Why is property investment good if properties de-valuate over time?

Question

So I was reading that investing in property is a safe and solid investment (but low on return). This is based on how the prices rise e.g. a property price in the 1980's vs 1990's vs 2000's vs 2015. To be honest I don't understand the rationale. If the building is e.g. from the 1980's (or older) wouldn't the value decrease as it is too old? i.e don't buildings lose their value as time passes?

I think that most people interested in buying a property would look into newer houses and not older ones that would require maintainance. So what am I misunderstanding here? Is this true only for properties used for commercial purposes?

Answer 1

When you buy a property the house or the building goes down in value every year (it gets depreciated) similar to when you drive a new car out of the lot. However, it is the land that increases in value over time.

As land becomes scarcer the value of land in that area will increase in value, as does land in sought after areas. If more people want to live in a particular suburb the land value will keep on increasing year after year. Sometimes established areas with houses built in the 1980s or even earlier can be worth much more than newly built areas. It comes down to the supply and demand of land and houses in a particular area. You might even get a situation where a run-down dilapidated house in a very sought after suburb sells for more than a brand new house in a less sought-after suburb nearby.

Properties can be a very good investment and they can be a very poor investment. It can largely depend on the decisions you make in buying your investment property. The first thing you need to make a decision on is the location of the property. If you buy a property in a good area that is well sought after you can make good capital and rental returns over the long run. If you buy poorly in an area no one wants to live in then you might have problems renting it out or only be able to rent it out to bad tenants who cause damage, and you may not get any capital gains over many years.

The second thing you need to decide on is when in the property cycle you buy the property. If you buy at the right time you can get higher rents and make some quick capital gains over a relatively short time. I can provide a personal example of this situation. I had bought a house (in Australia) in 2007 for $240,000 at a time when interests where at their highest (9%), no one was buying property and rents were on the increase (with low vacancy rates). Today, eight years after, we are getting $410 per week rent and the house next door (in worse condition than ours) has been put on the market asking for between $500,000 to $550,000 (most houses in the area had been selling during this year for over $500,000). So you can say that our house has more than doubled in 8 years. However, up to a few months ago houses were selling within 2 weeks of being listed. The house next door however, has been listed for over a month and has not had very much interest. So from this you can conclude that in 2007 we had bought near the bottom of the market, whilst now we are near the top of the market.

What you also need to remember is that different areas of a country can have different cycles, so there is not just one property cycle but many property cycles in the same country.

Answer 2

One reason for this is that many people don't simply allow their houses to rot and decay. If you're talking about a house built in 1980 and left vacant and unmaintained for 35 years, it probably will be in pretty poor shape.

But a homeowner generally wants to preserve their house and maintain it in good condition, so they invest in things like new roofs, siding, gutters, windows, paint, exterminators, new furnaces, hot water heaters, air conditioners, etc... All this stuff costs money (and for tax purposes, can often be factored into the cost basis of the house when it is sold), but it maintains the value of the property. A small hole in the roof may be fairly cheap to fix, but if left unrepaired, it could eventually cause much of the building to rot, making the structure near worthless. If a car slams into your living room, you don't generally leave it there; most people repair the damage.

It's not uncommon in some areas to have 100 year old houses (or 300+ year old houses in some countries) that were built well in the first place and have been well maintained in the interim.

People also renovate their homes, ripping out outdated construction and appliances and sometimes building new additions, decks, porches, etc... This also serves to make the property more attractive and increases its value.

Answer 3

As some others have pointed out, it's key to remember the difference in market value and accounting value.

To simplify things, book value is the only item that specifically depreciates... it happens in the world of accounting to try to time "when did I use a long term asset?" with "when did I obtain value from that asset?"

For a house, governments usually allow owners to claim depreciation of the building over a set period of time. This does not affect your resale value of the house.

Similarly, for a commercial property, governments set laws for how an individual or a company can time the "use" of that asset vs. their accounting. Some companies can have totally depreciated ("zero cost") assets that are still very productive.

Market Property values are derived from 3 specific sources:

1. Value in trade (think how much could I sell for vs comparisons?)
2. Value in use (think how much could buyer make by using asset?)
3. Income approach (think specifically about cash flows)

Value in Trade is an estimate of the value that others would be willing to pay for a similar asset. That's why you can buy a house today, and in a "normal" market, the same house should be worth a similar amount of money in the future.

Value in Use can be more interesting... this is where a farmer can extract $100,000 in value per year from 10 acres of land. But as a region develops, a manufacturing company can generate $300,000 per year from the same 10 acres of land. The company can buy out the farmer at a 'fair' price (>$100,000 per year) and still net positive from the investment.

Income Approach tends to be focused on properties that have a cash flow, but can be adapted to other property estimates. It evaluates the current "business case" for any property with the cost of money down, the overall investment price, and the expected value from any returns.

Remember, the market value is very simply, the price you could obtain if you sold the asset at a given time. It is rarely considered in terms of "how much will this go down?".

Book value is an accounting exercise and declines by a set amount every year, because it means you can estimate the "cost" of owning an asset vs the value it generates in a particular time period.

Answer 4

It's all about the land value. The structure is only ever worth as much as it would cost to build a new one (minus demolition costs)

Answer 5

I just read this:

Housing and inflation

Adjusted for inflation the price of a house has increased a miniscule amount. A better investment would be an ETF that buys REIT stocks. You would be investing in real estate but can cash in and walk away at any time.

Here is a list of mREITs:

Stockchart of REITs

Answer 6

Some of the other answers mention this, but I want to highlight it with a personal anecdote.

I have a property in a mid-sized college town in the US. Its current worth about what we paid for it 9 years ago. But I don't care at all because I will likely never sell it. That house is worth about $110,000 but rents for $1500 per month. It is a good investment. If you take rental income and the increase in equity from paying down the mortgage (subtracting maintenance) the return on the down payment is very good.

I haven't mentioned the paper losses involved in depreciation as that's fairly US specific: the laws are different in other jurisdictions but for at least the first two years we showed losses while making money. So there are tax advantages as well (at least currently, those laws also change over time).

There is a large difference between investing in a property for appreciation and investing for income. Even in those categories there are niches that can vary widely: commercial vs residential, trendy, vacation/tourist areas, etc. Each has their place, but ensure that you don't confuse a truism meant for one type of real estate investing as being applicable to real estate investing in general.

Answer 7

There are many different reasons to buy property and it's important to make a distinction between commercial and residential property. Historically owning property has been part of the American dream, for multiple reasons.

But to answer your questions, value is not based on the age of the building (however it can be in a historic district). In addition the price of something and it's value may or may not be directly related for each individual buyer/owner (because that becomes subjective). Some buildings can lose there value as time passes, but the depends on multiple factors (area, condition of the building, overall economy, etc.) so it's not that easy to give a specific answer to a general question.

Before you buy property amongst many things it's important to determine why you want to buy this property (what will be it's principal use for you). That will help you determine if you should buy an old or new property, but that pales in comparison to if the property will maintain and gain in value. Also if your looking for an investment look into REIT (Real Estate Investment Trust). These can be great. Why? Because you don't actually have to carry the mortgage. Which makes that ideal for people who want to own property but not have to deal with the everyday ins-and-outs of the responsibility of ownership....like rising cost. It's important to note that the cost of purchase and cost of ownership are two different things but invariably linked when buying anything in the material strata of our world. You can find publicly traded REITs on the major stock exchanges. Hope that helps.

Answer 8

Real estate is not a good investment. In fact, it's easy to make a case for it being the worst possible investment imaginable:

Imagine over a cup or coffee or a glass of wine we get to talking about investments. Then maybe one of us, let’s say you, says:

“Hey I’ve got an idea. We’re always talking about good investments. What if we came up with the worst possible investment we can construct? What might that look like?”

Well, let’s see now (pulling out our lined yellow pad), let’s make a list. To be really terrible:

• It should be not just an initial, but if we do it right, a relentlessly ongoing drain on the cash reserves of the owner.
• It should be illiquid. We’ll make it something that takes weeks, no – wait – even better, months of time and effort to buy or sell.
• It should be expensive to buy and sell. We’ll add very high transaction costs. Let’s say 5% commissions on the deal, coming and going.
• It should be complex to buy or sell. That way we can ladle on lots of extra fees and reports and documents we can charge for.
• It should generate low returns. Certainly no more than the inflation rate. Maybe a bit less.
• It should be leveraged! Oh, oh this one is great! This is how we’ll get people to swallow those low returns! If the price goes up a little bit, leverage will magnify this and people will convince themselves it’s actually a good investment! Nah, don’t worry about it. Most will never even consider that leverage is also very high risk and could just as easily wipe them out.
• It should be mortgaged! Another beauty of leverage. We can charge interest on the loans. Yep, and with just a little more effort we should easily be able to persuade people who buy this thing to borrow money against it more than once.
• It should be unproductive. While we’re talking about interest, let’s be sure this investment we are creating never pays any. No dividends either, of course.
• It should be immobile. If we can fix it to one geographical spot we can be sure at any given time only a tiny group of potential buyers for it will exist. Sometimes and in some places, none at all!
• It should be subject to the fortunes of one country, one state, one city, one town…No! One neighborhood! Imagine if our investment could somehow tie its owner to the fate of one narrow location. The risk could be enormous! A plant closes. A street gang moves in. A government goes crazy with taxes. An environmental disaster happens nearby. We could have an investment that not only crushes it’s owner’s net worth, but does so even as they are losing their job and income!
• It should be something that locks its owner in one geographical area. That’ll limit their options and keep ’em docile for their employers!
• It should be expensive. Ideally we’ll make it so expensive that it will represent a disproportionate percentage of a person’s net worth. Nothing like squeezing out diversification to increase risk!
• It should be expensive to own, too! Let’s make sure this investment requires an endless parade of repairs and maintenance without which it will crumble into dust.
• It should be fragile and easily damaged by weather, fire, vandalism and the like! Now we can add-on expensive insurance to cover these risks. Making sure, of course, that the bad things that are most likely to happen aren’t actually covered. Don’t worry, we’ll bury that in the fine print or maybe just charge extra for it.
• It should be heavily taxed, too! Let’s get the Feds in on this. If it should go up in value, we’ll go ahead and tax that gain. If it goes down in value should we offer a balancing tax deduction on the loss like with other investments? Nah.
• It should be taxed even more! Let’s not forget our state and local governments. Why wait till this investment is sold? Unlike other investments, let’s tax it each and every year. Oh, and let’s raise those taxes anytime it goes up in value. Lower them when it goes down? Don’t be silly.
• It should be something you can never really own. Since we are going to give the government the power to tax this investment every year, “owning” it will be just like sharecropping. We’ll let them work it, maintain it, pay all the cost associated with it and, as long as they pay their annual rent (oops, I mean taxes) we’ll let ’em stay in it. Unless we decide we want it.
• For that, we’ll make it subject to eminent domain. You know, in case we decide that instead of getting our rent (damn! I mean taxes) we’d rather just take it away from them.

-- Why Your House Is A Terrible Investment

There are plenty of good reasons to own a home, but the key word there is "home". Owning housing as an investment property is a horrible idea, and anyone who does it, especially right now with as bubbly as the market is looking again, (or, better put, still, since the last bubble never did fully pop and clear out the underlying systemic instability,) is an idiot.

And even after the current housing market bubble pops, it's likely to remain a bad idea for decades. We're never getting the early 2000s back, for basic supply-and-demand reasons: with the Baby Boom generation retiring, aging and dying off, they're not likely to do much more home-buying, and no generation after them is as big as they are, which means a glut of oversupply and weak demand for the entirety of the foreseeable future.

Answer 9

1. it is the land that goes up in value, not the house that is built on it
2. home owners are constantly making repairs and upgrades. this can make the house appear to go up in value if you ignore the money spent.
3. real estate is not always a good investment. property values frequently plummet when the population decreases (e.g. due to the loss of a major employer or industry). in rural areas, there can be long periods of time during which there are effectively no motivated buyers.
4. real estate is protected from inflation risk like a commodity, but can simultaneously provide value like a capital asset (in the form of rental income or living space)
5. mortgages provide both tax breaks and leverage. they also force the homeowner to accumulate wealth in the form of equity. that can be a benefit to someone who would not normally invest regularly.

Answer 10

Properties do in fact devaluate every year for several reasons. One of the reasons is that an old property is not the state of the art and cannot therefore compete with the newest properties, e.g. energy efficiency may be outdated. Second reason is that the property becomes older and thus it is more likely that it requires expensive repairs.

I have read somewhere that the real value depreciation of properties if left practically unmaintained (i.e. only the repairs that have to absolutely be performed are made) is about 2% per year, but do not remember the source right now. However,

• Inflation is 2% per year, so if you leave a property practically unmaintained, you can expect its nominal value to stay about constant
• Almost nobody leaves properties practically unmaintained. Properties are maintained and upgraded, and this adds to the value of the property, so you can expect a well-maintained property to keep not only its nominal value but also its real value. Just remember to include these additional maintenance and upgrading costs as expenses in your calculations.

Properties (or more accurately, the tenants) do pay you rent, and it is possible in some cases that rent more than pays for the possible depreciation in value. For example, you could ask whether car leasing is a poor business because cars depreciate in value. Obviously it is not, as the leasing payments more than make for the value depreciation.

However, I would not recommend properties as an investment if you have only small sums of money. The reasons are manyfold:

• The price you need to pay for a complete property is quite large, so if you do not have that amount of money, you need to use debt leverage. In my opinion, it is generally a bad idea to use debt leverage. Instead, more riskier (and therefore more returning) assets such as stocks should be preferred. With debt leverage, there is a risk that you hold negative equity at some point of time, but no stock will turn out to have a negative value.
• Property investments are hard to diversify. To diversify well, you should hold different sizes of properties, properties in different areas, etc. To have a well-diversified portfolio, it is generally recommended to have at least 20 different investments. Most of us do not have the money for 20 different property investments, but do have the money for 20 different stock investments.
• The risks in investing in just only one property are huge. E.g. what do you do if the property turns out to have a mold problem? You can lose the entire value of your investment almost overnight.

So, as a summary: for large investors property investments may be a good idea because large investors have the ability to diversify. However, large investors often use debt leverage so it is a very good question why they don't simply invest in stocks with no debt leverage. For small investors, property investments do not often make sense.

If you nevertheless do property investments, remember the diversification, also in time. So, purchase different kinds of properties and purchase them in different times. Putting a million USD to properties at one point of time is very risky, because property prices can rise or fall as time goes on.