Planrcoach: The case against housing

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Feb 19, 2007 10:42 am

Report finds residential real estate underperforms other assets

Wednesday February 14, 4:33 pm ET



CHICAGO (MarketWatch) -- Don't count on home equity to come through
with a significant portion of retirement funding, cautions a new report
by Fidelity Investments.

According to the study, home values
underperformed stocks and bonds over every five- and 10-year period
from 1963 to 2005. Home values have been slightly above the returns on
treasury bills during the same time, according to the report, "The
Equity You Live In: The Home as a Retirement Savings and Income Option."


"When
we started the work, the real question was: If I have home equity, how
should I think about using it in retirement," said Guy L. Patton,
executive director of the Fidelity Research Institute. "The conclusion:
The returns on residential real estate are probably less than what most
people think they are."


Over the more than 40-year period, real
compound returns on stocks outpaced that of residential real estate,
according to the study, with 5.95% average annual returns on stocks
compared with 1.35% in realty. A dollar invested in stocks in 1963
would have compounded to $12.36 by 2006, while the same dollar would
have grown to $1.79 in real estate.


====


The
Equity You Live In: The Home as a Retirement Savings and Income Option.


http://www.fidelityresearchinstitute.com/pdf/wp5_equity_fina l.pdf





I Shall call this chart, "SBBRE", fascinating that both residential real estate and annuities have 6% sales commisions.


At least annuities don't get termites.


Feb 19, 2007 11:09 am

Allreit this is 100% true but very misleading. Here is why:



$10000 into a fund at 5.95% = $10,595 after 1 year



$595 Gain



$10,000 down on a $200,000 house = 202,700 after 1 year



$2700 Gain



Any Questions?

Feb 19, 2007 11:37 am

What are the taxes, insurance and maintenance? Does it need new paint, appliances, etc? How liquid is it?


Feb 19, 2007 11:46 am

This is the problem with generalizing a situation.  First: I don't believe that most people look at their current home as an option for a source of retirement income. Most of my clients (and myself) look forward to living in the home without a mortgage.  Something you can't do in an annuity  


Second: the return on equity depends on where you live now and where you plan to live later, in retirement.  My home has gone up over 200% in value in the last 5 years and is not likely to go down in value, because the desireablilty of my area will continue to draw new people in the future. Big whoop.  If I were to sell it in 10 years and take the gain in the equity, unless I wanted to move someplace else with lower property values, there would be no advantage.   I would still have to purchase another home at similar price or lease at a high monthly rate.  No advantage.


I would, however, be very interested in a reverse mortgage when I decide to retire.

Feb 19, 2007 11:56 am
bankrep1:

Allreit this is 100% true but very misleading. Here is why:



$10000 into a fund at 5.95% = $10,595 after 1 year



$595 Gain



$10,000 down on a $200,000 house = 202,700 after 1 year



$2700 Gain



Any Questions?





Whoa there, How much did you spend on taxes, insurance, and maintenance for that house? Those hedges don't hedge themselves.



At 3% all in on the house, thats $30009 a year. And if you start having major repairs....



And who puts only 5% down on house?

Feb 19, 2007 12:02 pm
AllREIT:



At 3% all in on the house, thats $30009 a year. And if you start having major repairs....



And who puts only 5% down on house?





Make that $6000 pa on $200,000 house.



So even with 1.7% annual price appreciation on $200,000 home @ 19:1
leverage, you still lose money assuming other costs total around 3%.



Year 1: 200,000 --> 203,400, Less $6000 in Insurance, Tax, maintenance.  What a great investment.



Let's not forget the 6% surrender charge (CDSC) on houses.





Feb 19, 2007 12:15 pm

This is the problem with generalizing a situation.  First: I don't believe that most people look at their current home as an option for a source of retirement income.


Financial planning is about wealth creation, and is tailored to the individual. Home ownership is a good example.


1. Location: Earth has finite real estate. The area where I live is expected to grow by 1m over 15 years. It is one of the real beautiful places on this earth, noted for quality of life, land use planning, nature, access to the amenities of civilization.


2. Generally, the U. S. is blessed with real estate and freedom. Considering the 1 t + of excess in foreign deposits in China alone, and earth's 6b + population, U. S. trade policy, and so on, it is reasonable to assume that real estate, in the right location, will maintain reasonbale appreciation rates.


3. Location of a tangible investment: near the best schools in your city, near your office, your golf club, with a nice view, on a greenway, with a nice home office so you can save gas and be a good world citizen,  with plenty of space for you kids to invite their kids over instead of carousing on the streets. All things being equal, you can live inside and enjoy your home and you can't live inside your IRA.


4. Do the numbers. Unfortunately, many financial advisors have a conflict of interest in recommending that clients put more cash flow to their leveraged investment in "more house". In my own situation, considering state income taxes, the write off of property, mortage interest and other taxes, putting more money to a mortgage at the current like, assuming 5% home appreciation and eventually selling the gain at no taxes, is like putting money in a retirement at about 50 stocks and 50% bonds. Do the math for yourself, if you don't like it, don't do it.


5. Today's new homes are energy efficient, have cleaner indoor air, can be wired better for technology, have slate composite roofs, concrete "wood" plank siding, doubled paned energy efficient windows with some kind of special gas between the two panes, efficient hot water cirulation to save energy, and so on. For some, this will be an appreciating asset inside which you spend the majority of your time - working from home one or two days per week, watching the world on wall sized high definition screens, doing laps in your own energy efficient pool, and so on.


6. Alternatively, live in a tiny flat and save every penny into a diversified investment portfolio. Hire an advisor to allocate according to historical research and projected returns. Of course, the world, with its 6 billion plus people is becoming more complex and uncertain every day. But in 25 years, if we compound your IRA at 10% every year ......


7. Of course, reality lies in the middle. My point is, your own home is your very best real estate investment - we're not talking about going into the rental business here. I remember traveling with a CPA, about ten years after the fact, he turned to me and said, " I'll just always remember that you urged me to own a bigger home - to step up and make the plunge. Now, when I look back, that was my best investment. Do you have any other ideas like that?" I said, "Yes, let's talk about the bonds of local governments from all across America - held in a mutual fund - the ones that yield a little more, they're still backed by the taxing power of local governments ..."


8. I really don't mean to debate the point, Allreit, as it comes down partly to individual preference and location. This has about as much to do with termites and rust as does the practice of living one's




 life for others.

Feb 19, 2007 2:26 pm

I Shall call this chart, "SBBRE", fascinating that both residential real estate and annuities have 6% sales commisions.


Interesting chart. I wonder if there will ever be another 20 year period in history like the first 20 years of this chart.


 

Feb 19, 2007 2:58 pm

I was making a generalized statement to make a point, also note who authored the study. I doubt 1.95% is very realistic and 5.95% sounds a bit low to me as well.

Feb 19, 2007 3:37 pm

I think the reference was to Allreit, who generally takes an apparently cerebral approach to financial planning problems.


 the return on equity depends on where you live now and where you plan to live later, in retirement.  My home has gone up over 200% in value in the last 5 years and is not likely to go down in value, because the desireablilty of my area will continue to draw new people in the future. Big whoop.  If I were to sell it in 10 years and take the gain in the equity, unless I wanted to move someplace else with lower property values, there would be no advantage.


No comparative advantage in absolute terms if you live in the same place. Except, you "marked" yourself to the market during those ten years. Leverage appreciation is leveraged appreciation.


If the extra cash flow was in a retirement plan instead, you pay taxes when it comes out. If the extra cash flow is locked up in the house, you have to sell to get the money out tax free.


How about a reverse mortgage. These products are becoming more competitive every day - I wonder why? This is a sort of homeowners twist on the old "borrow from your self" strategy, without the insurance product.


Another question: in ten or twenty years, do we all think taxes are going to be lower, higher, or about the same as now? I believe there would be a popular revolt in the cap gains treatment on sale of primary residence changes. Whereas tax treatment of IRA distributions (taken along side Social Security "income", other pensions) will be more like a frog in a pan on cold water over the gas stove situation.


Pay your taxes now, while they are "cheap". Control your investment (choose all aspects of your home investment wisely). Combine this with other types of strategies.

Feb 19, 2007 8:33 pm
bankrep1:

I was making a generalized statement to make a point,
also note who authored the study. I doubt 1.95% is very realistic and
5.95% sounds a bit low to me as well.





Of course Fidelity has a dog in this fight. I'll respond to the good points planr made a second post.



Note well that Fidelity is talking about compounded real returns. So 5.95+ 3.00% Inflation == 9% which is the historical nominal return on stocks. 1.35+3 == 4.3% nominal return on housing.



My main point, is that IMHO the last few years of the housing bubble have given people a highly distorted view of the returns from residential real estate.



You have alot of people who buy into the Robert Kiyosaki illusions that
"real estate" (i.e residential real estate) is the road to riches.
Riches that come by flipping houses or just sitting on your own
house/personal gold mine. This is just like the late 1990s internet
bubble. People thought 20% pa returns on stocks were normal



There is really no housing shortage in the US
except in highly constrained submarkets. Most (95%+) of the country is
just a sub-division away from more McMansions, or infill condo/housing
developments.



The current housing inventory on hand is something like 7-8 months and
it will only go up, as homebuilder's keep building and forclosures
(from ARM resets + background rate) reenter the market.

Feb 19, 2007 9:02 pm

I have yet to meet someone in retirement that is "using" their home as an investment.  Most of the time people say this, but the reality is, they either stay put, or they spend just as much on their next residence. 


Yes, it is wise to "invest" in your home (rather than rent).  But people should not "count" home equity in terms of tangible, spendable assets for retirement (unless they are 100% certain they will be downsizing considerably). 


But most novice investors have it backwards.  They think paying down their mortgage early is an "investment" in their home, when in reality, all you are doing is giving back leverage.  Even after you try to explain the math and the reality to them, it just doesn't sink in.


I find, however, that for many people, there is true comfort in paying off their mortgage in full.  When people need that peace of mind, I let it be.  For people really interested in fully maximizing their wealth, we include use of home equity leverage in that discussion.

Feb 19, 2007 9:22 pm

My main point, is that IMHO the last few years of the housing bubble have given people a highly distorted view of the returns from residential real estate.


Allreit, thanks for the thread discussion.



Good point, it is scary how second mortgages have apparently financed our negative national savings rate.


Most (95%+) of the country is just a sub-division away from more McMansions, or infill condo/housing developments.


Reason to be really smart about investing in and enjoying your own home.


The current housing inventory on hand is something like 7-8 months and it will only go up, as homebuilder's keep building and forclosures (from ARM resets + background rate) reenter the market.


Good point - but we might die tomorrow, too.  Build wealth, and enjoy your life today.  Very good chance the stock market will correct ten or twenty percent in the next year. Who cares.


I believe you said you are a risk taker. Take a risk on your own house investment, that is smart betting. Encourage your clients to do the same. It a tangible, enjoyable asset that everyone understands. No concidence that there is a trend toward greater % of income going to mortgage payments.


As far as the Fidelity study, they are very smart people. They are calling our clients now, about providing personal 401k advising. We know where their bread is buttered. Mine gets buttered through creating total wealth for my clients.


for many people, there is true comfort in paying off their mortgage in full. 


Good point, 24. Nothing wrong with it - having your mortgage paid off is a very important form of true wealth. Just like, spending the dividends off stocks or bonds.


Work with this kind of personality, just like - completely separately - you have to figure out how to get paid from compulsively cheap people who don't like to pay for anything. Still good clients who just need your help.


Feb 20, 2007 4:12 am
planrcoach:
Location: Earth has finite real estate. The area
where I live is expected to grow by 1m over 15 years. It is one of the
real beautiful places on this earth, noted for quality of life, land
use planning, nature, access to the amenities of civilization.

But there is an almost infinate ability to create more housing. Thus without scarcity, the potential for housing appreciation at rates above inflation are highly limited.


That is pretty consistant with FMR's finding of a 1.35% real return on housing.


. Generally, the U. S. is blessed with real estate and
freedom. Considering the 1 t + of excess in foreign deposits in China
alone, and earth's 6b + population, U. S. trade policy, and so on, it
is reasonable to assume that real estate, in the right location, will
maintain reasonbale appreciation rates.


China's economy and US residential real estate are unrelated. All
the chinese are not going to spend their money to move to the US. The
only way to force appreciation is to make housing scarce.


This is why Manhattan is expensive but the outer boroughs cheaper,
and the exurbs even cheaper. Given the pro building legal landscape in
much of the US, there is endless building of new subdivisions and so house prices converge on the cost of building a new house (which isn't very much).



[quote]4. Do the numbers. Unfortunately, many financial advisors
have a conflict of interest in recommending that clients put more cash
flow to their leveraged investment in "more house".[/quote]


I'm like a primerica rep, rent and invest the difference.


More seriously, I advise clients to be very reasonable in their purchases of housing and/or borrowing to do so. Far better to be the mortgagor than the mortgagee.


[quote]In my own situation, considering state income taxes, the
write off of property, mortage interest and other taxes, putting more
money to a mortgage at the current like, assuming 5% home appreciation
and eventually selling the gain at no taxes, is like putting money in a
retirement at about 50 stocks and 50% bonds. Do the math for yourself,
if you don't like it, don't do it.[/quote]


Your IRR is much worse, because of all the cash outlays on taxes, insurance and maintenance. Your house requires enourmous and variable cash inflows just to maintain its value. Figure on average 3.2% a year of its gross value, but possibly much more if major repairs are ever needed.


Don't forget the 6% surrender charge on the house.


[quote]5. Today's new homes are energy efficient, have cleaner
indoor air, can be wired better for technology, have slate composite
roofs, concrete "wood" plank siding, doubled paned energy efficient
windows with some kind of special gas between the two panes, efficient
hot water cirulation to save energy, and so on.[/quote]


But if that is the standard, then having the standard features
doesn't make a difference. It's like selling a car with A/C and an
AM/FM radio.


I would also say that on the whole new houses are poorly built
because the cost of building is spread over more squarefeet. The
fixtures and general finish levels on new McMansions are very poor.


[quote]7. Of course, reality lies in the middle. My point is, your
own home is your very best real estate investment - we're not talking
about going into the rental business here.[/quote]


You haven't talked to EOP shareholder's have you?


Going by FMR's research, if the return on housing is 1.35%, then you
would do alot better with TIPS. There is a massive propaganda machine
to promote residential real estate in this country. But the wheels are comming off the short bus.



Feb 20, 2007 10:54 am

Good points. Until I started practicing what I believe, I might have agreed with you in general.


All the chinese are not going to spend their money to move to the US. The only way to force appreciation is to make housing scarce.


( Minor point), Not all, but the ones that do have $$. In my area, this has already begun. How do you think we are going to deal with the trade imbalance ( along with appreciation of the Yuan). Chinese investment here will complement immigration from Mexico.]


Meanwhile, I a very happy with my investment in new construction in a great location - it is a shining portfolio star. Around here, listing prices have started going back up.


Great discussion!

Feb 22, 2007 10:21 pm

It is interesting if you take real estate and add in the costs. Everything from maintenance, insurance and taxes. Up here in New England its about 5k for 200k home a year. On top of this 98% of Americans have a mortgage with interest. Most new buyers have over 10k of interest on a 200k home.



So when you take in the extra 16k on a 200k home that has just appreciated 100% in 4 years it is interesting to think the appreciation will continue at this pace. I also know people who purchased homes in the late 80s after a big dip at 135k from 200k. Now the same home is over 225k. So prices do go up and down.



At a base the home has to increase about 6-8% just to cover costs. Now at the same time people need a place to live so rent by it self will cost "x" dollars.



Babbs if the economy does ever turn bad then do you still think your home is imune from a drop? If so look at the .com bubble. Up 100% over a few years then reality set in.

Feb 23, 2007 12:10 am

Of course, it depends on where you live. Logically, an old "McMansion" in a Minneapolis suburb might not fare as well as a new beach house on Cannon Beach.


Advisors should have the courage to be honest with their clients, though, and recommend putting cash flow in the right place.


Since many cities are reaching new population levels, choked traffic, high fuel costs, and a generally declining quality of life, along with retiring baby boomers' needs, we need to think beyond the numbers.


I think they call it 'life planning.'

Feb 23, 2007 12:17 am
AirForce:

It is interesting if you take real estate and add in
the costs. Everything from maintenance, insurance and taxes. Up here in
New England its about 5k for 200k home a year. On top of this 98% of
Americans have a mortgage with interest. Most new buyers have over 10k
of interest on a 200k home.





By the time you factor in the costs of ownership, you arent saving very much if anything over renting. "Investments" with continious negative cashflows tend to have very poor IRRs.



According to NAR it is currently a good time to buy or sell a home. How is that possible in a zero sum transaction? At best it could be an indifferent time to buy or sell a home.

Feb 23, 2007 8:57 am

I have to agree with Planrcoach.  As a military spouse, my family moves every 3 years or so.  We've bought a house in each place we've moved and subsequently sold it for a nice profit each time.  Each time, we've invested in the house, making upgrades that would make it more attractive when we sell (new countertops, upgraded bathrooms, decks, hardwood floors, etc.).  We've kept track of our expenses and make sure that the listing price more than includes what we've spent on the house to upgrade it.  However, there are many tax benefits.  Your mortgage interest is tax deductible, as are some home repairs.  If we were to rent, we're only making someone else rich.  Over the years we've made between a 60% - 90% profit less realtor fees, lawyer fees and mortgage fees.  The profit we make, gets invested.  We've been very fortunate, but owning our home has made sense each time and has help us increase our net worth exponentially. 


When my husband retires, we'll build our "dream" house and establish roots to begin our "second" careers.  However that house too will help in our net worth.  If we were to rent, that wouldn't be the case.  A house 99% of the time if maintained, will be worth more at the end of each day, than when you woke up.  Unlike car loans or credit card debt.  JMO from my experience.

Feb 23, 2007 10:20 am

In addition, for most people, ownership (control) itself is a tangible benefit. When you have to move every few years, the feeling of ownership may help "normalize" life. From a financial planning point of view, this type of benefit has real economic value. As Nick Murray said, " Places in the heart, not places on some chart."