Personal Finance Essentials
Real Estate as an Investment Asset
Is Real Estate Really an Investment?
What Every Homeowner Should Know
Your Home Is Not an Investment
A common belief is that a home is the best investment you ever made. This deserves scrutiny. Your home is where you live — you need it regardless of its financial performance. When the home rises in value and you sell it, you still need somewhere to live, and the next home will have risen in value too. Any apparent outperformance from real estate is typically a result of leverage — the mortgage multiplies your return on the cash you invested — not from real estate being a uniquely superior asset. From 1982 to 2009, home values appreciated at an average of about 4.6% per year. The stock market averaged over 10% per year in the same period.
What Counts as Real Estate Investment
Genuine real estate investment includes rental properties, raw land, real estate investment trusts (REITs), stocks of mortgage lenders and home builders and mutual funds that invest in real estate companies. Professional investors typically allocate 3% to 5% of their portfolio to this asset class. Most individual investors own zero real estate investments — they mistakenly count their home.
The Dangers of Leveraged Real Estate Investment
Real estate investors know that leverage — borrowing money to buy property — amplifies returns. It also amplifies losses. Never borrow money to invest in real estate. If you buy investment property, buy it with cash, and maintain at least twelve months of full carrying costs — including mortgage, taxes, insurance, maintenance and allowance for vacancies — in liquid reserves. One cautionary example: an investor buys a house, watches it appreciate, then borrows against that equity to purchase a rental property. The rental does not generate enough income to cover carrying costs. A tenant stops paying. The investor cannot make either mortgage payment. He is forced to sell the rental at a loss exceeding $25,000.
Timing the Real Estate Market
Real estate, like every other investment, goes through boom and bust cycles. Historically, investment fads follow a predictable pattern: prices rise, media coverage draws a flood of buyers at the peak and then prices collapse. The real estate boom from roughly 2000 to 2007 saw prices rise more than 100% nationally before falling sharply. People who bought late in the cycle — after hearing friends’ success stories from years earlier — experienced the full brunt of the decline. Trying to time these cycles is nearly impossible. The better approach is consistent, long-term investing with proper diversification across asset classes.