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Realatrends Real Estate

Laguna Beach Real Estate Company

  • Home
  • Properties
    • Search Properties
    • Featured Listings
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      • Aliso Viejo
      • Dana Point
      • Corona Del Mar
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      • Newport Coast
      • San Clemente
      • San Juan Capistrano
  • About Us
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  • Resources
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949-494-8830

Real Estate News

May 2022 – Real Estate Newsletter

By

Clark Smith

Posted in Real Estate Newsletter On May 1, 2022

The benefits of purchasing and owning your place of residence are both financial and emotional—pride in homeownership and the feeling of security are huge intangible benefits.

TOP STORY:

– Is Your Home a True Investment?

We recently encountered one of those advice-to-Millennial financial websites that have popped up in recent years. This one shall be nameless, but its advice of the moment was that purchasing a single-family home is not an investment.

The author, let’s call him Tom, hastened to say he wasn’t advocating avoiding homeownership, merely pointing out that, if making a smart investment is the foundation of your buying decision, think again. His reasons, and we aren’t saying they are good ones or bad ones, (at least not yet) are worth an airing.

Homeownership is broadly seen as an investment because of a perception that real estate almost always appreciates. While this has generally been true, Tom says that growth has rarely outpaced inflation. Over 100 years, average real estate values have risen less than 1% on an adjusted basis.

State Your Purpose

The primary purpose of homeownership is providing shelter and Tom maintains this purpose invalidates a major facet of a sound investment, the ability to buy and sell in a manner that maximizes return. With shelter the purpose, a house must be purchased when it is needed and sold when that is no longer the case. This puts a homeowner at the mercy of the real estate cycle. Circumstances, personal or financial, may force a purchase or sale at an inopportune point in the cycle. Buying high and selling low is the antithesis of a true investment.

An ideal investment should provide the prospect of a capital gain somewhere down the road, but also an income stream. If the down payment was invested instead in a savings account, it would generate interest. If it were put into Treasury Notes, there would be a guaranteed yield. Even some common stocks provide a regular dividend. But, unless the house is a two-to-four unit dwelling that the homeowner can both live in and: rent out, (and Tom does specifically exempt this configuration from his not- an-investment stance) homeownership is not likely to bring in a cent of income no matter how long it is owned.

Reverse Flow

Owning a single-family home will instead almost guarantee a constant flow of cash in the opposite direction. In addition to monthly mortgage payments there will be real estate taxes, insurance, and utilities as well as a need to protect and maintain the property with constant maintenance, regular repairs, and occasional updates. Over the years these costs can add up to thousands of dollars, which Tom says reduces the eventual return on investment.

Inflation adjusted price growth may be small, but as long as prices don’t fall, a homeowner still builds equity, if not from appreciation, then from amortization. But Tom contends that equity is highly illiquid and to use it, one must either sell the property or refinance it. If the homeowner sells, he or she will most likely have to use that equity to buy another house. So, unlike selling a stock, art, or gold, and unless the homeowner buys a less expensive home or becomes a renter, this is trapped equity.

The Piggy Bank Misstep

Of course, that equity can be liberated through a cash-out refinance or a home equity line of credit (HELOC), but Tom argues this can make homeowners feel richer in the short term while jeopardizing their long-term financial security. He points to the disaster that followed the cash-out frenzy before the 2004-2006 house price bubble burst

As prices rose, some homeowners cashed- out multiple times. Then, with equity sucked dry, they watched their homes plunge into negative equity when prices declined, leaving them little room to exit homeownership with their finances and credit intact when they could no longer make their payments. Not only had equity evaporated, but refinancing/ HELOCs had enlarged their monthly payments, making default more likely.

Tom says that considering a home a perpetual and growing investment can lead to such risky behavior. A homeowner should think of a house as a home, he says, while putting money into true investments, like financial assets or real estate that produces rental income. “Then kick back and enjoy living in your house. That’s the real purpose of owning one.”

The Rebuttal

Tom has some valid points; however, I we think he has framed some of them incorrectly, overlooking that a home is a mixed asset with both personal and investment components. Thinking of it in that way makes the investment potential more apparent.

According to the U.S. Census Bureau, the average sale price of homes sold in the U.S. climbed each year from 1963 to 2007. That’s not forever, but it is a good run. In some of those years the increase was substantial, in others fractional, but it has averaged (and this is going back to 1891) 3.2% in nominal terms. Over the years, if a long-term investor, which is what we are all advised to be, decided to sell, he or she would rarely have been a captive of the real estate cycle.

Then of course came the crash. From 2007 to 2012, home prices declined by 3%.

How Now Dow Jones?

Yes, the one exception to rising home prices turned out to be a doozy. But let’s be fair. How did what Tom considers a “real” investment perform? First, if you want to talk about cycles, housing can’t compare to the stock market. There have been 26 “Bear” markets, marking a 20% decline in the Dow Index, since 1928. Such adjustments are not necessarily gradual nor is there often much warning. The Dow fell more than 800 points on 14 different days in 2020 alone.

Hard to conclude that Wall Street was a better investment than homeownership in the last crash. Housing prices had been trending lower for more than a year heading into the Great Recession while the stock market was weathering the storm. The Dow was holding at around 13,700 in December 2007 when reality hit. By March 2009 it had lost more than half its value, falling to 6,625. For those who were not forced to sell either their stock or their homes, both assets returned to pre-recession value at about the same time, in early 2014.

SEARCHING FOR REASSURANCE

California may be the top housing market in the country, but Californians seem worried about a housing crash—at least judging from the surge of Google searches.

Last year, Californians searched online about housing at a collective pace 69% above the 17-year average. Housing searches were at the highest level since the mid-bubble-bursting days of 2007 and nearly tripled the pre-coronavirus search concerns of 2015-to-2019.

The searches revolved around 4 terms: “housing bubble,” “housing crash,” “home prices,” and “housing market.” Nationwide, searches for these terms were 107% above average with California at the top.

Despite fears of the housing market bubble bursting, some experts say it’s not going to happen. Ann Brown, The Moguldom Nation

Location, Location, etc.

Here we pause to mention a negative Tom missed. The old location, location, location factor. Some areas, the State of Oklahoma comes to mind, never benefitted from the boom, but neither did it suffer unduly from the bust. Other places, like Detroit and Cleveland, have never recovered from a long, slow slide that was only exacerbated by the crash. Unlike cherry picking a promising stock or market sector, finding a good location in which to invest becomes complicated when you must commute from it to work.

Tom also overlooks homeownership’s tax advantages. While these are less generous than a few years ago, homeowners will be able to deduct a portion of their housing costs on their annual returns and a big chunk of the profit may be sheltered from capital gains taxes when the house is sold. Sell a few shares of stock at a profit, however, and the IRS will want its share.

Outflanking Inflation

The gains reflected in rising housing prices are, as Tom said, mitigated by inflation. That 3.2% nominal gain becomes 0.3% (even lower than Tom maintained) when adjusted for inflation over the century ended in 1996. Over those 100 years, national home prices only outpaced inflation by a cumulative 15% but then from 1997 to 2005 home prices went up 76% faster than core prices. Now, some eight years after the recovery from the Great Recession began, inflation adjusted prices have not yet caught up with those in 2006.

But, if home price gains are eroded by inflation, homeownership is also what the Wall Street guys call a “hedge” against it. Inflation may propel property taxes higher, the cost of maintenance and repairs will certainly rise, but the amount owed each month on a thirty year fixed-rate mortgage will not change. Home prices move somewhat in concert with inflation, so equity, and thus the eventual return on investment (ROI) will continue to increase. Rents, on the other hand, rise with inflation and there is no investment on which to realize a return.

If you were to buy a $600,000 house, put 20% ($120,000) down, and obtain a 4.5% 30-year fixed-rate mortgage, the payment (Principal & Interest or “P&I”) would be $2,432. An average rent for a two-bedroom apartment in Los Angeles, as an example, in December 2021 was $2,933. The more than $561 per month difference is almost enough to cover taxes, insurance, and that upkeep Tom was concerned about. If you live in the house for 10 years, that payment will remain at $2,432, but assuming even a modest 1.0% annual increase, your apartment rent will inflate to $3,240.

BIGGER AND BETTER?

One of the results of the pandemic was the need for more residential space to accommodate home offices and remote learning. Census data for the fourth quarter of 2021 shows the median floor area of a newly constructed single – family home increased to 2,338 sq. ft. and the average was 2,561. These were increases of 6.3% and 10% respectively from post-housing crisis lows.

Square footage grew from 2009 to 2015 as builders built larger homes with higher profit margins, then declined from 2016 to 2020 as more starter homes were developed. Home sizes are predicted to continue to increase to allow space for remote work in the post – Covid-19 environment. Builder

The Power of Leverage

The leverage available to homebuyers I gives each investment dollar more bang for the buck. Buy a hundred shares of Tesla and Charles Schwab will want to see your $100,000 check within five days. You might be able to put a Renoir on the Mastercard, but that is a pricy way to decorate the entry hall. However, decide to purchase a house for $600K and almost any bank will be happy to lend you $480,000 to do so. The GSEs and FHA might front all but $21,000 of it. Leverage increases the return on investment, especially at today’s still low interest rates.

The mixed nature of homeownership makes calculating an ROI difficult, but here is one way to look at it. After 10 years the mortgage balance on that $600,000 house has fallen to $374,000, the $120,000 down payment has grown into $206,000 of equity at the original purchase price. Using the historic annual appreciation rate of 3.2% could bring the selling price to $822,000, and cash proceeds at sale of $448,000.

Over those 10 years, monthly P&I payments have totaled $291,850 (the interest portion of the mortgage payment has averaged only a little more than $1,500 per month). If those payments are viewed as an additional investment ($291,850+$120,000), the profit on sale would be over $36,000. But, if they are considered personal expenses which would have otherwise been paid as rent, then the return on the original $120,000 would be 373% ($448,000/120,000). Incidentally, over 10 years, the rent on that two-bedroom place in LA would total $343,080.

SHE BUILT IT

The Utah Parade of Homes featured The House that SHE Built, a 3,200 sf home in Saratoga Springs designed and constructed by an all-female skilled labor team from across the country. The house was built to spotlight opportunities for women in the home building industry.

Proceeds from its sale were divided between scholarships for women pursuing construction management or trade programs, women-run charities including a local domestic abuse shelter, and educational events to help teach young girls about home building careers. The project has also inspired a children’s book that aims to educate young people on the home building industry as well as elevate women in the field. NAHBNow

Home Sweet Home…

This is a simple example, and yes, we have ignored opportunity costs (other ways you might have invested that money), the costs of buying and selling, and some other expenses Tom outlined. We concede that other investments might yield a greater return, but few provide the leverage and the low risk available through homeownership and none of the others give you a roof over your head. And that is hard to put a price tag on, isn’t it?

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