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John Vanhara Realty Profits Understated — As Usual
by Peter G. Miller
If you’ve seen the June issue of Money magazine you know that the topic of the month is real estate and specifically, “How Real Estate Really Builds Wealth.” Money does a great job with a number of insightful articles and a bevy of statistics.
And yet there is one particular item with which I disagree. Emblazoned in black and white on page 73 the magazine tells us that, “the pace of home appreciation nationwide will cool from last year’s 7% to more like 3% to 5% this year.” Why am I discomforted with such numbers and predictions? There are two reasons, actually.
First, I’m not sure how anyone can predict tomorrow’s home appreciation, either nationwide or down the street. For decades teams of soothsayers and economists have attempted this trick and no one seems to have consistently determined what the future will bring. Such forecasts would be much more interesting if there was a penalty for being wrong, say the loss of a crystal ball, advanced degree — or both.
Second, and more significantly, real estate appreciation is greatly understated at 7 percent.
To understand why, imagine that you bought a home for $1 million with 10 percent down. You have now acquired an asset for $100,000 in cash plus a $900,000 mortgage. You have to live somewhere, preferably indoors, and so the mortgage payments and repairs can be seen as “rent” because you have the use of the property. As to the $100,000, if you didn’t buy the home that cash would be available for alternative investments. In effect, your investment is not $1 million — you didn’t bring $1 million in a sack to closing — it is $100,000.
Now suppose your property really did gain 7 percent in market value. At the end of the year your manse would be worth $1,070,000. You’re ahead by $70,000. How much did you invest? $100,000. Is $70,000 equal to 7 percent of $100,000? Even with the new math the right figure is 70 percent.
So how does real estate really build wealth? Leverage.
All of which brings us to the chart on page 80 of Money’s June edition, a chart which attempts to show the comparative performance of various investment options between 1975 and 2002. Small stocks do best in this comparison, followed by large stocks, bonds, real estate, and gold.
Now let me see: How many people buy stock with 10 percent down?
The better way to create a comparison would be to chart the appreciation, if any, of actual cash investments — say $100,000 placed in stock, bonds, homes, and gold using the leverage typically available for each investment option. Leverage, after all, is a legitimate investment tool, one which justified margins on Wall Street. And if leverage is okay on Wall Street, why is it not okay with real estate?
Leverage, of course, is an equal-opportunity concept — it multiples results when values rise and it also multiples results when values fall, therefore it is a notion which cannot be endorsed without a strong dose of caution and reality.
There is, however, a practical difference between leverage in real estate and leverage on Wall Street: If home values fall no one says you have to pay off your mortgage by Friday as long as you continue to make full and timely payments. With securities, if you bought stock on margin and values fall sufficiently you will receive a margin call demanding more money or allowing your shares to be sold at current and depressed values.
Once we’re done calculating investment results with leverage, we should also calculate amortization, the process of paying down debt on a monthly basis over time. The effect of amortization in real estate is to reduce monthly mortgage “costs” and instead create a kind of forced savings. Mortgage amortization may not be the world’s best investment, but if the choice is reducing debt or losing money — the option most popular on Wall Street during the past three years — then amortization looks awfully good.
What about stock dividends? Yup, they’re absolutely a benefit for shareholders when paid — but there sure seem to be a lot of stocks which pay no dividends or where dividends — unlike amortization — are uncertain.
Lastly, there is a little matter which is hard to reflect in charts and graphs. Nobody buys real estate hoping the price will fall, something which cannot be said of short-sellers on Wall Street.
Source: Realty Times
For more information on the units, contact MillionSaverHomes.com is local Las Vegas real estate broker at 702.212.3513.
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