Zillow Talk Takeaway #5: Stop Worrying, Real Estate is a Great Investment
All this week, I will be publishing my five key takeaways from the new book Zillow Talk: The New Rules of Real Estate by Zillow CEO Spencer Rascoff and Chief Economist Stan Humphries. You can read my review of the book at Inman News here, and the rest of the “five takeaways” here.
Real estate is a great investment. There, I said it, and I’m proud to say it. You won’t hear it from the people on CNBC or Fox Business, who all come out of Wall Street and don’t understand real estate. And you won’t hear it from “contrarian” economists who love to make facile comparisons of real estate values to stock prices showing that equities have been a better long-term investment than stocks. But you’ll hear it from me.
But you won’t hear it enough from many real estate professionals, whom I think are a little gun-shy about promoting real estate as an investment. Part of it is the shell-shock from the 2008 market correction, when so many people took our advice to buy a home and ultimately lost everything. Part of it is also the media hype about the real estate bubble, which has made people self-conscious about saying nice things about the real estate market. Or maybe it’s because real estate agents get stereotyped (often fairly) about always thinking a “GREAT TIME TO BUY!”, and they’re afraid of getting colored with that brush.
The fact is this: other than short period between maybe 2005 and 2009, it really has been a “great time to buy” real estate for most of the past 40 years or so.
And I don’t see why we shouldn’t be proud of our asset class. I mean, everyone else is. I’ve never met a Wall Street stock analyst who thought that stocks were generally a bad investment. I’ve never met a life insurance salesperson who thought I had enough coverage. You should only work in a business you believe in, and whether you’re a stockbroker, insurance provider, or real estate broker, you should believe in what you market.
The fact is, real estate IS a great investment. Indeed, I’m on record (on videotape in fact) promoting real estate as an investment back in 2012, before the market in my area started to turn around. And I’m an investor in my brother’s great company OwnAmerica, which promotes residential real estate investment, helps institutional investors buy portfolios, and teaches agents how to help their clients make those investments.
And now with the publication of Zillow Talk: The New Rules of Real Estate by Zillow CEO Spencer Rascoff and Chief Economist Stan Humphries, we have some good data to back us up. Rascoff and Humphries go through the typical arguments about whether real estate is as good an investment as stocks, but come to an atypical conclusion:
We won’t bore you with the math, but when factoring all of these variables and distinctions into our calculations – from stock dividends, to rental income, to tax advantages – the result surprised even a couple of die-hard real estate fans like us. Based on our analysis, from 1975 to 2014, the S&P 500 averaged an annual return of 10.4%, while residential real estate returned 1..6% each year on average. That’s right: all things being equal, investing in real estate is definitely the better bet.
(Page 22).
I want to unpack that a little, because Rascoff and Humphries “yadda yadda yadda” a lot of their argument when they say they won’t get into the boring math. Although I don’t have access to the mountains of data that they did, I think I basically understand what they were doing.
Here’s the thing. The problem that Wall Streeters and many economists have is that when they evaluate real estate as an investment, they make the simple comparison of property values to equity values. That is, they look at what would happen if you invested $100,000 in the stock market versus $100,000 in real estate at any given time, and then look to see which investment appreciated more.
But that’s not how real estate investment works for most people, for a couple of reasons:
1. The Impact of Financing and Leverage on Investment Returns
Most people don’t buy their homes for cash, they finance them. And that means that they don’t buy a $100,000 home with that $100,000 of cash they have to invest – rather, then buy, say, a $500,000 home. You can’t do that with stocks, unless you’re willing to trade on margin, which most people can’t (and absolutely shouldn’t!) do.
But that changes the calculation a lot. For example, if we ran that typical stocks-v-real estate comparison over a period of time, and found that stocks appreciated by 20% and real estate by only 10%, we’d probably conclude that stocks were a better investment, because that $100,000 in stocks was now worth $120,000 and the real estate investment was only worth $110,000.
But that’s not the right baseline! We measure real estate appreciation based on the value of the house itself, so if real estate did appreciate by 10%, then that $500,000 house is now worth $550,000, a $50,000 return on that $100,000 invested.
2. The Value of Having a Place to Live
Also, when analysts look at that stock-v-real estate comparison, they rarely focus on where that investor lives. That is, if the investor puts $100,000 into that $500,000 house, he has a place to live. But if he puts that $100,000 into stocks, he doesn’t. You can’t live in a stock portfolio. So he’s going to have to find a home, which means paying rent (or psychic rent, if he goes to live with his parents). Meanwhile, our home buyers already have a home.
Now, both the home buyers and the stock investor are going to have to pay for their residences – the home buyers through their mortgage and the stock investor through his rent. And inmy experience, people generally make the same general monthly payment whether they are renting or buying, since most home buyers can’t get financing to spend more than a third or so of their income on housing, and most renters use that as a guidelines for how much rental home they can afford. But the difference is that the home buyers are slowly building equity in their home. Yes, much of their mortgage payment goes to pay interest, but part of it goes to acquire more of that $500,000 house.
Let’s say that both our renter and our home buyers stay in the home for 30 years. After that 30 years, the renter still has that $100,000-plus-appreciation for his stock investment. Meanwhile, the home buyers have $500,000-plus-appreciation for their real estate investment, because over that 30 year period they’ve slowly paid down that principal. So that rental will have to make a 500% (5x) on his investment to even compete with the real estate investor.
3. Tax Advantages
Analysis also usually miss (or gloss over) the tax advantages of owning your own home. Without going too much into some “boring math,” most real estate agents understand that capital gains on the sale of a personal residence are generally tax free up to a certain cap ($250,000 individual, $500,000 family).
So to follow up on our example where stocks wen up 20% and real estate went up 10% since the initial $100,000 investment. Our stock investor is going to pay 15% federal capital gains tax on that $20,000 of profit he made on his equities investment, reducing his gain by $3,000. But our home buyers, assuming that they bought that house as their personal residence, are getting that $50,000 of profit tax-free.
Conclusion
Now, I’ve yadda-yadda-yadda’d over a lot myself. I haven’t gone into the higher transaction costs for buying and selling real estate, or the maintenance costs, or some of the other factors that generally reduce the value of owning real estate. Then again, I also haven’t gone over the value of “forced savings,” and the fact that owning real estate helps protect you from the volatility of the stock market.
But the basic fact remains that real estate is a really good investment, and real estate professionals should be proud of their asset class.
Now, I should make one thing clear. This has all been my (short) take take on why real estate is a good investment. I can’t be sure that it’s consistent with the argument put out in Zillow Talk. I don’t know what Rascoff and Humphries were actually doing with all the “boring math” they skipped, so I’m not speaking for them. But it’s clear they were doing a much more sophisticated analysis than most economists and Wall Streeters do when they just make the facile comparison between stock and home prices, and that’s a really important addition to the eternal debate about what is a better investment.
Zillow Talk: The New Rules of Real Estate – Takeaway #1
Zillow Talk: The New Rules of Real Estate – Takeaway #2