Wednesday, December 3, 2008

Is Real Estate Our Best Shot At Wealth?

Real estate has been a tremendous wealth builder over the years, but now that we are seeing record price falls is it still the best path to wealth? 91 percent of homeowners surveyed by real-estate-services firm Realogy Corp. thought that owning a home was the best long-term investment they could make, according to the Wall Street Journal. Looking at those numbers, it seems as though people still think that real estate investment is a good road to wealth, but what about the experts? According to a recent article in the Wall Street Journal, most experts expect housing prices to level out over the next few years, and then regain a more historically balanced appreciation rate of between 2-4 percent per year. The tone of the article—which you should read if you haven’t already—seems to imply that real estate is not such a great investment, and certainly not the best path to wealth for Americans. After reading the article I agree with many points that were made, but I also think that they left out some huge pieces to the equation.

In the article Kenneth Rosen, chairman of the Fisher Center for Real Estate at the University of California, Berkeley, advises that people should think of their own homes mainly as places to live, not as investments. This is wonderful advice: The house you live in is not an investment nearly as much as it is just a roof over your head. Throughout the article the author evaluates the merit of real estate investment assuming solely that the “investment” is a person’s primary residence. Yet, when he interviews investors that talk fondly of real estate, they talk not about their primary residences but about rental homes they own. This is a huge difference, and I feel one that the author did a very poor job of differentiating. I agree that primary residences are a poor investment, but that is not their purpose. Rental housing on the other hand can be an incredible investment if managed properly.

I agree with the article’s point on real estate appreciation not being a reliable wealth builder. No one can predict which way prices will go next, and people should not rely on appreciation estimates when evaluating the worth of an investment opportunity. Investors should look instead at the cash flow numbers. Cash flow is something tangible, and it doesn’t require a call into the psychic hotline to predict. In addition properties that command better cash flow typically do not drop in price as much during market fluctuations. Dramatic price drops happen when people sell in desperation. They have to get out from under the house, so they drop the price until it sells. What motivation does an investor have to drop the price on their rental house if it is bringing in money every month? The answer is that they have very little motivation to do so, and so they probably won’t.

So while I agree that property appreciation shouldn’t be counted on anymore, that doesn’t make real estate a bad investment. Primary residences and rental properties are two entirely different animals and should be looked at independently when evaluating the merit of real estate as an investment. Investors can still make great money in the real estate market if they focus on the right things. Is it the best path to wealth for Americans? I think the answer to that question is yes and no. I think it can be for the right person, who is willing to put in the time and energy. For the person who tries to cut corners, real estate investing is likely to be a painful and costly experience.

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2 comments:

December 4, 2008 at 12:10 PM Anonymous said...

sure! buy homebuilder's puts

December 4, 2008 at 2:08 PM Eric Ames said...

Haha...that certainly has been the case lately. I wonder, though, how homebuilder stocks will react if that mortgage interest rate buy down to 4.5% bill goes through? Somehow I think it will help homebuilders more than those facing foreclosure.

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