t expect a return on your residence with your own capital.

  11. Thanks for your article, Jimmy. I think you are jumping between two different issues, though. Your conclusion seems to focus on owning rental properties, where the rest of the article is comparing the cost/benefits of renting to the cost/benefits of owner-occupying a home. You will likely not be making 17% ROI on an owner-occupied home…

    There are plenty of pros and cons in comparing the renter lifestyle with home ownership. However, if you’re attempting to focus and compare just the COST differences, you need to consider two important factors: (1) the potential savings you have per month by renting instead of owning and (2) the actual maintenance expenses and necessary upgrades that come with home ownership. Now that we are coming out of the foreclosure crisis, where homes could be purchased dirt cheap, in most places renting is once again less costly than owning. And, as Shiller stated, if you want to maintain your home’s value, you need to upgrade appliances, carpet, etc. It’ll be difficult to sell your home for top dollar if you still have shag carpet and yellow 1970s appliances.

    To me, it’s not that shocking that Shiller is comparing homes to cars; they are both physically depreciating assets. They both require maintenance which is an expense that needs to be factored in to any cost/benefit analysis.

    Whether or not to own rental properties isn’t what those other “experts” are discussing.

      • “The physical structure on a property is a depreciating asset. As it ages, it requires capital infusions for maintenance, updating to stem functional obsolescence and, depending on its design, updating to prevent it from falling out of style.”
        http://www.investopedia.com/articles/mortgages-real-estate/08/housing-appreciation.asp

        Residential buildings are even recognized by the IRS as depreciating structures. They are assigned a depreciation schedule of 27.5 years. This is the depreciation Shiller is alluding to and what Jimmy wrote off as ridiculous.

        As Kyle Hipp points out in his post above, the maintenance expenses to compensate for physical depreciation and functional obsolescence, which are required if a home is to maintain its value or to increase in value, are quite significant. This is why these maintenance costs must be factored in when comparing costs/benefits of home ownership versus renting.

        Jimmy glossed over maintenance expenses as if they weren’t important; they are a MAJOR factor in this comparison.

        Shiller is no idiot. In my opinion, the the blog entry above is amateur analysis, as it took Shiller’s words and misconstrued them and added no further in-depth thought. Detailed costs and tax benefits must be laid out if we’re to see a clear cost comparison between renting and owning.

        Again, this blog has nothing to do with rental property ownership. It’s owning a home vs. living in a rental unit.

        • Thor

          You made a lot of points above. I’ll try and tackle them below:

          1. Tax Accounting vs Market Value are two completely separate issues.

          2. I did not misconstrue any of his words – I QUOTED HIM DIRECTLY.

          3. “amateur analysis” – my point was to show that by owning you hedge your housing costs for 30 years with some variability with maintenance expenses. With renting you are completely out of control of your housing costs.

        • 1) There is depreciation in physical characteristics and depreciation in price/market value. Shiller is referring to physical depreciation, which is why it is accurate to compare homes to cars.

          2) It seemed as though your blog interpreted his words (misconstrued) to mean price/value depreciation, which is not what he was discussing. Physical depreciation is very real in housing, which is why the IRS recognizes it with a 27.5 year depreciation schedule. My intention in bringing up tax accounting was to show that this depreciation in housing exists.

          3) If you wanted to show financial benefits of owning a home, you need to break down the costs with actual estimates. Writing off maintenance without any cost analysis or comparison isn’t examining the issue at hand.

          Renting instead of owning can be hugely beneficial if done responsibly. This fact is drowned out by people blogging about how important homeownership is. As evidenced by the foreclosure crisis, many people are not capable of managing the finances homeownership requires. While there are huge benefits to owning, renting can present a savings, which can be used for other investments.

          Also, housing costs in owning is rarely “fixed”. Maintenance issues arise constantly and need to be budgeted for…

        • Thor

          I feel if we were having this discussion over a beer we would probably agree on a lot of things.

          Unfortunately, this is a different medium so I’m just going to let you have the last word.

          I wish you success in investing.

        • One quick note and I’m done too. When you discuss the maintanance cost of home ownership you are correct, their are costs in keeping up a house. However, those costs are ALWAYS born by the people who live in the house, it doesn’t matter if a homeowner pays for the repairs directly or a landlord pays then collects reimbursement from the tenant.

          While the tax code gives a bonus to investment realestate ownership in the form of depreciation over 27.5 years the actual cash value of a house will increase over time as has been consistantly shown. I challenge you to show me any 100 year old home, which hasn’t suffered abuse. that you can buy for less now than when it was built. As far as style upgrades to a functional house those things are not required and aren’t a cost of ownership thay are unnecessary improvements. Therefore I believe saying a house depreciates in the true sense just might prove someone worthy of the current Nobel prize.

  12. Housing as an investment has always been under attach from “Wall Street” news sources and pundits. And from gold bugs. These other investment classes are competing so it is to be expected. Shiller was talking about more price declines a couple years ago when the opposite actually happened. I tend to listen to economists that get it right…not wrong.

  13. WOW! Great article!

    What astounds me is that Shiller just won the Nobel Prize!!!

    Here the guy is supposed one of the “smartest” people walking this planet and he teaches at one of the “best schools” but this is the crap he says? It just goes to prove that formal education alone will get you trapped into the rat race and will make you middle class at best!

    This fuels my hatred for traditional education even more. They idolize people like this who clearly only see the world from one perspective….the employee perspective. Oh and btw…don’t tell them they are wrong. They will throw their useless degrees in your face like the pompous, ignorant pigs that they are!!!

    Sorry for the rant! 🙂

    Great post!

  14. Reread the article after seeing the comments, and would agree they are referring to primary residence. If the average Joe had $100,000 and a choice of buying a house with it (cash), or renting a comparable home and investing the 100k into the market and getting a return of say 10% the argument may have some merit. In the bigger pocket arena we don’t consider this much of an option but the average Joe might. This is why financial investors tell their clients not to pay off their house, but finance it at 4% interest (deductible interest) and invest the money and hopefully get a return of 10%. I can’t stomach the stock market but understand the principle behind this. On a side note – Robert Kiosaki redefined assets and liabilities to better reflect his philosophy. He says an asset puts money in your pocket, a liability takes money from your pocket. I love this thought, it’s non traditional. Most consider their primary home as an asset, but Kiosaki would say no. Take 2 minutes and watch him explain it much better…. http://www.youtube.com/watch?v=byRSKEw0oa8
    Thoughts??

    • Love the Kiyosaki comment!

      Agree – but AGAIN point out – would you rather be writing the check to your landlord or to your mortgage company – and ensuring no “rent” increases for the next 30 years?

  15. Michael Dorovich on

    “Absolutely! Housing traditionally is not viewed as a great investment. It takes maintenance, it depreciates, it goes out of style. All of those are problems. And there’s technical progress in housing. So, new ones are better…”

    Is this the same Shiller of the Case-Shiller Home Price Index? Talk about scary. As a college professor, I wonder what his income is and what kind of return he gets on his money. It kind of makes you think that the more education you have, the dumber you are.

  16. I think a primary residence CAN be a good investment, but also that people typically buy more house than they can afford, & more than they would have if they were to rent. The smartest folks I know bought a modest house with a very large yard relatively early in their career, then continue living in their smallish (but paid for) house even as their income increased substantually. Over the years they have added onto/remodeled extensively (it now has a deluxe granite kitchen, and the bedrooms have been reconfigured countless times), but that has still cost only a fraction of the $ they would have otherwise paid in rent. They haven’t had a mortgage payment in at least a decade, & live quite nicely.

  17. Christopher Lesko on

    Jimmy,
    Great post! I started getting a bit frustrated as I followed the debate in the comments section, but let out a sigh of relief when I got to the Robert Kiyosaki comment. I think that adopting his view on what truly is an asset and liability is beneficial to anybody’s wealth acquisition strategy. Bottom line, owning is definitely the more stable approach for your primary residence, since you are not subject to the risk rent increases or having the landlord decide not to renew your lease. It’s kind of like owning your own business: why make somebody else rich if you can put the money in your own pocket and call all the shots?

  18. “Homeowners understand that you can’t sell a home with 30-year-old roofing, carpet, and kitchen appliances. Sure, the home price might go up, but investors must adjust prices for years of maintenance and renovations.”

    This guy works at Yale? Apparently he hasn’t looked at many houses for sale within like a 200 mile radius of where he works…

    On a more serious note the argument that if you rent you can plow all those savings into better yielding investments is very flawed. Yes some savvy investors can decide to rent where they live and invest the money they would have put down and any potential other savings into better investments.
    That is a TINY subsection of renters though. Most people rent because they have to rent. Not that many have the cash to put into a down payment and to pay the extra monthly expenses of owning. They make there rent and spend any extra on doodads that really have no value. This doesn’t make them bad people as most homeowners do this too, they just maybe saved a little bit more at one point or just have a better job.

    Most people don’t make good investments so most peoples homes aren’t great investments. If you are a good investor you home can be a great investment but taking money saved by renting can also be made into great investments. The success of these strategies has much more to do with the investor than it does with what ever asset they are investing in.

  19. Well, Jimmy, He does make sense. A) You are assuming people own their homes. They rarely do. Additionally, and relatively other assets rarely have an operating cost, something that owns a real estate does have. B) If we do land up in a high inflation period (which I doubt we will) then the best hedge against inflation is stocks or gold, not real estate. C) Before the real estate mania set in real estate growth averaged around 5%. Are you saying 5% ( exclusing inflation adjustments) return is great for an investment that is illiquid?! D) The only reason real estate is currently attractive is because of interest deduction. Eliminate that and real estate becomes a burden, a liability not a great investment. The only way real estate is a great investment is if you have a property you inherit and you rent that property out. Otherwise, going out there and buying a house for investment purpose is foolhardy. E) Yes savings rates are low. However, there are other alternative investments. For the past few years, investment grade dollar denominated bonds have given back investors 17-18% in return, the same return you get on rent, and without the hassle of the inherent risk in renting to another person. Some of the safest assets in the world have given you the same amount of return F) Maybe you didn’t read Schiller correctly. He said if you buy a car, don’t use it and then sell it. The important term being doesn’t use it. Anyways, I personally think we should invest in real estate for purposes like putting down our roots, not having to deal with a landlord, or if you are actually clever and liquid enough to spot a market that is undervalued etc. But in very rare instance, do I see real estate as a great investment.

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