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squiffy
09-30-2005, 04:30 AM
Just read in a money magazine online article that Warren Buffett supposedly lives in the same home he bought back in 1958 for 31,500 in Omaha NE.

It was worth about 700,000 in 2003.

Home price appreciation over time in NE is probably a lower rate of return than other states, such as CA and NYC. So it would be interesting to get long term data for other houses in NYC and CA.

Anyway, putting those numbers into various calculators.

Inflation
1958 31,500 home would be worth $210,406.92 if it just kept pace with inflation. So home clearly rose above inflation rate, as calculated by CPI.

http://data.bls.gov/cgi-bin/cpicalc.pl

IRR Internal Rate of Return or Average Annual Yield calculator gives about 7% annual return.

http://cgi.money.cnn.com/tools/returnrate/returnrate.jsp

But you also have to remember, he paid no rent for the 47 years. So he is actually ahead quite a bit and has "earned" more than 7% annually on the home.

Assuming he originally had say a 6% mortgage and 30 year fixed loan, then he was ahead early on, even after considering the cost of borrowing money.

The money cost him 6% a year. But the home was appreciating at a tax-deferred 7%. (Possibly tax free depending on sale or transfer on death rules). In addition, his cost of borrowing was not 6%, but say 4%, because of tax deductions. So even after borrowing costs, he was ahead about 3% a year, not including rental savings.

So one way to look at owning real estate over the long term is this. You pay no rent for the entire time you are in the home, this could be as much as say $1200 or more a month, depending on the size of the home and the going rental rate in your town.

PLUS. At the end of 30 years, you own the home outright, and the home has probably appreciated in value at a rate that is so high that you beat inflation AND beat the cost of borrowing.

So you pay no rent. And you get back all of the money you paid toward the mortgage, plus interest!!!!

In the short run, you are cash poor. But it is like a forced savings. All the money that you paid in, you should get back eventually in home equity. And once the 30 year mortgage is paid off, you get tax-deferred or tax-free appreciation at 7%, PLUS still pay NO RENT, until you die.

My colleague in Fresno recently sold his 1400 sq ft home. He has two kids and wanted to buy something bigger.

He paid about 95K in 1994 and sold for 279K in 2005. I put the numbers in the IRR calculator and he earned about 9.3% a year for those 10-11 years. Not bad. PLUS did not pay rent. So his actual gain was more than 9%.

He originally had an 8% mortgage, but about 5 years into it refinanced. And then refinanced again as rates fell more.

And Fresno's appreciation historically has not been nearly as good as say SFO or LA.

It would be interesting to hear some numbers for people in NYC, LA, and SFO over the long-term say 20-30 years.

And I am not even considering the fact that most people only put out a small down payment of say 20% to 0% down these days.

Which gives you a great return on investment, due to the leverage.

You may only put down say 10,000 to buy a 200K house. So if you make a 10% return or more on the 200K house, your 10,000 investment is giving you say a 20K per year return, or nearly 50% return on the money actually invested. (Though you do have to make the monthly mortgage payments, which reduces your return relative to money invested. )

squiffy
09-30-2005, 04:37 AM
So owning real estate, has two aspects, or two potential income components -- a use component and an investment component.

There is a USE or rental component (ability to live in the home) and a SALE/TRADING or investment component (the home value appreciates over time, generally above the rate of inflation and above the cost of borrowing money to finance the purchase).

You can either live in it yourself, and pay not rent. Or you can lease it out and collect the rent from a tenant.

Plus, if you own the property, you benefit from any long-term appreciation in the value of the asset.

Note a stock has no USE component, only an INVESTMENT or TRADING component.

You buy a stock at 10 today. And hope to sell it for 11 (10% gain) at some time in the future either 1 hour, 1 day, 1 month, or 1 year from now.

You cannot live in the stock or rent it out for someone else to live in.

So real estate is interesting in that you can live in it or rent it out, while waiting for it to appreciate in long-term trading value.

Note, from a philosophical standpoint, we are all buy and hold investors. When you buy a stock, you must HOLD it for some length of time, before you can sell it. The only question is -- how long is the optimal holding period to optimize your profit, considering trading costs, the predictability of price increases/decreases, and tax considerations.

Note that some of the tax and trading considerations which force Warren Buffett and Peter Lynch (with billions to invest) to be long-term buy and hold investors DO NOT necessarily apply to average investors with only a small amount to invest.

squiffy
09-30-2005, 04:47 AM
Here is average home price appreciation data. The only problem is that it is an "average". It is more interesting to examine a specific home.

And another problems is that it is only for the second quarter. More helpful would be long-term statistics over 20-40 years, so that you can get a realistic picture of likely long-term appreciation.

And once again. Remember that these statistics only show part of the equation -- your gain from the sale price of the house and lot.

It completely ignores the fact that you pay NO RENT for the entire time that you live in the property, which would add significantly to your gain.

I will try to do an analysis later of my own situation. And I will also try to get some data from friends in Hawaii, who have condos there.

Anyone else with some long-term data, please post.

http://money.cnn.com/pf/features/lists/nar_2q05/

crazy canuck
09-30-2005, 06:38 AM
Don't know if this helps, but according to this guy the housing bubble will burst in mid 2006.

Is There a Real-Estate Bubble in the US? (http://arxiv.org/abs/physics/0506027[/)

His models explain most of the major crashes...tho it is always easy to do in hindsight. I read his book (Why stock markets crash) and he knows what he is talking about.

Ray Zee
10-02-2005, 01:01 AM
plus tax advantages from owning you rown home. the interest is deductable and 250 or 500000 gain is tax free. you laso get to deduct lots of things if you also have a rental. property ownership is a no brainer if you can hold it over time.
in montana where i live since 1990 property in my area has increased ten fold in value. plus tax breaks plus rent= riches. those that sat on the side lines talking about how it could go down are still renting from me and paying much more for the pleasure.

cwsiggy
10-02-2005, 01:21 PM
I don't think the average home owner realizes the leverage aspect to owning real estate. (10% down on 100k - market up 5% - congrats, you just made 50% on your original investment - before transaction fees) They simply know that in general they make money over the long run.
Peter Lynch said that in this nation, real estate has never ever gone down (nationally) since it has been tracked.

ggbman
10-02-2005, 09:50 PM
[ QUOTE ]
I don't think the average home owner realizes the leverage aspect to owning real estate. (10% down on 100k - market up 5% - congrats, you just made 50% on your original investment - before transaction fees) They simply know that in general they make money over the long run.
Peter Lynch said that in this nation, real estate has never ever gone down (nationally) since it has been tracked.

[/ QUOTE ]

What about when the property tanks 30%? I think real estate investing is the best long term investment out there, but spewing out stats like that are worthless without considering the potenital risk as well. If you need to sell the property and can only get 70% of what you bought it for in the first place, which does happen, then you are taking a BIG hit.

cwsiggy
10-02-2005, 11:55 PM
Of course that is always the risk with leverage. When real estate prices go down in regions of the country, it certainly wakes people up to the concept(and wipes them out if they have to sell - job loss, moving etc.) That stat is true though about the national pricing according to the white haired wizard of investing.

Peter666
10-04-2005, 11:36 AM
I don't see how a property that you live in is considered a real investment until you sell the property, take the cash and buy something cheaper to live in, thereby having a net gain.

Without positive cash flow (and the property you live in usually generates negative cash flow) you are not invested! Banks encouraging people to take out large mortgages because their home is an investment is the biggest lie in financial planning! You are making bankers extraordinarily rich by doing so.

squiffy
10-05-2005, 12:29 AM
You can define an investment in any way you want. You can define an investment to be a small furry animal with four legs, which other people call a beaver. You will just have trouble getting other people to agree that your definition is useful or meaningful.

If you define an investment to mean only what you get when you actually sell the property, that is a pretty narrow investment.

If you pay 200k for a home. And today your neighbor's identical home sells for $1 million. Then it is customary to assume that you have 800K equity in your home. And bankers will lend you money even if you haven't sold the home.

You are right. Bankers can be stupid. And they are doing way too much lending. And when everyone wakes up, they will realize that their "equity" is an illusion.

I think you are right though. People assume that the values are lasting and permanent. Whereas the truth is, in theory, you MIGHT be able to sell your home for the market price, IF you were to put it on the market today, and IF your 100 neighbors don't put their homes on the market simultaneously.

But that is how our economic system is set up. If the bankers will lend me the money, I can borrow it.

You are right though, if there were some restrictions on lending terms, we might all be better off and it might discourage bubble formation.

Just as they limited lending stock market gambling money on margin. They should probably do more to limit overboard lending to buy real estate.

Sniper
10-05-2005, 10:38 AM
Squiff,

Never forget that your mortgage is the bank's asset... an asset that will provide the bank with a nice return over the life of the loan!

squiffy
10-05-2005, 10:40 AM
The bank gets 6% a year. The real estate owner could be getting 9% a year or more on the land, plus playing no rent. It can be win-win.

And I would be happy to pay 6% to make 9% plus, tax-deferred, possibly tax-free, over 30 years.

Peter666
10-05-2005, 11:29 AM
I don't think a beaver is a good investment. I expect a true investment to give me a net gain. A person taking a mortgage of $200,000 over 25 years on the house they own actually pays around a million dollars for that house. You must take into account property taxes, cost of maintenance etc. It is very unlikely that you will be + EV when you get that million dollar loan from the bank. It's an illusion.

I also believe your 9% per year figure on land is exhorbitant. My records show that a little less than 3% is the average figure.

While taking a mortgage on the house you live in for the long term maybe beneficial over renting for the same period of time, it should not be considered an investment.

Buying a property for cheap, renovating/building and selling it at a much higher price is a different matter.

squiffy
10-05-2005, 11:23 PM
Peter Lynch Learn to Earn page 103.

You're right. It's not a good idea to borrow money to buy a home. It's generally not a very good investment.

That 9% figure I quoted is probably impossible to achieve.

ChipWrecked
10-09-2005, 05:29 PM
If there is not a real estate bubble in California, middle class earners like myself will never be able to buy a home. Something just smells wrong about that.

I work with a guy who crows about how his $140,000 house from 4 years ago is now worth $350,000. And this is in the Sacramento area.

So we sit in our apartment and wait. And look at undervalued markets like Salt Lake City, though we really would rather stay in California. I can't believe we're alone in this. Looks like another mass eastward migration out of here, get ready y'all.