Behavioral Aspects: Real Estate Investing
Investments are supposed to be financial decisions. When we take finance classes, we are taught models to evaluate investments and base our decisions on. However, in real life, people take investment decisions emotionally. This is truer of real estate investments. Most people are emotionally attached to their homes or the idea of a home. Hence […]
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Quantitative Easing and Interest Rates
Quantitative Easing (QE) impacts almost every market in the globe. This is because it impacts certain fundamental economic factors which are interconnected across the world. One such factor is interest rates. The policy of Quantitative Easing (QE) is capable of significantly impacting interest rates in various ways. Since interest rates can literally change the market […]
Owning a house is a dream for most people around the world. This is the reason why investment in housing is disproportionately higher amongst the middle class. The middle class seldom invests in stock markets. On the other hand, almost every middle-class salaried person in America and even across the globe owns real estate.
Also, most of the people that own real estate do not buy it outright. Instead, they buy it with borrowed money. The impact of this investment decision on their lives is huge. There is a term called “house poor” in America. This term describes the people who do make a decent amount of money. However, since they owe most of their money to banks in the form of mortgage payments, they have to lead a poor lifestyle.
Slowly, the millennials are realizing that the real estate dream may not be worthwhile. This is the reason millennials are prioritizing spending on travel and education over buying a house. Traditionally, a house has been believed to be an investment. In this article, we will list down seven major reasons as to why buying a house isn’t really an investment.
Investments are useful because they can be promptly sold in times of need. Consider the case of stocks and bonds. These investments have a ready market where they can be exchanged for cash in a matter of minutes. The same is also the case with investments such as gold and silver.
Real estate is probably the only illiquid investment that is held by middle-class people in their portfolio.
Selling real estate is difficult in all markets. In downtimes, it becomes even more difficult, and sellers often have to wait six months to one year before they can obtain cash in lieu of their property. It is therefore not advisable for the middle class to have a huge portion of their portfolio in an asset class from where they cannot withdraw it easily.
The real estate market is not only illiquid but also opaque. In the case of stocks, bonds, and other securities, the listed prices are the exact same thing as transaction prices. However, in the case of real estate, the listed prices are very different than the rates at which transactions actually take place.
It is very difficult for a buyer to actually know the correct buying price. The market is famous for buyers and sellers being ripped off by unscrupulous middlemen if they are not careful.
Real estate also has abnormally high transaction costs. Firstly, each time a sale takes place, the government has to be given a large sum of money. Also, there are costs such as legal fees, brokerage and appraisal costs which are involved in every real estate transaction.
Hence, each time a transaction takes place roughly 10% of the value is lost to transaction costs. This also contributes to the illiquidity point that has been mentioned above. However, the bottom line is that since the transaction costs are so high, buyers are left stuck with the property they purchased even if it turns out to be a mistake.
Real estate investments are known for providing low returns. Traditionally, the returns on real estate investments have been less than the rate of inflation.
It is only in the past few years that there was a sudden spike in the capital appreciation earned on real estate. The rentals earned are also negligible. Also, in order to earn rent, a lot of time, money and effort, has to be put in. Also, many times, it is just difficult to rent out houses. Hence, there is an element of risk as well.
On the whole, the returns earned by real estate are comparable to risk-free investments even though a lot of risks has to be taken. This is what makes realty a bad bet for the middle class.
Buying real estate forces a person to settle down in one geographical area. Because of the transaction costs mentioned above, real estate cannot be bought and sold too often.
The problem with settling in one geographical area is that the opportunities are severely limited. This is the reason why millennials chose not to buy a house. In this era of layoffs and job changes, owning a house is more of a liability than an asset.
As already mentioned above, real estate purchases are usually leveraged. This means that people are paying large chunks of their income in interest. All these payments are being made with the assumption that real estate prices will rise. The problem is that if the prices don’t rise, investors stand to lose a lot of money.
It needs to be understood that the price doesn’t need to fall in order for the investors to lose money. Even if the price stays stagnant, investors have already lost a huge chunk of their savings which they paid out in the form of interest.
Lastly, since real estate consumes most of the salary that a middle-class person earns, it consumes most of their portfolio.
Instead of having a balanced portfolio which protects the investors in the event of a downturn, most of the savings of the middle class are in the housing market. This is the reason when the housing market went down in 2008 the entire economy went into shambles.
The bottom is that “buying a house as soon as you can” is OLD advice. Millennials are well aware of the several financial pitfalls there are to owning a home.
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