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Monday, February 1, 2010

Residential Housing: How Good a Long-Term Investment?

Pop Quiz

Want to test your knowledge of the housing market?

Just answer the following question:

How good a long-term investment is residential housing?

A. Terrific.
B. Mediocre, at best.
C. Both A. and B.

Correct answer: C.


"Mediocre" Camp

Like the three blind men (maybe they were economists?) and the elephant, it depends what you focus on.

The "mediocre return" camp focuses on housing's appreciation rate relative to inflation.

Depending on your time frame and geographic focus, most studies conclude that housing's long-term rate of appreciation just barely outpaces inflation.

"Terrific" Camp

The "stellar return" camp instead focuses on such things as imputed rent, leverage (now a dirty word), and housing's favorable tax treatment.

Imputed Rent. Although it sounds complicated, "imputed rent" is really nothing more than the housing benefit you derive from owning your own home. In fact, it's arguably more than just what you would have paid to rent your home; it also includes the psychic and emotional benefits that come with home ownership.

If you omit imputed rent from housing's long-term return, its performance is unimpressive; if you assign even a modest number -- say, 6% annually (tax-free, by the way) -- housing's suddenly a standout performer.

Leverage. The way Wall Street uses leverage, the term truly is an obscene word.

However, used conservatively by homeowners to acquire a long-term asset, leverage is a financial wonder.

Assume Bob and Sue Smith bought a home 20 years ago for $150,000, putting down 20%.

Next assume that their home appreciated an average of 3.7% annually over that period -- respectable, but certainly not amazing.

Today, their home would be worth $300,000, or double what they paid.

But what did the Smiths really pay?

If you base their return on the $30,000 they initially put down, suddenly their investment has appreciated 10x, at least on a nominal basis (that is, before accounting for inflation).

Preferential Tax Treatment.

When it comes time to sell, the Smiths' gain looks even better, because couples don't pay capital gains unless their home has appreciated more than $500,000 (the corresponding number for singles is $250,000).

So, the Smiths' gain is $300,000 less $150,000, minus another 7% for selling costs (of course, they used a reputable, full-service Realtor!).

That comes to about $130,000, tax-free.

If you want to carry the analysis further, you'd also want to take account of (deductible) real estate taxes; repairs and maintenance; what you would have made investing the money you instead put into your mortgage and related housing costs; and the value of the tax deductions associated with paying mortgage interest.

All those factors can "push the dial" a bit, in either direction.

However, it's probably safe to say that for the majority of long-term homeowners, how they did financially is secondary to the gratification they got from living in their own home all those years.


Land for sale point cook victoria said...

Nice Posting............

Sildenafil Citrate said...

I think that if you know how to choose a place, and I mean a good place with future as I call it, it can be a good long-term investment!