On the risk of investing in real estate for the long run

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Sclass
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Re: On the risk of investing in real estate for the long run

Post by Sclass »

Thank God I’m not an average salary man.

This is another great reminder that there isn’t a one size fits all strategy.

My only advice after reading this is do your own calculations before you take anyone’s advice on the biggest investment of your life so far. Do some soul searching to check your appetite for risk and your discipline under duress. We are all different.


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Solute
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Re: On the risk of investing in real estate for the long run

Post by Solute »

Investment property seems like a great choice if that chart is accurate. A $20k down payment and then just the effort of upkeep, which can be passed off to a management company. Much better than having to pay rent into the S&P 500.

white belt
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Re: On the risk of investing in real estate for the long run

Post by white belt »

@unemployable

After taking a look at the methodology, I find that graphic to be quite misleading for the following reasons:

-The S+P 500 calculations do not subtract a monthly rent from the monthly contributions. I am confused by this because it makes for an apples to oranges comparison since in one scenario you get a place to live, and in the other two you still need to pay for housing, which is the average consumer’s greatest expense.

-There is nothing automagic about rental real estate. If you are going to rent out a single family house that you could otherwise live in, now you are going to have to pay someone else so you can rent/live in a comparable house, which will also happen to be around the same market rate your tenant is paying you. This is not to say that rental real estate isn’t a viable strategy, just that it is much more involved than just buying a typical home and renting it out.

-Starting your analysis from 1987 makes for some very nice data cherry-picking and recency bias. 94% of US Domestic equity returns over the past 90 years comes from the years 1984-2007. There are numerous periods where stock returns have been negative or flat (1929-1946, 1964-1983). We are in the longest bull market in history for stocks.

-The author included property taxes in his calculation, but made no mention of the countless tax benefits associated with mortgages and property ownership. Additionally he makes no mention of capital gains taxes in the S+P 500 calculations.

I am not familiar with the author or his site, but I gather he writes for the mainstream PF audience with the mantra of efficient markets and indexing. I also see he sells a course on index investing, so my critiques might fall into the category of things that his paycheck depends on him not understanding.

white belt
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Re: On the risk of investing in real estate for the long run

Post by white belt »

Another factor to consider for the ERE adherent on the rent vs buy debate is utility costs. Utilities for rental units are either paid directly by the tenant and/or passed on to the tenant based on usage rates of the average tenant. In the case of my current apartment, all my utilities are included in my rent. I am likely overpaying with this arrangement since I use only 10-20% of the electricity, water, gas, etc of the average tenant. Of course if my utility consumption was much higher than average then I’d be benefiting from such an arrangement.

shemp
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Re: On the risk of investing in real estate for the long run

Post by shemp »

I gave a sophisticated discussion of the OP's case earlier, but as with white belt's rebuttals, OP perhaps incapable of understanding these arguments. Here's a simpler argument. Owning real estate has essentially the same set of risks as owning stocks. Therefore, in the very long run and averaging across all houses/stocks, both asset classes should give the same return, since eventually people figure out which investment does best and adjust prices accordingly, which brings returns back to equality, comparing apples to apples.

For both stocks and real estate, it's possible to do very poorly by overpaying when you buy. OP's case merely shows what happens when people overpay for houses somewhere with a mediocre local economy. We could just as easily show an example of someone who bought Japanese stocks in 1989 and is still underwater, as proof that all stocks are always a bad investment in the long run.

With stocks, overpayment risk can be greatly reduced by dollar cost averaging purchases over a 40 year work life using same amount of savings each year from slowly changing salary. (This won't work for EREs, who don't work 40 years.) Stocks also allow geopolitical and industry diversification, whereas owner occupied housing necessarily tied to one local economy. These advantages of stocks should be reflected in higher prices and thus lower returns for stocks versus owner occupied housing, same as all the tax and other advantages of owner occupied housing should be reflected in price adjustments in the opposite direction. Markets tend towards efficiency in the very long run.

Sophisticated exception to efficient markets rule occurs when you do something other people don't do with regards to owner occupied real-estate. For example, most people do not rent out rooms in their house, so prices don't reflect profits possible from this. Fourplexes at one time had advantaged rules for mortgages, so living in one unit of a fourplex, while renting out the other units also and renting out a spare bedroom in your unit, plus doing all your own repairs, accounting, legal work, etc used to be a fast path to ERE, because prices did not reflect this very unusual usage pattern.

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unemployable
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Re: On the risk of investing in real estate for the long run

Post by unemployable »

Y'all haven't mentioned another assumption that chart makes. Hint: Accounting for it would make real estate (both primary and investment) more favorable than what the chart shows, perhaps to the point where it would surpass the S&P.

The guy who runs that site rented during his career while running a business that deals with advertising apartments and collecting rent online. So he clearly has a pro-rent bias. Although he repeatedly makes the point to live in as cheap a house as you're comfortable with.

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Sclass
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Re: On the risk of investing in real estate for the long run

Post by Sclass »

When I looked at this problem twenty years ago I worked it out on a single sheet of paper. Basic time value of money calculation. I benchmarked myself against my roommate who bought a $600,000 home in 2000 in Silicon Valley. Sunnyvale to be exact. We had the same degree and same entry level job at sister companies.

I got the calculation somewhat wrong. I underestimated the 7% annual appreciation on his home over twenty-one years. The stock market has only done a few percent better over that period and what’s a few percent right? ;)

My rent was half of his monthly housing cost. I put the rest in stocks. Luckily they did better than my predicted rate of return in my one sheet wonder. Two wrongs make a right?

It all worked out about the same. Plus or minus a few bucks. My buddy still works. Most of his money is in his Silicon Valley home. He’ll eventually retire and sell his home. It’s sad when they try to stay and become the cash poor house rich boomers of Silicon Valley. There’s a lot of those. The dumb ones hang on as the region out grows them, the smart ones become my landlord.

I’m glad I didn’t go for the Sunnyvale home. My friend proudly says entry level Google engineers are priced out of his neighborhood now. Okay whatever. You pick what you want.

You can borrow the money or you can borrow the house. It’s all in the interest rates. YMMV. That’s why it is so important to do your own calculations for your locale and investing ability.

Andy Dufresne
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Re: On the risk of investing in real estate for the long run

Post by Andy Dufresne »

To add to what SClass is likely implying, over very long time horizons (which are becoming ever shorter with technological uphevals), you can wake up one day even in Silicon Valley and discover demand is vastly diffrent now that people can Zoom, so location risk is likely significantly understated in most people's calculations.

Personally speaking, I recently purchased an apartment (and at my age I would not be considered more than slightly ER, not ERE) for a very simple reason - the math works - I am getting an apartment in a very good location, for 50% off (yes, fifty), and I can take out a 75% mortgage at extremely low rates for 20+ years while the rest of my funds work in the equities markets. How much will I make on my equity is hard to tell, but the chance of losing it all or not making at least a respectable return are quite low, so I pulled the trigger.

white belt
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Re: On the risk of investing in real estate for the long run

Post by white belt »

I think this thread highlights the difference between housing as viewed from a Wheaton Level 4/5 vs Level 6/7.

In level 4/5, the focus is purely on the numbers. Is it cheaper to rent or get a mortgage? Housing is viewed as something to be optimized, typically based on cost but also factoring location, size, etc.

In level 6/7, housing is another node in the web of goals. Certain housing situations synergize with other parts of the web of goals, while other situations introduce friction. Looking at purely housing costs is somewhat one dimensional because it doesn't factor in the effects on the rest of the web of goals. A home isn't just a place to sleep and keep your stuff, it might also be a homestead, business headquarters, and community gathering place. I'll see if I can come up with some examples, but I am still working through the level 5 to 6 transition myself. I hinted at some things earlier in the thread, but there are many things one can do in an owned property that are not possible in a rented property (solar panels, grey water system, biogas setup, intensive gardening, raising livestock, running certain kinds of businesses). All of those could increase income or reduce expenses more than the money saved from renting a small apartment. Of course, if one expands their boundary from household to community then many of these may be possible without owning a property.

Another factor for the average person is that a mortgage is the only way to get access to the benefits/risks of leverage. The average Joe isn't going to learn options trading to take advantage of leverage.
Sclass wrote:
Mon Jan 04, 2021 8:30 pm
My rent was half of his monthly housing cost. I put the rest in stocks. Luckily they did better than my predicted rate of return in my one sheet wonder. Two wrongs make a right?

It all worked out about the same. Plus or minus a few bucks. My buddy still works. Most of his money is in his Silicon Valley home. He’ll eventually retire and sell his home. It’s sad when they try to stay and become the cash poor house rich boomers of Silicon Valley. There’s a lot of those. The dumb ones hang on as the region out grows them, the smart ones become my landlord.
What was the square footage of your apartment vs his house? In the US, the cost of construction usually means that builders are incentivized to create larger houses which go way beyond 300-400 sq ft per person. Right now I am renting a 300 sq foot apartment, which it would not be possible to purchase unless I buy a multi-family property and take on the job of landlord. I am in full agreement that living in a small space generally saves money, and housing is so local and personal that everyone needs to do their own analysis.

Why don't these cash poor house rich boomers just do a cash-out refinance? It's a common tactic in the real estate investing world when people want to get all their cash out of a property and deploy it elsewhere.

shemp
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Re: On the risk of investing in real estate for the long run

Post by shemp »

white belt wrote:
Tue Jan 05, 2021 10:42 am
[...discusses various factors that advantage owner occupied real estate...]

Another factor for the average person is that a mortgage is the only way to get access to the benefits/risks of leverage.
And you aren't the first person to notice these factors, by any means, and therefore prices on real estate have been adjusted (positively or negatively, as case may be) to reflect all these factors, thus eliminating them as advantages versus stocks, on AVERAGE. (If you only buy/sell one piece of RE, like OP, then you don't get the average, but rather a specific case, which might differ greatly from average.)

All that remains are inefficiencies, which can help or hurt. Sometimes you are the only buyer available who can see the underlying value in a slightly odd piece of real estate, so you get an incredible bargain. Sometimes you are forced to quickly sell a slightly odd piece of real estate and only one buyer available who can see the underlying value, so they get an incredible bargain. Lots more inefficiencies in owner occupied real estate than publicly traded stocks.

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Sclass
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Re: On the risk of investing in real estate for the long run

Post by Sclass »

white belt wrote:
Tue Jan 05, 2021 10:42 am

What was the square footage of your apartment vs his house?

Why don't these cash poor house rich boomers just do a cash-out refinance?
Ahhh, the details. I left them out because it gets too complex. Our homes were roughly 2000sq ft. But, I rented in Los Altos, he bought in Sunnyvale. It’s a complicating detail. I could walk to his home, but my place had a market value of roughly 2x his because of the neighborhood. I didn’t bring it up because it complicates the story. Too distracting. Oh yeah, and to clarify I rented a three bedroom home that used to be a farmhouse close to the Los Altos City Hall. 100 yo structure. It wasn’t an apartment. Had an orchard and a fruit packing shed. I did my startup in the shed for a year before we outgrew it.

The house boomers did refi to roof and remodel. My godmother took a HELOC out to get her son out of debt.

I think she doesn’t want to sell because the home is part of her identity as a rich person. She won’t feel rich if she sells it and leaves town. I’m just guessing I don’t have esp.

She doesn’t want to do a reverse mortgage for the same reasons. That’s what poor folk do. They hock their possessions so they can eat. At least I think that’s how she feels but without getting into her head I don’t really know.

It’s like those european aristocrats living in run down chateaus selling off their collections to pay taxes. Selling is like losing identity.

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