Is Real Estate ever a BAD investment? If so, when?

Question

Even in a bad market, over 30 years won't the value of Real Estate always go up? Is it always a sure bet? If not, what should an investor or buyer consider?

Answer 1

No, it can really not. Look at Detroit, which has lost a million residents over the past few decades. There is plenty of real estate which will not go for anything like it was sold.

Other markets are very risky, like Florida, where speculators drive too much of the price for it to be stable. You have to be sure to buy on the downturn.

A lot of price drops in real estate are masked because sellers just don't sell, so you don't really know how low the price is if you absolutely had to sell.

In general, in most of America, anyway, you can expect Real Estate to keep up with inflation, but not do much better than that. It is the rental income or the leverage (if you buy with a mortgage) that makes most of the returns. In urban markets that are getting an influx of people and industry, however, Real Estate can indeed outpace inflation, but the number of markets that do this are rare.

Also, if you look at it strictly as an investment (as opposed to the question of "Is it worth it to own my own home?") there are a lot of additional costs that you have to recoup, from property taxes to bills, rental headaches etc.

It's an investment like any other, and should be approached with the same due diligence.

Answer 2

Real estate is a lousy investment because:

• it's illiquid (not all that easy to sell)
• it's indivisible (you can't sell off your garage if you need emergency cash for a medical bill)
• it's often tied to risks in the local economy which affect your job, which means that if you have a place in Michigan and the auto industry goes under then you've lost money on your house as well as losing your job. (investing the money lets you diversify)
• the down payments have opportunity costs (you could invest them in relatively risk-free locations and earn similar rates of return)
• you don't enjoy tax-deductible maintenance costs, so upkeep can be more expensive

Renting a home and buying a home, all else being equal, are pretty similar in costs in the long term (if you can force yourself to invest the would-be down payment). So, buy a home if you want to enjoy the benefits of home ownership. Buy a home if you need to hedge against rising housing prices (e.g. you're on a fixed income and couldn't cope if rent increased a bunch when the economy heated up). Maybe buy a home if you're in a high tax bracket to save yourself from being taxed on your imputed rent, if it works out that way (consult your financial advisor).

But don't consider it a really great investment vehicle. Returns are average and the risk profile isn't that attractive.

Answer 3

All other factors being equal, owning your primary residence is almost always a good investment over the long haul.

Why? Because you have to live somewhere, and rentals, especially long-term leases that are important when you have kids in school, etc., are generally in the same ballpark as a mortgage in most markets. Giving $1,500 to a landlord gets me 30 days of living somewhere. Giving $1,500 to the bank gets me a place to live and equity in an asset which requires maintenance, but always has intrinsic value.

Detroit is one extreme, Manhattan or Silicon Valley is another real estate extreme... everywhere else is somewhere in the middle.

What isn't always a good investment is speculating in highly elastic "investment property" like vacation condos as an amateur. It's a cyclical market, but our attention spans are too short to realize that. As most of the other answers to this question indicate, people tend to be down in the dumps and see all of the problems with real estate when the market is not very good. Conversely people only see the upside and are oblivious to problems when the market is high.

Answer 4

Real estate is always an interesting dynamic. In most cases prices have always gone up.

Price is mainly a function of demand. Sometimes demand is artificially inflated over a short term period and can come down quickly due to corrections. During recessions the housing market will usually slow down. There are some rare instances where certain areas never recover (see Subprime Mortgage Crisis Savings & Loans Crisis where scores of unwanted properties exist). Things to consider:

• Principle residence: This matters since most people are not in the habit of buying and selling frequently their main residence since there are costs such as moving expenses, taxes, commissions involved. Most owners will hold this investment over a longer period and will not be affected as much in a bad market.
• Location: The old adage that about where the property is. Is it close to schools, recreation facilities, shopping centres, public transit? These things increase demand and affect the eventual sell price.
• Speculation: If the property is solely for investment, owner's typically want to hold over shorter periods. In a bad market one may need to be prepared to hold the property longer than anticipated which can incur more costs.
• Buyers: If there is a steady stream of new home owners demand will increase. Where are the potential buyers coming from? Are these people who are starting out for the first time? Are they due to immigration?
• Availability of Money: If borrowing costs are low this can increase the demand.

Answer 5

I'm surprised to even hear this question with the current state of devaluation of real estate.

One thing I'll add to the other answers is to make sure you are doing a true apples/apples comparison to other investments when considering real estate. You can't just take subtract the purchase price from the sales price to get your ROI.

Real estate has very heavy carry costs that you need to factor into any ROI calculation including:

• Debt servicing such as mortgage interest (if any)
• Annual Property Taxes
• Repair and maintenance costs
• Homeowner's association fees
• Periodic Renovation/Remodeling (It takes about 20 years for a house to go from Architectural digest to Brady-Bunch)

One more point: A house that you live in shouldn't be considered an investment, but rather an expense. You have to be able to liquidate an investment and collect your return. Unless you plan to move back in with your parents, you are always going to need a place to live so you can never really cash out on that investment, except perhaps by downgrading your lifestyle or a reverse mortgage.

Answer 6

As Yishani points out, you always have to do due diligence in buying a house. As I mentioned in this earlier post

I'd highly recommend reading this book on buying a house associated with the Wall Street Journal - it clearly describes the benefits and challenges of owning a house. One key takeaway I had was - on average houses have a "rate of return" on par with treasury bills.

Its best to buy a house if you want to live in a house, not as thinking about it as a "great investment". And its certainly worth the 4-6 hours it takes to read the book cover to cover.

Answer 7

There's an aspect to real estate that's under-discussed. When you take all factors into account, it just about keeps up with inflation over the long term. Three factors:

1. adjust for size. i.e. don't let the fact that in the last 30 or so years the median home has grown in size by about 1.5%/yr. The house measured is not the same house year to year, obviously.
2. Income tends to rise a bit faster than inflation over the long term.
3. A payment of say, $1000/mo will support a $136K mortgage at 8%, but $197K at 4.5%. So, with no change in payment, a buyer sees his potential for borrowing jump by 50% based on rate.

Now - when you normalize all of this, calculating the "hours worked" needed to pay for the median home, you find a nearly flat line at just over 40 or so hours of pay per month.