February 11th, 2019 7:02 PM by Jackie A. Graves, President
Folks used to say, “You can’t go wrong with
real estate.” They sure don’t say that anymore. It’s been a rollercoaster dozen
years for home prices—and some experts think another rough patch is in the
Since the housing crisis began in mid-2006, national home prices have plunged by
more 25% of their value — only to bounce back, rising more than 50%. While that
may sound like a significant recovery, it’s a lot less impressive when you
consider that more than a decade elapsed in the meantime. Today, home prices
are about 12% above where they were in 2006, equating to a gain of less than 1%
Could we be facing another dip? According to the National
Association of Realtors, home
10% over the past year, in part because of rising mortgage rates. That’s
worrisome: Slowing home sales often precede a fall in house prices.
But my goal here isn’t to scare away potential home buyers.
Quite the opposite: I think everybody should strive to become a homeowner—but they should do so
with their eyes wide open.
What do I mean by that? Real estate discussions almost
invariably fall hostage to anecdotal evidence. We all
know folks who supposedly made a mint in real estate, as well as people who
lost their shirt. But forget the anecdotal evidence, and instead focus on
statistics and commonsense.
To that end, here are my 13 rules for real estate:
Homeownership isn’t as safe as it feels. A house is a big, leveraged,
undiversified bet—arguably riskier than owning a diversified stock portfolio.
Yet it doesn’t feel that way. Why not? Partly, it’s familiarity. We look around
our house and see the value that’s there. And partly, it’s a money illusion. If
we got daily updates on our home’s value, like we do on our stock portfolio, we
wouldn’t be nearly so sanguine about our huge real estate wager.
We shouldn’t buy unless we can see staying put for at least five
years—and preferably seven years or longer. Buying
and especially selling real estate involves steep transaction costs, and we
need many years of price appreciation to overcome that hit.
Over the long haul, home prices nationwide should rise roughly in line with per-capita
GDP. Why per-capita GDP? That’s a gauge of our ability to pay. Sure enough,
over the past 40 years, per-capita GDP has climbed 4.5% a year—and home prices
are up 4.3%, according to Freddie Mac. Meanwhile, inflation
clocked 3.4% annually.
Obviously, we’ll get years when home prices climb faster or
slower. But over the long haul, we shouldn’t expect to do a whole lot better
than a percentage point or so a year more than inflation.
The land underneath our homes should appreciate, but the
dwelling itself will depreciate—and we’ll need to fork over hefty sums just to
keep up with the general increase in home prices. As a rule of thumb, expect to
spend a sum equal to between 1% and 2% of a home’s value on maintenance each
Any gain in our home’s value will likely be largely or entirely
offset by transaction costs, maintenance, property taxes and homeowner’s
insurance. Subtract those costs from our home’s annual price gain, and we
probably aren’t keeping up with inflation and there’s a good chance we’re
The benefits of leverage are often offset by the cost of leverage. Homeowners may put down just 10% or 20% of a home’s purchase
price—but they collect 100% of any price appreciation. Result: Even prosaic
property price increases can be transformed into wondrous gains—or so it seems.
Let’s say we might put down $30,000 on a $300,000 home. If the
home’s price rises 30% to $390,000, our home equity would soar 300%, from
$30,000 to $120,000. But how much did we pay in mortgage interest to get that
leveraged gain? Often, the total interest paid rivals the increase in home
The mortgage-interest tax deduction has always been
overrated—and, today, that’s truer than ever. If we pay $1 in mortgage and
we’re in the 22% tax bracket, we only save 22 cents in taxes, which means the
other 78 cents is coming out of our pocket.
This assumes we itemize our deductions. But with the 2019 standard deduction at $24,400 for
couples filing jointly, many homeowners will find their total itemized
deductions are less than their standard deduction—which means they’re getting
zero tax benefit from all the mortgage interest they pay.
If you’re a homeowner with a fixed-rate mortgage, what you
really want is inflation. Why? That inflation
will likely drive up both your home’s price and your salary, while leaving your
mortgage payment unchanged. That means you can repay the mortgage company with
depreciated dollars, while having more disposable income for everything else.
While a home’s price appreciation and mortgage-interest tax
deduction will likely prove disappointing, homeowners enjoy one huge benefit:
They get to live in the place. How much is this imputed rent worth? Think about how much you’d collect each year if you
rented out your house.
All homes should be priced to deliver the same expected total
return. Folks will talk about real estate in, say, San Francisco and Silicon
Valley, as though these are magical markets that somehow defy economic norms.
The reality: The total return—the combination of price
appreciation plus rent or imputed rent—should be similar across property
markets. In other words, in highflying real estate markets, rents tend to be
modest relative to home prices, so total returns aren’t unusually high. This
has been borne out by academic research.
A paid-off home is the cornerstone of a comfortable retirement,
for two reasons. First, by paying off our mortgage, we eliminate a major
expense, making retirement more affordable. Second, thanks to the forced
savings that come with paying down a mortgage’s principal balance, we eventually
come to own a major asset free and clear. That asset can then help us to
finance our retirement, either by trading down to a smaller place
or taking out a reverse mortgage.
Remodeling is a money loser. If we undertake home improvements, we’ll increase the value of our home—but by less than the
dollars we spend. For proof, check out Remodeling magazine’s annual cost vs. value survey. It analyzes 22 home improvement projects. Depending
on the project, if we sold soon after making these home improvements, we might
recoup as little as 50% of the money spent.
A real estate agent’s greatest financial incentive isn’t to get
us the best price, but to get us to act quickly. If we spend an extra month
looking for the right home—or holding out for a higher price—the agent might make little or no additional commission, but he or
she will have to put in substantially more work.
Still, don’t allow yourself to be rushed. If you keep your house
on the market for an extra month and make $10,000 more, that would be a huge
win. And if you buy a house you aren’t entirely happy with and end up moving
soon after, that would be a terrible mistake.
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