Quote from pitz:
Most of the people here are completely missing the point; if housing, according to Case and Shiller, barely has long-term appreciation in excess of inflation, and if the cashflow from rental is substantially below the T-bill rate, then your long-term overall ROA is around 6-7%. Which, incidentially, is roughly what a 30-year mortgage costs today.
If you are paying 6.5% to leverage an asset that returns 7% in the *long-term*, then you are only earning a 0.5% spread, and to earn a 10%/annum return, you need to use 20X leverage. Obviously very risky. Even if the spread widens to 2%, you need to use 5X leverage just to obtain a 10%/annum ROE. 10X or even 5X leverage is *very* risky, even in real estate.
But you can park your cash in a stock porfolio and earn 10%/annum in the long term fairly consistently (the long-term return of the Dow or the S&P500 is around 10%/year) without using leverage, on a tax advantaged basis. If you apply even moderate amounts of leverage (again, tax-advantaged), you can increase long-run ROE far beyond that available with investment in housing.
What you have been seeing in the past 2 decades has been asset re-pricing. With stocks, we refer to this as P/E multiple expansion, which, of course, is completely unsustainable and will eventually revert to the mean.
OK, one of us is failing to see the other's point. In real estate, you either take out a mortgage (lets say at 6%), and you pay interest on the amount borrowed, or you pay rent. I promise you, that when you rent, you're still paying down the mortgage, (for someone else) which is the same 6%. Whether you rent or purchase, you're still paying as much as, or almost as much as, a mortgage payment due to market forces.
By your logic, if I'm renting, I when I calculate my stock portfolio return, I should take that 6% I'm indirectly paying for housing away from the 10% I'm making in stocks. But you can see the fallacy with that logic. You shouldn't do that for the same reason you don't subtract out your grocery bill when you calculate your stock portfolio return.
Here's what I don't think you're getting. (Truly, pardon me if I'm wrong). If inflation is at 3%, and I pay 10% of the purchase price of a house to control that asset, then I am making 30% return on the downpayment. Thats because though I am shelling out $100K to control a $1 million dollar house, I get the growth of 3% on the ENTIRE value of the house. The $1 million. Not the amount that I actually put down as a down payment.
So, if that million dollar house is only yielding the inflation rate, I am making 3% of $1 million dollars a year in equity or $30,000. So my house is going up in value at $30,000 a year, yet I only invested $100K to control that. That is a 30% return.
If I took that $100K and invested it in the stockmarket, I would get a 10% return on the $100K, but I'd still be shelling out a rent payment every month comparable to a mortgage payment.
Yes, I pay maintenance cost, but I get a tax break that offsets it.
You see, the crazy thing about real estate as an investment is that with the leverage, even a property appreciation below the inflation rate (a negative real rate) can still lead to stunning gains. If you're leveraged at 10 to 1, even if the value of the property goes up 1% a year, essentially falling behind inflation at 2 to 3% a year, (a "real" loss) you're still making 10% returns.
Another way to look at it is like this. Imagine If I came to you and told you that I'll rent you any place of your choosing for 20 to 30% over the prevailing rent. And, I will let you lock into the rental payment for 30 years, and if you complete that contract, you never have to pay rent again. There is a catch that you'll have to put up some earnest money for 6 to 10% of the value of the property, but the good news is that if you ever decide to back out of the contract, I'll give you your money back plus 30% interest. Too good to pass up?
SM
