NYT Article: In the Long Run, Sleep at Home and Invest in the Stock Market

Discussion in 'Wall St. News' started by CPTrader, Aug 19, 2005.

  1. What do you guys think about this?


    August 19, 2005
    In the Long Run, Sleep at Home and Invest in the Stock Market
    The housing boom of the last five years has made many homeowners feel like very, very smart investors.

    As the value of real estate has skyrocketed, owners have become enamored of the wealth their homes are creating, with many concluding that real estate is now a safer and better investment than stocks. It turns out, though, that the last five years - when homes in some hot markets like Manhattan and Las Vegas have outperformed stocks - has been a highly unusual period.

    In fact, by a wide margin over time, stock prices have risen more quickly than home values, even on the East and West Coasts, where home values have appreciated most.

    When Marti and Ray Jacobs sold the five-bedroom colonial house in Harrington Park, N.J., where they had lived since 1970, they made what looked like a typically impressive profit. They had paid $110,000 to have the house built and sold it in July for $900,000.

    But the truth is that much of the gain came from simple price inflation, the same force that has made a gallon of milk more expensive today than it was three decades ago. The Jacobses also invested tens of thousands of dollars in a new master bathroom, with marble floors, a Jacuzzi bathtub and vanity cabinets.

    Add it all up, and they ended up making an inflation-adjusted profit of less than 10 percent over the 35 years.

    That return does not come close to the gains of the stock market over the same period. The Standard & Poor's 500-stock index has increased almost 200 percent since 1970, even after accounting for inflation.

    Yet investment advisers worry that this reality is getting lost in today's enthusiasm for houses, even as some economists say the housing market has peaked. People are buying homes purely on speculation, trading real estate almost as if it were a stock. Surveys show that a large majority of Americans consider real estate to be a safer investment than stocks.

    "With how strong the real estate market has performed, there is the urge for people to chase returns," said Jeff A. Weiand, executive vice president of RTD Financial Advisors in Philadelphia. "But it's very difficult to beat the long-term historical record of stocks."

    Since 1980, for example, money invested in the Standard & Poor's 500 has delivered a return of 10 percent a year on average. Including dividends, the return on the S.& P. 500 rises to 12 percent a year. Even in New York and San Francisco, homes have risen in value only about 7 percent a year over the same span.

    That does not mean real estate is a bad investment. It is often an important source of wealth for families. But its main benefit is what it has always been: you can live in the house you own.

    "The biggest value of the house is the shelter it provides," said Thomas Z. Lys, an accounting professor at the Kellogg School of Management at Northwestern University. "Too many people are fixated on speculation whereas most of the benefit really comes from usage."

    Despite the fact that home values usually appreciate over time, most of the value of a house actually comes from the ability to use it. In this way, it is more like a car, albeit one that does not become less valuable over time, than it is like a stock. Whenever people sell one house, they must immediately pay to live elsewhere, meaning that they can never wholly cash out of a home's value.

    Including the value of living in a house - that is, the rent that a family would have to pay to live in an equivalent house elsewhere - homes in New York have returned more than 15 percent a year since 1980, according to an analysis by Mr. Lys.

    But only five percentage points of this return comes from sheer price appreciation, as opposed to the value of shelter. Mr. Lys accounted for property taxes, spending on renovations, interest payments and the tax deductions on those payments, and the fact that most house purchases are made with mortgages.

    When the sale of a house brings in a cash windfall, homeowners tend to focus on the fact that they made a down payment that was just a fraction of their house's value, lifting their return. But many forget just how much money they spent on property taxes, a new roof and the mortgage interest.

    Add to all these factors the corrosive effect of inflation, and the returns are even lower.

    The Jacobses - she is an administrator for a magazine and he a lawyer - were quite pleased with the sale of their house in New Jersey. To them, it was a place to raise their two children more than it was an investment.

    When the couple spent about $100,000 to redo their master bathroom, install a walk-in closet and build a deck in the mid-1980's, Mr. Jacobs recalled saying to his wife, "We'll never get the money out that we put into this, but at least we'll enjoy it for 15 years or so."

    Told of the comparative returns on his house and the stock market, Mr. Jacobs said, "Of course I couldn't live in the portfolio."

    Today, however, he has come to see the advantages of the stock market. The Jacobses now rent an apartment on the Upper West Side for more than $4,000 a month and have invested the proceeds from the house sale in the stock market, making it easier for them to raise cash by selling shares.

    "I didn't want to take the money that we pulled out of the house and have all that money tied up in an apartment where I still have expenses of maintenance fees," Mr. Jacobs said.

    But many people seem to be going in the opposite direction from the Jacobses. Eighty percent of Americans deemed real estate a safer investment than stocks in an NBC News/Wall Street Journal poll done this spring, while only 13 percent said stocks were safer.

    Part of that sentiment is driven by the recent memory of the stock market collapse in 2000. Many homeowners seem to have forgotten that less than 15 years ago house prices in the Northeast and California fell, but the money they lost on technology stocks is still fresh in their minds.

    Stocks are also more volatile, and their price changes can be viewed every day. "The news doesn't report to you daily that your house price might have gone up or down," Mr. Lys said. "So you think your house price is more stable than it really is because you don't observe these minute-by-minute gyrations."

    Economists caution that any comparison between real estate and stocks is tricky, because real estate is typically a leveraged investment, in which a home buyer makes a down payment equal to only a fraction of a house's value and borrows to finance the rest. While it is possible to borrow money from a brokerage firm to buy stocks, most individual investors simply buy the shares outright.

    When home prices are rising, the leverage from a mortgage lifts real estate returns in the short term. Someone putting down $100,000 to buy a $500,000 home can feel as if the investment doubled when told that the house is now worth $600,000.

    But the power of leverage vanishes as homeowners pay off the mortgage, as the Jacobses have. Leverage also creates more short-term risk, especially for those who have stretched to afford their house.

    "If the home went down by 30 percent, you'd probably be sitting with a bankruptcy attorney," said Jonathan Golub, United States equity strategist at J. P. Morgan Asset Management in New York. "If your I.B.M. stock goes down by 30 percent, no big deal. So you had $100,000, now you have $70,000. You don't declare bankruptcy; you just don't go out to the movies as much, or you retire a year later."

    But such risks are hard to imagine when many markets are still enjoying double-digit percentage increases every year. The number of people buying houses they do not plan to live in has surged. There are also Internet exchanges where investors can trade yet-to-be-built condominiums or futures contracts tied to average home prices in big metropolitan areas.

    But economists and investment advisers say that most of the value from real estate comes not from anything that can be captured by flipping it, but from the safety net it provides in bad times. Even if the market shifts downward, "you have a roof over your head," said Jonathan Miller, a real estate appraiser in Manhattan.

    Beyond the shelter it provides, the biggest advantage of real estate might be that it protects people from their worst investment instincts. Most people do not sell their house out of frustration after a few months of declining values, as they might with a stock. Instead, they are almost forced to be long-run investors who do not try to time the market.

    Harlan Larson, a retired manager of car dealerships near Minneapolis, still regrets having bought Northwest Airlines stock at $25 a share a few years ago. It is now trading at less than $5.

    By comparison, he views the four-bedroom home he bought for $32,500 in 1965 - or about $200,000 in today's dollars - as a money tree. He and his wife recently listed it for $413,000. That would translate into an annual return of 1.2 percent, taking into account inflation and the cost of two new decks and an extra room.

    They plan to move to Texas after it has sold. "I wish I'd bought more real estate," Mr. Larson said.

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  2. Yep.
    And it's all about the power of growing dividends.
    Check the stats with any asset-allocator like First Quadrant in Pasadena. They will show you all the facts you need to know on market returns, and how dividends play a HUGE part!

  3. i think the article is a poignant debunking of the housing as value myth, however i don't agree with the idea that stocks are always a great investment for the long term. why have immutable faith in a single asset class?
  4. Chagi


    My only beef about dividends is that it generally speaking isn't terribly cost effective to reinvest them unless you:

    a) have extremely low brokerage commissions
    b) have significant enough self-directed capital that the dividends are sizeable enough that commissions are minimal


    c) have your funds sitting in a mutual fund

    My point about this is that economists tend to look back over the past "x" number of years when they write about this sort of thing without considering transaction costs. The transaction costs could actually be fairly significant too, assuming that one is holding a diversified portfolio of dividend paying stocks (as any good investor supposedly should)...

    It's fortunate that ETFs have arrived on the scene, because they largely negate the need for an investor with moderately good market knowledge to put their money into a mutual fund (since you can diversify via a single investment).
  5. d) DRIPs let you reinvest for free, generally at a slight discount to fair market value
    e) Ameritrade will reinvest dividends for you commission free, just drop them an email. In fact it pisses me off, I had to mail them to get them to stop. I don't know if other brokers will do this too.

  6. buffett is living proof that stk is better investment than hse.
  7. Trump is living proof that real estate is better investment than stock. :D
  8. Pabst


    Last I saw, the maximum margin on stocks was 50%. The down payment on RE may be as little as nothing. If someone buys a 100k home for 10% down and sells it down the road for 200k they didn't make 100% profit, they made 1000% profit. Minus of course carrying costs like interest, property taxes, ect.

    For seasoned RE speculators, it's not just the appreciation but the leverage that makes property a home-run trade. Not to mention that a well purchased rental/income property has an imbedded free call.
  9. Oh yeah who is richer?

    anyway Trump made his money mostly in commercial real estate if I am not mistaken
    really it doesn't take much analysis to realize that real estate gains for most remain an illusion of wealth more than actual wealth. You cannot cash out as with stocks unless you are willing to move to a much less expensive area . In my book getting rich means moving to a better area, upgrading not downgrading your lifestyle
  10. lol, this comment is inane. buffett is living proof that entrepreneurs make the most money...and gates, and the guys from google, and the owner of ikea, and most of the world's richest people.

    #10     Aug 20, 2005