One ad says: "You might be wondering if buying a home right now is a smart financial decision. The fact is, homeownership is key to building long-term wealth, no matter when someone buys." They cite a N.A.R. study as evidence of their claims that real estate is a better investment than stocks. "Thanks to the power of leverage, a homeowner’s return on investment is even more impressive over time. For example, over 10 years, a $10,000 investment in the stock market at a normal 10 percent market rate of return would yield $23,600. The same investment as a down payment on a $200,000 home at a normal appreciation rate of 5 percent would return nearly 5 times the stock market return, at $110,300."
Begin rant:
My stockbroker can't tell me that buying stocks on margin is a good idea,
but the N.A.R. somehow gets to tell us that housing is a good investment,
encouraging us to use margin (leverage, mortgage loans, debt) to increase our
payoff, without even a footnote about the risk of leverage. What's up with that? Are they trying to position themselves as investment advisors?
End rant
What's wrong with the N.A.R. logic? Carrying costs, transaction costs, liquidity and leverage.
That theoretical $200k house -let's put it in California to make things simple - has monthly carrying costs. Property tax ($167), insurance ($120), maintenance ($85), and the mortgage payment ($1,022 P&I) add up to a monthly carrying cost of $1,392. Assume a 23% combined federal/state tax rate; the homeowner might save $215 a month in taxes, for a net housing payment of $1,178.
Homes are complex because they combine the saving/equity building function with the gives-us-someplace-to-live function. As an investment, any savings below comparable rent is analogous to cash-flow income from an investment (think dividends or interest payments) and any excess cost over comparable rent is a loss. So we have to look at rents. First, let's notice that the homeowner will pay his/her own water, Mello Roos, trash, etc. A renter usually gets basic services included for free with their rent. Let's put the theoretical buyer into the Sacramento housing market because you can find $200k fixers in bad neighborhoods around Sacramento. (We won't burden the house payment with the Kevlar vest, alarm system, Glock, and carry permit you'd need in the neighborhoods with homes priced under $200k.) Okay, so trash and water service will run about $100 a month. Add that to the $1,178 net housing cost and you get a rent-comparable monthly cost of $1,278. $200k buys a crummy house in a crummy neighborhood; Sacramento area rents start at $650 for a house, $1000 will get a 2-bedroom.
So the carrying cost in excess of rent has to be charged against the "investment" value. $1,278 minus $1,000 equals $278 a month. If you didn't buy a house, we assume you would have left the $10k down payment in the stock market, paid $1,000 a month rent, and invested the $278 extra dollars per month. At 10% compounded annually, your $10k investment plus $278 monthly deposit will grow to $73,410, roughly three times more than the Realtors(R) acknowledge in their comparison, but still less than the $110k the Realtors(R) claim you will make on a house.
Oh, but you don't get to keep all of that $110k appreciation. Transaction costs are relatively low in the stock market and more than a little higher on houses. First, you buy the house, and pay closing costs which vary dramatically from one community to another, but 2% is not unusual. That's $4k rolled into the loan on our theoretical house (remember, you only have $10k to "invest"). Then, when you sell you have transaction costs - typically, about 8% (6% to your Realtors(R) and 2% to all the other miscellaneous parasites). So subtract the $4k closing costs you paid at time of purchase, and the roughly $24,800 closing costs you'll pay to sell, and that $110k appreciation you earned on your "investment" is only $81,178 net. But you've also paid down the loan by a little more than $52k; so you walk away from closing with $133k.
Not bad. Except that the Realtors(R) are assuming 5% annual appreciation on a house, an assumption that is aggressive at best in the current housing market. If the home price depreciates 10% in the next two years and then grows at 5% annually, the $200k house will only be worth $253k 10 years after you buy it, slashing your appreciation in half. You pay the Realtors(R), title company, county recorder, etc. 8% of your selling price - about $20k in closing costs - and the loan is paid down by $52k (you took a fixed-rate mortgage, didn't you?). You walk away from closing with a check for $80 Grand. Oh, wait, did you remodel the kitchen or install landscaping? Subtract those costs from your theoretical gains.
But I thought buying a house was going to make me a LOT more than the stock
market! I saw the other ad about how ethical Realtors(R) are - they
couldn't have lied!
Liquidity refers to how easy it is to get your cash out of an asset. Checking accounts are highly liquid, while rare antique sports cars are relatively illiquid - you have to find someone who wants to buy it and can afford your price. Housing is moderately liquid in a normal market. Realtors(R) might say it's always a good time to buy, but it's definitely not always a good time to sell. We are seeing homes in my area sitting on the market for well over 6 months - I've seen some sit vacant for over a year. If you have to move before the house sells, you'll be stuck with 2 home payments. You'll want to leave the utilities on so your Realtor(R) can show the house, and you'll probably hire a cleaning service and landscaper. Over 6 months, your carrying costs on the vacant home will be well over $7,000. If you need to pull your money out of the stock market, there are always buyers for decent stocks (no webvan.com, thank you very much). If you need your cash from stocks, sell today, pick up your check tomorrow. No muss, no fuss. Suppose you think the market is going to crash. With a liquid investment like stocks, you decide to sell one day, sell that afternoon. With a house, selling (or "liquidating" your equity) requires quite a bit of fuss - moving, cleaning the house up so it shows well, even finding a Realtor(R) and signing a contract.
Now back to that leverage that makes me so cranky. Realtors want you to compare a leveraged house purchase against an unleveraged stock purchase. That's not quite fair. If you don't mind the risk of leverage, borrow some money from your stock broker to "lever" your way to riches. If you leveraged your stock portfolio - using 50% margin - you can invest $20k. That $20k would grow to $47,158, leveraged. Add the $278/monthly premium you pay to be a homeowner instead of a renter, and your stock portfolio will grow to $96,990 in 10 years. On the other hand, when you leverage your way into a house with a low downpayment, it's easy to end up upside down in a market downturn, owing the mortgage company more than what your house is worth (before Realtor(R) fees, no less).
Apples to apples, the National Association of Realtors is misleading the public. Shame, shame. But don't just take my word for it - Forbes says the stock market has returned 4 times the returns that housing has from 1980 to 2004:
Real Estate Vs. Stocks - Forbes.com: "But if you take a longer view--say 25 years--you'll find that the S&P 500 has actually stomped the real estate market, from Boston to Detroit to Dallas. From the start of 1980 to the end of 2004, home sale prices increased 247%. A pretty sweet deal, it would seem. Over the same period, however, the S&P 500 shot up more than 1,000%."
If you're looking for an investment, talk to an investment professional. If you're looking for a house, that's when you talk to a real estate professional. And whichever you do, make sure you do due diligence - never take a salesperson's word at face value.
This article is not intended to be investment advice; it is merely intended to provoke greater transparency and discourse in the housing market. Please seek the advice of appropriate professional advisors to determine your personal investing and/or housing needs. Copyright 2008. All rights reserved.
17 comments:
...and then grows at 5% annually...
Doesn't seem logical that in the long run that housing can go up in value faster then incomes (about 2-4% per year depending on region). It's people's incomes that pay the loans, taxes and insurance, and peoples wages that build and maintain the houses. Shiller backs this up with historical data without ever getting into the logic.
Good post, but if you buy a home and you invest as a hedge, don't you come out ahead? And what about the tax deduction that you will get from both investment strategies, where if you rent you donate to Uncle Sam. Good beat down on NAR though, but other info needs to be established as well.
Hi, latechdude,
I think the rule of thumb is that housing appreciates 2-3% higher than inflation. Employers generally give raises to catch up with inflation for the average worker, a bit better than inflation for very good workers. So housing appreciation is sustainable in a haves and have-nots, shrinking middle class, foreigners buying up real estate kinda world.
Hi, anon, I agree. Owning a home plus investing in tax-deferred retirement accounts and a taxable brokerage account has been very good to my family, but our house is only 1/10th of our net worth. Long-term, homeownership is a good financial strategy, but I still don't think a home is an investment.
Ah, Taxes. The imaginary buyer in my post would only save $130 a year from the mortgage/prop. tax deduction (it just barely exceeded the standard deduction). My home is paid down so much that it's barely a write-off, but that's good because it means we're not paying much interest. $0 spent is cheaper than $1 spent for a tax deduction.
I think the last poster's post needs to be pulled - this is a forum for opinions about the topic, not rantings that do not belong here....
anon 6:35, Thanks. I agree. I don't like deleting comments, I'll grant some leeway. But that one is over-the-line and w-a-y off-topic.
NAR is a fraud. I did enjoy your article but in the future there is no use in talking about NAR anymore since we all know it's a phony propaganda machine touting itself as an organization. They're a non-issue as far as I'm concerned at not even worth the time discussing. Maybe and article on Mickey Mouse would be more relevent and factual.
I have to agree that the National Association of Realtors should stick to keeping track of actual statistics and educating real estate professionals then creating ads that hurt it's credibility. (Who can forget the $40 Million 2006 ad campaign -- It's a good time to buy and sell?)
Your calculations above do contain a lot of variables and leaving out the tax advantages of owning vs. renting could be a big factor especially if you are in a higher tax bracket.
I also think if you did some research on the biggest crooks in the real estate fiasco, you find that the biggest scams were being run by non-REALTORS.
Hi Anon 4:59, Thanks for stopping by.
I did include tax savings in the calculations, at about $200/mo. It's true that tax savings are higher at higher tax rates and purchase prices. It was N.A.R. that chose $200k as the sample price point. However, the tax savings is not a given.
I am sure you're right that the FBI will prosecute more non-realtors than Realtors(R). But Realtors(R) restricted MLS access and then failed to disclose to buyers when comps include cash-back-at-close, downpayment grants, fraud, etc. that inflated valuations on properties that were then used as comps. They defrauded millions of buyers through inflated purchase prices.
I think it may be necessary for you to do a little research and to separate fact from fiction. For the record I am a Realtor and have been for the last 7 years. There are bad people in this profession as well as good people, and there are good people who are just misguided and misinformed as there are in every profession.
The MLS is restricted because it is a tool of our trade but is this also serves the function of maintaining standards of practice and privacy for companies,agents, sellers and buyers.
I am not sure why it should matter that it is considering the NAR which you so obviously despised lobbied us realtors for the release of full property addresses on the web to make it easier for buyers to do their own footwork (oh, and they won too) so if you have an issue with it, take it up with your local real estate companies because it is now directly in the hands of sellers whether or not to post the address and other information on the web.
As for the "secret" information we withhold in order to "pad" the prices of realtor marketed homes...All terms and conditions of a sale are public knowledge and can be accessed by the town the sale took place in (unless the inhabitants of the town voted against it) so going to a realtor is not necessary but it is easier ...you can call just about any real estate office nationwide and request a copy of all the recently sold data...also the websites of all local realtor associations will publically post the same information.
Homes are not appreciating this year at 5%...but if you average the past few years the answer is yes...that is an actual fact. If you question me or the NAR feel free to go to www.fedstats.gov and take a peak for yourselves.
In my area we still are appreciating but it has slowed to 1%...where at some points inthe past few years we have been up to as much as 21% appreciation in one year...so it all what you compare it against.
Over the long term for most homeowners real estate is a good investment. Real Estate is a traditionally cyclical market, just as stocks are & the same rule applies...buy low sell high...I would think smart buyers would be out doing something now while the market is going down and interest rates are dropping as well.. so the new rates should help offset high taxes (but won't cover it all)...and there is always a matter of negotiation...which most sellers are more than happy to do these days...supply is high, demand is low. Ask the seller to pay your first years tax bill...heck in this market ask them to pay 2 years!
As for homeowners who hate the NAR...you should consider the fact that they are the largest organization lobbying for YOUR home owner rights currently in washington...
FINALLY I get to my last issue with this whole blog. I actually spent a lot of time working for a Community Action Program devoted to Affordable & First Time Homeownership as well as credit counseling & foreclosure prevention. There are people out there who genuinely got taken for a ride. HOWEVER, I can tell you from experience there are also a lot of people out there that just don't pay their bills and are jumping on the mortgage crisis victimization bandwagon. I can personally tell you I have worked with a GREAT NUMBER of people I cautioned not to buy a home for the amount they were approved for. I believe as well as great many other agents that it is always best to buy a home at least 10-15,000 under the amount you've been approved for...just because you're approved for 200,000 doesn't mean you need to buy a 200,000 house...I can't tell you how many buyers stopped working with me because I had the NERVE to advise them...as if somehow I knew better than they what was best for them...so before you jump all over agents take a long hard look in the mirror and all the people who are on this post acting as if they have all the answers because you are THAT kind of person. Anyway, I apologize for the EXTREMELY long winded post but this all needed to be said.
I left my last post on a seriously harsh note there and didn't intend too...I did not mean anything personal to anyone posting here in what I wrote, it is my frustration in my job coming out. I love clients who care to keep themselves informed but there is a difference between being well informed and I don't mean buying into media hype to the point where you doubt very move your agent makes. If you don't plan on listening to your realtor, choose one you will listen too or just do it yourself.
The home buying market is falling but not as bad as the media makes it out to be. In the end this will work in the publics best interest because agents are dropping out of the business like flies...
basically weeding out the wheat from the chaff. When all is said and done and everything corrects itself the professionals left standing will be the ones worth using. All kinds of people get into preofessions like real estate when the market is good because money is easy to be had...when times get tough those kind of people generally jump ship and the same goes for the mortgage business.
Hi, Mindy, thanks for stopping by!
I'm afraid I take issue with your characterization of MLS data. My county recorder does not record asking prices, nor the broker comments data field in MLS. A buyer who is working with a Realtor should be given this information if it reveals an inflated selling price, or if it is consistent with comp inflation/fraud (like properties selling over the asking price).
I assume you group yourself with the good Realtors you talk about, so I ask you: Do you disclose evidence of price inflation? Do you bother to check?
I made an offer on a property during the bubble, with a Realtor(R). He provided comps, but not the full MLS record on each property. One comp sold above asking price; I asked him about it. Bear in mind, last time I bought a house, it was the buyer who funded a down payment, and mortgage companies didn't let sellers pay buyers to buy a home. I had no idea cash-back, down payment grants, straw buyers, etc. even existed. My licensed, ethical Realtor(R) told us that the over-asking sales price probably indicated that the market was sizzling hot, and maybe we should give that sale extra weight in determining our offer. Let me tell you, I reviewed every house within 50% of meeting our requirements, and I read the sales log in the paper every week, and the market was not sizzling hot, and neither was the house that sold over the asking price.
I didn't end up buying that house or any other. We're still living in our old house, paying our old mortgage, and I assure you, there's no risk of foreclosure here. This isn't an issue that affects me directly, but it is an issue of fairness and honesty and the ethical and fiduciary duties of Realtors(R) who hold themselves up as people who represent the interests of homeowners and homebuyers, but, when it really, really counts... well, back to my question: Do you disclose comp inflation to buyers?
Mindy, I really do appreciate your input. I agree completely that the real estate market needs to shake off the chaff, and the downturn will do it. Homebuyers deserve better than they’re getting today.
In response to your question I am specifically a buyers agent and it is my job to disclose all information that would have an impact on my buyers bottom line. I provide a buyers Market analysis like sellers get on every house they have a serious interest in making an offer on and I disclose any home I feel has been over priced (inflated)& encourage my buyers to only bid up to its real value and no higher unless it is something they really want.
You have a right to have your realtor do a buyers market analysis and to specifically ask them to adjust for financial terms/seller to buyer compensation. (Maine requires we disclose outside downpayment assistance programs as well like Nehemiah or The American Dream Initiative) If a home has been purchased with any type of HUD first time home buyer product deduct 2,500-5,000. That is the typical amount for all DPA program contributions no matter where they come from.
There are 2 things that generally make a home sell for more.
1. Multiple offers (which can be house/area specific not necessarily market specific but that can also be a factor)
2. Doen Payment Compensation
The problem unfortunately starts with the listing of the properties. Sellers are in charge of what their homes get listed for. The Realtor gets choice to walk away or take it even if it's over priced and 80% will not walk away. In tighter markets (where competition for listings is high some realtors will over bid to insure the listing. That happened in my market with the bubble. I went for more than one waterfront listing and got hosed because someone had come in behind me and said their home was worth far more than what I had. In one instance someone went in and "out did" me by $250,000...it's ridiculous and it makes the job hard but it happens. I was reading about what inspired your blog and wanted to tell you to check your States Community Action Programs (CAP agencies). They get excellent loans made specifically for Non-profits. I am not sure of your financial standing but as long as you do not exceed 80% of your areas median income you qualify. Some of them even have on staff buyers agent to help (and they get paid hourly so their is no hardcore sell to make for them). If you can't find one go online and look for someone who is specifically a buyers agent with at least an associate brokers license or a full fledged brokers license (stricter standards of education and liability for accuracy). I think perhaps that is why I am careful. I am a broker and therefore held far more accountable for my actions than a sales agent. I hope this helps!
Hi, Mindy, Glad to see you back! I think it's terrific that you give your buyers complete price data. I wish all Realtors(R) did, and I wish cash-back and other comp inflators were tracked in a publicly accessible database.
Thanks for the tip on affordable housing programs, hopefully a reader will find it useful. I'm afraid I wouldn't qualify.
It's a shame that brokers are held to a higher standard than Realtors. Real estate attorneys don't make nearly as much per-case as real estate agents make on starter houses in my area. For the price buyers pay (yes, technically the seller pays, but only if the buyer pays them), they deserve truly professional, high-ethics, high-standards representation. Not just the lucky buyers and sellers, not just the ones who know how to play the game, not just the ones who know someone who would recommend their agent, not just the ones working with a broker, but every buyer and every seller.
It's apalling that buyers and sellers don't demand better. When a starter house nets each agent and each brokerage $5k+, I'd think consumers would insist on $20k total worth of value.
Hi! It's Mindy again. I absolutely agree with you! It is a shame that people just can't be honest & straight forward, it just makes life easier and makes for better business.
If you wish feel free to check out my real estate blogs. The one I have for sellers. I am part of team so even though I only help buyers I am responsible for managing the blogs. My buyers blog is:
http://mainehomesforsaleonline.wordpress.com/
While I am way off in Maine my blogs give general advice it's not Maine specific.
Hey It's Mindy Again! Here is a link to an article I thought you might find interesting. The new FHA reform has made Down Payment Assistance programs pretty much obsolete. Therefore avaoiding artificially inflated prices on homes.
http://www.realtor.org/fedistrk.nsf/c2c6e17e27e92119852572f8005cd953/428ff29e5bfceed5852572f9004d82cd?OpenDocument
Also look at the latest press release listed to view the 6 changes made to the FHA program.
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