Thursday, December 27, 2007

where renting is underrated...

Well, perhaps real estate is not always a good investment....

Home prices in the United States fell in October, 2007 for the 10th consecutive month, posting their largest monthly drop since early 1991. Home prices fell by an average of 6.7% in the S&P/Case-Shiller home price index. The index tracks prices of existing single-family homes in 10 metropolitan areas compared to 2006.

This has me wondering......What would this type of price action do to some one's net worth who had a large proportion of their assets tied up in their home? (our home is ~74% of our asset base)

Well, assuming I was Joe Average U.S. citizen living in a major metropolitan area:
My last reported net worth would have declined from $131,011 to $116,606, a decline of over 11%.

If I happened to live in Miami, Florida where house values declined a whopping 12.4% during the same period my net worth would have gone from $131,011 to $104,351, a decline of over 20%. That hurts!

Of course I realize that these devaluations are gradual, and not month to month, which is not how I am representing it above but it does have the same net affect. This type of data reiterates why I am trying to diversify away from our over weighting in real estate.

11 comments:

4Life said...

I actually did an elaborate analysis at one point trying to justify a home purchase - it failed when compared to stocks. If you buy a house for your primary residence, it needs to for a reason other than an investment.

Best Wishes,
Dividends4Life

Sami said...

but you need a place to live for the next 5-20 years, right? if it is down 10% or 50% it should not matter in the grand scheme of things, unless your plan is to flip it.

Off course the home is part of net worth. but if you sell at a time when prices are down, and move to another house overall you would be breaking even. Because you would be getting a house that has gone down in value by at least an equal amount to your house.

It is a psychology thing where people feel better when they sell at a profit but pay more to buy their next house. but in the grand scheme of things they actually are worse off.

MG said...

sami, I agree with you but most people don't see it that way. It is surely a psychology thing most of the time but the point I'm trying to get across is that too many people see real estate as the holy grail.

Your examples to not work in this scenario:

You buy at let's say $500,000 which is an extremely inflated price. Your home then declines to $400,000 or lower, it does not matter if you sell and buy another house you are still out the $100,000. You are assuming prices will recover in some reasonable amount of time.

What I am getting at is that perhaps in some situations, (ie Vancouver currently) it might be better to rent and time the market.

FourPillars said...

Not sure how you did the calculation but the decrease percentages were for the past year (not for one month).

Mike

Canadian Dollars said...

do you anticipate problems happening at home in canada? It's hard to say whether our real estate is overvalued or not. Some metropolitan areas like Toronto and Vancouver have seen real estate prices rise to great levels.

MG said...

4P,
Of course I realize that these devaluations are gradual, and not month to month, which is not how I am representing it above but it does have the same net affect.


CAD$, I think there will be declines soon in Vancouver, and perhaps Toronto and Alberta markets.

Paul said...

Those of us in California who refused to buy into the real estate frenzy, are occasionally seeing houses priced at slightly more than 50% of 2005 peak prices. Meanwhile, as a renter for the past 5 years, my net worth has increased with all of it 100% liquid and not tied to real estate (yet). It is still cheaper to rent in Sacramento by a wide margin.

MG said...

paul, thanks for your comment.

Paul's situation is exactly what I am getting at here...

FinancialJungle said...

Very engaging discussion.

As a renter in Vancouver, my goal isn't to time the market, that's because I'm already reaping the cost savings today.

Vancouver investors are taking double-digit growth for granted, but this can't go on for long. The math is elementary. Over the past 4 years, homes are up ~60% and 5-year fixed up ~33%. Housing costs have more than doubled, but salaries and rents hardly budged.

pitz said...

sami, a problem that a homebuyer might encounter, if their property drops substantially, is their ability to obtain a new loan (typically Canadians use 5-year loans) is impaired. Someone who put 20% down, just to see their home drop in market value by 50%, will not only be underwater, but will not be able to renew their mortgage when the time comes.

Now, on RE versus the stock market -- you can buy the broad market indicies at a 6% income yield right now (ie: the TSX, the S&P500, EAFE, FTSE, etc.), and growth that will somewhat resemble inflation + some fraction of real GDP growth. Or you can buy a house with probably a 3-4% income yield, with inflationary growth in income. What looks like a better deal? In Canada, which 'investment' gets you a tax deduction for borrowing to buy it, and which does not?

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