Thursday, July 12, 2007

Does a mortgage eliminate the benefits of investing in real estate?

Is real estate really a good investment? I had a few minutes free and used zillow.com and bankrate's mortgage calculator to run some numbers. I picked a house in my neighborhood that was around 10 years old and had an average price today compared to the other homes in my neighborhood.

The home was originally purchased for $110,000 in 1999. With a standard fixed 30 year mortgage at a reasonable 6% interest, your monthly payment would be $660. Today if you were to sell the house, it is supposed to be worth $156k. Last year (home prices have gone down a bit in my area - and will get worse as there are so many homes on the market now! my neighborhood is FULL of for sale signs, but anyway) the home was work $160k, the highest in a 10 year period. I'll go with $160 assuming you sold it in 2006 and got the best possible price so far.

Your profit would be $50k minus 5% sales commission or so, leaving you with $42k in your pocket. Assuming you didn't put down a large down payment, the interest you paid to the bank for 7 years was $44,001. You lost $2k in your "investment" even though your house value went up $50k.

So, what do you think? Unless you pay cash (so your savings earn you interest while waiting to buy and your house value isn't eaten up by the money you're paying the bank while you own) isn't mortgaged real estate a pretty bad investment, without seriously high appraisals? Maybe like the appraisals we were seeing until recently?

Just a thought.


5 comments:

Jim said...

A house is only a good investment if you actually live in it for a long period of time. The amount of money you pay on a typical mortgage even at a good interest rate depends on the down payment. If you put a large down payment on the house, the less interest you'll pay for the timeframe you live there. At some point if the house is sold, depending on the market, the money made is simply the remainder of the equity in the house.

Right now I think renting is probably the better option for most people anyways. There are so many houses out there for sale and the markets are soft everywhere. In terms of investment though, real estate is only an investment if you have the cash, roughly 70-100% of the value of the house, plus have the money to fix it up, and can actually flip it in these markets to turn a profit. Rental properties can also be a good investment as long as everything is working smooth and rent is paid on time. I think houses are more of a personal investment because they become a home. My parents house is 15 years old, built from the ground up, there are trees that grow taller as I get older, and they completely own it. Their farm on the other hand is an asset they could sell one day if they wanted. Invest in an actual investment to make money, real estate is not it.

Matt said...

From a long-term perspective, residential real estate is not a good investment when you compare it to the alternatives. The return you get is not enough to compensate for the risk you take. If you're just looking for a something to invest $150,000 in, a few index funds would be better than an extra house.

When you actually live in the place you own though, you have to consider that you're not paying rent. Also, the mortgage interest tax deduction works in favor of owning vs. renting.

Also, check out the link below. It really got me thinking.

http://assetbuilder.com:9669/blogs/scott_burns/archive/2007/04/07/The-Sublime-Beauty-of-Falling-Knives.aspx

Anonymous said...

I disagree that you need to live in a house for a "long period of time". We purchased our home 6 years ago in Ventura County, California for $300,000. It was a 1,000 sq. ft. 50 year old post war crackerbox. We sold it last January for over $700,000 - over price - through Help U Sell, (so we paid a VERY low set "fee" instead of a realtor). We made $400,000 total on our house. We then took this money, relocated to a gorgeous, growing area in another state, where we were able to purchase a gorgeous 3,500 sq. ft. brick colonial in immaculate condition with CASH. We now have no mortgage at all, a MUCH better quality of life, and more financial freedom that we ever could have imagined we'd have at our age. (we're pretty young) When we bought our first home (in Ventura County) we were living in the "City" (Los Angeles) at the time, and our rent there was more than our mortgage payment ended up being on our house. We had just had a child and didn't want to raise her in the city.

My feelings about real estate as an "investment" were exactly the same as yours. My husband is an Ivy league educated investment planner, so we are somewhat "educated" when it comes to financial matters, but I still agreed with you. We were told when we purchased our home that by the time we were finished paying it all off in 30 years, with a very low fixed rate loan, we would have paid something close to $900,000 for that house. And that didn't include repairs and maintenance over the years!

What chaged ALL of this and made the difference was something that can never be predicted or counted on - the "market". We made a killing on our real estate in a very short period of time, simply because we bought and sold at EXACTLY the right moments. Investing in real estate is no different than investing in stocks or bonds, or gold ...it's ALL TIMING. I know MANY people who purchased their homes in the early 90's for $300k and when they needed to sell (due to work relocation) couldn't sell their homes for a penny over $150k. They lost their shirts. And, frankly, the couple who purchased our home for $700,000 in January have already lost money because the real estate market is tanking in California. We got out just in time but they bought when the market had already hit it's peak and started to tumble right after they moved in. The "sub-prime" disaster hit the papers the week we closed escrow. I can't imagine that those tiny little old track houses will ever jump up to a million, even in 20 more years (who could ever afford them then?) but that's the mystery of it all. The market might skyrocket again (highly unlikely in my humble opinion) and then it would have been a good investment after all. I also believe it depends on where you live and buy. When my brother in law (a fireman) graduated from college, he and his wife were able to buy a house in San Francisco. Homes in SF are now millions of dollars and I don't know any 22 year olds just graduating college who can begin to afford that. It's all timing. It's all a big crap shoot. We happened to be very lucky.

Anonymous said...

Last poster. You said it yourself, it was all about luck. No, you didnt time the market and now that makes you a financial genius. You just heppened to buy at a pre-bubble time and the market shot off. You sold and did good but please, get off the 'I am a financial genius because I timed it perfectly' horse. My ex gardener Jose here in SoCal made about 650k selling his crapshacks in Santa Ana. He is a long stretch from being a financial guru. Catch my drift? Good luck.

Anonymous said...

Wow. You TOTALLY missed my point. I believe if you read my post, you will notice that my entire point was "IT'S ALL A BIG CRAP SHOOT. WE JUST HAPPENED TO BE VERY LUCKY". You start by saying that I'm not financial genius and then back that up with the fact that I myself stated it was "luck". You stated that I did NOT time the market so that makes me a finacial genius? That doesn't make sense. NO, I did NOT time the market (MY poiont exactly) and thus am NOT a financial genius. How does MY comment that it was all just "dumb luck" tranlate to "I'm a financial genius because I timed it perfectly". I was LUCKY because all we did was buy a house to live in that was cheaper than our rent and then the market went crazy. We sold ONLY because my husband was relocated - out of our control or desire - and once again, got LUCKY because escrow closed the week the subprime disaster hit the papers and real estate in our area started to go down. Again, completely UNPLANNED. There really are some stupid people on the web. You are proof of it.