Why do people believe that housing is such a great investment?

November 26, 2009

Finance

Since I am a visual kind of person, I have two graphs shown below.  The graph on top shows housing prices from 1890 to Present.  The graph below it shows the Dow Jones Industrial Average from roughly the same time frame (1900 to Present).

What is interesting is that the graph of housing reveals that throughout its history, prices have remained relatively stagnant except for a ridiculous and unprecedented bubble characterized by the “housing can do no wrong” mentality of the 90’s and early years of 2000.  If this is any indication of how much the current housing market has to fall in order to reach normalcy, then we’re in for a bumpy ride.

djia1900sOn the other hand, take a look at a graph of the Dow Jones Industrial Average since inception.  Sure, there are ups and downs, as there is with any other type of investment, but overall it looks pretty solid to me.  I would definitely take it over Graph 1; that’s for sure.  We’re talking about a time span of 100 years, two World Wars, the Great Depression, and the market has still managed to yield 8-10%.

So why does the stock market get such a bad rap whereas real estate walks on water?  People are quick to point out the dot com bust or the current crisis in a heartbeat.  However, when it comes to real estate, optimism reigns supreme.  It is only a matter of time before it recovers, they say.  I truly believe that it boils down to one issue.

If people invested in the market the same way they invest in housing, they would be better off in the long run.

Think about it.  When you buy a house, you get your 30 year fixed loan and pay off your mortgage diligently for the next three decades of your life.  Sure, your home price is only beating inflation by a percentage point or two, but you are slowing building equity in the house with each payment.  By the time you “own” your house, you have an asset worth a substantial amount of money.  Subtract the inflation, maintenance, interest, upgrades, fees, and costs associated with that house for the past three decades, and watch that profit shrink to a fraction of what you thought you earned.  But hey, it’s better than not saving at all, which is what most Americans do.

Now let’s take an investor who has the same diligence and invests his $2000 per month in the market.  He buys an appropriate allocation of index funds and bonds and holds it for 30 years, adjusting his allocation yearly.  I am willing to bet you that that same person does better over the long run than the person who invests in housing.

Unfortunately, that’s not how the average investor approaches the stock market.  Instead, he tries his luck at picking individual stocks (not properly diversified), trades frequently (loses money by paying high transaction and management fees to others), invests sporadically (unlike the consistency of a mortgage), doesn’t have the right allocation mix (too risky or conservative for his age group), and still has the nerve to blame the market for his incompetence.  If we were to transfer this poor investment approach to the housing market, it would be the equivalent of someone who flips houses for a living without a clue as to how to do it.  Sure, there are people out there who make a killing on it, but those guys are few and far in between.

Is housing bad?  Of course not.  It’s just not the golden horse everyone thinks.  Take it for what it is, a forced savings plan, nothing more.

3 Comments on “Why do people believe that housing is such a great investment?”

  1. Vince Tung Says:

    House is a good investment “when” your mortgage interest is lower than then the “inflation” – that is the appreciattion rate of the house price. In this case, you are investing with the money that you borrowed (that you don’t have). For stocks, you need the actual capital for the initial investment. Besides, having a house you don’t have to rent and uncle Sam subsidize 30% to 50% of the interest you paid by tax deduction.

    You chart is true only when you buy a house with cash, but most people don’t. Also, you chart ignores that house also generates income (the rent that you don’t have to pay or the rent you collect from a tenant). Also, your chart did not show the Tax advanage (for borrowed money). If you borrow the same amount of money to buy stock, you pay much higher interest rate and there is no tax advantage.
    For example, an initial investment of 5K on a house prices 500K with a mortgage 5%. At the end of year, if the house price moves up 10%. You gain 25K. A 5K investment in stocks, the price need to rise 500% to have the equal gain.

    However, because the initial overhead of buying house is high (the closing fees), it is not recommended for short term (less than three to five years) investment.

    How about that!!!!!!!!!!!!!

    Reply

    • Nuno Says:

      You are ignoring risk. Housing holds a beta of near 1. That means it holds nearly the same risk as the market. So for you to compare returns on a 500K housing investment you would need to compare it with 500K investment in the markwt, not 5km
      To understand so you basically only need to think that you lose much more by investing 500k in a house if the price falls 50% than if you invest 5k on the stock market. The probability of losing 50% is more or less the same in both cases.

      Reply

  2. Taylor Says:

    You just made my evening. I have a degree in Finance, but in my mind its pretty simple. There is no way that buying a house is an investment. It doesn’t meet any of the criteria. People look down at me because when I rent, but when I tell them I will be way further ahead in the future they look at me like I am crazy. Even after explaining the fact that you will often pay the price of your home in interest (so even if your house doubles you will end up loosing money with all the other expenses) people seem skeptical. I am very curious why this thought process has occurred. Nice to know that there is actually people in the world who can think!

    Reply

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