Why Real Estate is NOT a Good Investment

“…From 1890 through 1990, the return on residential real estate was just about zero.” – Robert Shiller, Yale economics professor

“When I ask my younger friends why they want to buy a house, they stare at me blankly. ‘They’re a good investment,’ they reply like brainless automatons who are at risk of being smacked by me.” – Ramit Sethi

Disclaimer #1: I’m looking at real estate from a financial standpoint. I won’t take into account the investment you’re making in your family, or the feeling of security you get from owning your own home, or the freedom to paint the walls whatever color you want. I’m only looking at monetary returns.

Disclaimer #2: I’m not a finance blogger. This post is merely an aggregation of what I’ve learned in simple terms. If you want to read the experts, see my long list of sources at the bottom of this post.

Like most Americans, I bought into the myth that owning property was a money-making endeavor. It was only recently, at the age of 30, that I came across the wealth of information out there showing how it’s not.

It all started when I read Alice Schroeder’s Snowball: Warren Buffett and the Business of Life. This was the authorized, all-access, 900+ page biography covering Buffett’s personal life as well as his career. I was shocked halfway through when it describes his first fight with his wife. What was the fight over? Buying a house. The wife wanted one, but Buffett refused because it was such a “waste of money.” This is modern history’s most successful investor refusing to buy a house.

Soon after finishing that book I met another gringo in Bogota, Geoff, who worked as a financial consultant. His parents bought a house in San Diego at a seemingly low price and now it’s worth an astronomical figure. Being financially astute, he ran the figures on the investment and showed them how and why the house’s value had only kept up with inflation. No more.

Here’s the key to understanding why real estate is NOT a good investment. The price of the house is not the only money invested in owning. To truly measure the return, you must factor in ALL costs of owning:

1. Taxes – personal property taxes.
2. Interest – the interest on your massive loan from the bank (you can deduct the ~20 – 25% of this you’ll save on income tax if applicable).
3. Maintenance – every time you fix the roof, replace a window, or do anything a renter wouldn’t have to.
4. Insurance – fire, earthquake, homeowner’s, flood, etc.

When factoring in these additional costs of owning a home, and the fact that the real estate agent who sells it at the end will take 5 – 6% of your selling price, the return rarely proves to yield more than 1 – 2% on your investment. About the same as a savings account. This doesn’t take into account volatility in the real estate market or the view of many economists that the recent housing bubble lasted 20+ years, and that prices won’t return to previous peaks for many more.

The stock market, given all its ups and downs, historically averages an 8% return. So a “good” investment (and much less risky) would be to rent a comparable house in the same neighborhood. Take the difference between the mortgage payment (plus all additional costs of ownership) and the rent payment, and invest that amount in a diverse index fund. If you invest via a Roth IRA or 401K, much of that money won’t be taxed.

With this option (renting and investing the difference in an index fund), you don’t face the risk of having all your money in one investment (a house). This is a central tenet in wise investing – diversifying your holdings. And you’ll see a significantly higher return while incurring less risk.

The only way I see a real estate investment matching or beating the general stock market is if the property was purchased under extreme conditions. People privy to inside information (from corrupt government officials about future development in the area, for example) have beaten the market by investing in real estate. Another example comes from a guy I met in Buenos Aires who bought his San Telmo apartment in early 2002, just after Argentina defaulted on its debt payments in the midst of its financial crisis. Buying property dirt cheap in economic disaster nations may prove profitable (in Venezuela whenever they get rid of Hugo Chavez, for example), but the risk involved is much greater than investing in the general market.

Again, this was a simplified overview of why real estate isn’t a good investment. If you’d like to read more, check out these resources:

The ultimate post summing up all reasons why real estate is not a good investment

Ramit Sethi’s real estate tag (author of I Will Teach You to Be Rich)

5 myths about home sweet homeownership (Washington Post)

A House is a Home, Not an Investment (NY Times blog)

Your Home Isn’t the Nest Egg That You May Think It Is (Wall Street Journal)

Is Your Home a Good Investment? (Wall Street Journal)

Home Not-So-Sweet Home (by NY Times columnist and Nobel Economics laureate Paul Krugman)

In the Long Run, Invest in the Stock Market and Sleep at Home (New York Times)

Here’s an article complaining about Americans still believing home ownership is a good investment

Hilarious blog post why the $8000 tax credit shouldn’t affect your decision

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