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Why Real Estate Is The Worst Form Of Investment You Can Make
When it comes to investment options, there is a lot of prestige associated with real estate property. For many reasons, many people think real estate investments are more ‘real’ than investing in stocks and bonds, for example. There is a certain psychological certainty and a certain level of assurance one gets when one can drive over to the location of the investment property. You can always have a place on the map to point to and claim as your very own property.
And unlike other types of property, land doesn’t go out of style. As the population increases, your property’s appeal and value increases with increasing demand. Finally, nobody can physically take your property away unlike an expensive Andy Warhol print or Ming vase. With all that said, there are serious reasons why real estate is the most problematic or troublesome investment option out there.
One of the worst investments you can ever make is buying your own home. That’s not to say it’s the worst purchase. The word “investment” taken to mean something that we purchase with an expectation of seeing a return due to an increase in value for example.
It’s common knowledge and something that is taught throughout our lives that if you rent a place, you are in fact throwing your money away. Nevertheless, the opposite is true. By becoming a homeowner, you are throwing your money away, and you are also throwing away some excellent investment opportunities throughout your life too.
The Cost of Owning Your Own Home
To begin with, let’s discuss the actual cost of home ownership. Today, the average home within the U.S. is worth around $175,000, although this of course varies by region. Some pay this off entirely, though the vast majority of buyers usually pay off their homes through a mortgage.
Over the first 5 years, the typical homebuyer spends around 80% of the mortgage payment as interest payments. In other words, or another way to view this is, if you were to purchase a product which costs $100 each month, you’d only be paying $20 monthly towards the actual price of the product. Not at all a wise investment to make!
Comparing a renter to a buyer (that has a mortgage) of the same house, it takes the buyer over 20 years of mortgage payments before they will be paying less each month than would a renter.
Furthermore, when it comes to repairs, renting is of course the better option. Should the washing machine break down, or the roof develops a hole, the renter has nothing to worry about, whereas the home owner must pay up.
Over and above the cost of repairs and/ or renewals, there are needless to say other associated costs that the buyer must pay. Home insurance and property taxes just for example.
A Poor Investment
Owning your own home makes for a terrible investment. Historical trends over the long-term witness housing appreciating at a rate which is barely above that of inflation (3 to 4%). Stocks on the other hand have offered an inflation-adjusted 7 to 10% annually.
Thus, the ‘real’ rate of an investment in a home is zero. Stocks are certainly an infinitely better investment than home ownership. Furthermore, a bad year can delete years of appreciation on a home. Take 2009 for example where we witnessed 15% + drops all around the country due to the housing “bubble”.
While the vulnerability of real estate investments to financial market-triggered sell-offs and depreciation is this investment option’s most dramatic weakness, real estate also comes with a basket of smaller drawbacks. These drawbacks are quite traditional and aren’t going to disappear anytime soon.
First, and most obvious, it takes time to unload even the best real estate property. At the very least, you will have to wait a month or several weeks to unload your property. By that time, other surrounding properties’ values can further drive your pricing down.
Whereas with stocks, you can very easily and quickly sell-up and get out, with a home, you can be stuck with it for years irrespective your desperate desire to sell-up.
As solid as real estate may seem, its value is driven by credit markets and overall market sentiment. When the Central Bank lending policies and interest rates change for the worse, real estate gets hit-hard. How hard? Very hard. The sad truth is that much of real estate’s inflated and fast-growing value is often due to the availability of cheap credit. Cut off this supply through, say, currency devaluation, stock market crashes, or inflation-fighting policies by your local central bank and interest rates can shoot up.
Once interest rates creep or zoom up, many home buyers who previously could ‘afford’ to buy homes are now effectively blocked from buying homes. This can send shock waves throughout the larger real estate market and trigger sell-offs to avoid foreclosures. These are the patterns and warning signs the Great Recession and financial crash of 2008 brought to the table. We would all do well to remember how the financial crash played out because it dramatically shows the severe weakness of real estate as an investment option.
Another problem with real estate is that it is a slave to location. As the old saying goes, the secret to real estate success is location, location, location. This is a serious drawback to real estate since each property must be looked at as unique. Unlike trading in gold or stocks where you can be sure that the price is knowable and predictable, due to the unique nature of locations and their impact on price, you might not make as much money off your property even though it is near an ideal solution. These small location changes can make a big difference.
Maintaining Flexibility Through Renting
Renting is a better option to owning a home simply because you maintain far more flexibility. Your place of work may be located an hour or more commuting time from your home. In total, that would make for around 10 hours of commuting each week. If you rent on the other hand, you could potentially get a place right across the road from your place of work.
The same also applies to future employment opportunities. Plenty of people avoid taking employment opportunities which represent career growth due to the hassles involved in selling their home and finding a new one.
But flexibility is not merely about the time it can take to travel from point A to point B. The ownership of a home can tie up hundreds of thousands of dollars that could be invested far more lucratively elsewhere. You miss all forms of investment opportunities as well as other aspects within your life such as great holiday deals or new items that perhaps you’d like to buy but cannot due to a sizeable repair bill or because of a costly mortgage.
In conclusion, individuals tend to be in favor of home ownership as opposed to renting because it offers a sense of stability. However, you can argue that the only thing that is stable about home ownership is the consistent manner of which your hard-earned income goes towards interest, repair costs, and insurance costs.
You can’t just buy real estate and let it lie there until you unload it. You have to pay property taxes. That’s right-to add insult to the injury of buying real estate which you might later become ‘under water’ on, you still have to pay property taxes. Depending on the state you live in, these taxes might set you back.
Also, if you choose to develop your property, you have to pay for the upkeep of your property. At the very least, you don’t want vandals to turn your property into a crack house. You have to pay management. You have to pay for repairs. You have to continuously pay these while waiting for your property to appreciate enough so you can unload it.
Considering its weaknesses, the best use of real estate is to help diversify your investment portfolio. You get protection from inflation and you get psychological benefits. Just make sure you keep real estate’s drawbacks in mind when planning for the long term.
Furthermore, even when the mortgage payments conclude, there’s still taxes that must be paid. It might be argued that a home owner never does truly own their home. But rather, their home owns them!