6 Myths About Real Estate

by Nora Dunn on 15 October 2008 11 comments
Photo: Nora Dunn

When stock markets go down, people tend to thank their lucky stars they own real estate, and others yet rush to the real estate market as a safe haven. But real estate isn’t always what it is cracked up to be either. Here are six common myths about owning real estate.

 

"Bricks & Mortar are as Solid as it Gets"

While technically this is true (a hammer will prove this fact, albeit leaving a bit of a mess in your living room), real estate is not to be considered a solid investment that is impervious to market fluctuations. You can lose money investing in property – a lot of it.

Where real estate makes up for market losses in some people’s minds is in the accumulation of wealth through paying down a mortgage and increasing the principal share. You may sell the property at a loss, but end up with more money in your pocket than when you started (if you’re lucky, after fees and commissions). This is an example of “good debt”  hard at work; something that can be achieved with modalities that include but are not limited to real estate.

 

"Fixer-Uppers Mean Big Profits"

Susie bought a fixer-upper for $180,000, and enjoyed renovating it over the following eight years, at which point she sold it gleefully for $270,000. However, once she sat down and took into account the cost of buying and selling, property taxes, and her renovation costs of $35,000, her actual profits from this exercise were less than $20,000. Her effective rate of return (not accounting for inflation, which makes her overall profit even more grim) was less than 1.5% per year. So although big dollar gains may seem alluring, they aren’t always as profitable as at first blush. Let’s not forget that unless you enjoy living in squalor while the house is renovated, your quality of life and enjoying your home could be substandard. Or conversely, allowing the home to sit empty while you maintain another home has additional financial costs that affect your rate of return.

 

"Real Estate is the Best Tax-Preferred Investment"

Real estate is indeed a mechanism for harboring potentially large gains from taxation, although capital gains-based investments are also tax-preferred. In fact, if you invest the same amount of money in shares for the same duration you own your home for, you could arguably see even larger after-tax returns. Most people however, don’t have the stomach or patience to invest hundreds of thousands of dollars into the markets with substantial loans (mortgage-equivalents) to go along with it, and then sit patiently on said market investment for the next 15 years or so.

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"You Call All the Shots with Real Estate"

Although you have the ability to decide where, when, and how to buy, and then you have complete control over how the property looks and feels, you don’t call the shots with regards to the evolution of your neighborhood and how it affects your property value. You could have the spiffiest house on the block, but if the rest of the block isn’t following suit, you won’t likely recoup the money spent to spiff up the place when you sell. Even one crappy neighbor can ruin the party.

 

Speaking of Neighbors - and Liquidity…

You may move in to discover that your dreams of popping by the neighbor’s place to borrow a cup of sugar are dashed when you realize your neighbor is a drug dealer with a grow op in the basement, and all manner of folks coming through at all times of the day and night. Or your neighbor could simply be a mean, crotchety person who evolves into the enemy of all that is good in your world.

This is when you begin to understand an inherent disadvantage of real estate in comparison to investing in shares: real estate is not as liquid, and you could be stuck with a nasty situation for longer than you are comfortable with. Being personally invested in this way can be downright painful.

 

"Property is Less Volatile Than Shares"

If you could monitor the value of your property every day like you do with stocks, you might just discover that your rock-solid real estate investment is as wobbly day-to-day as any stock is. Thank goodness you can’t. Now I wonder what would happen if we couldn’t monitor our stock investments every day…we may all be much richer in the end, with fewer grey hairs for all our worrying about market fluctuations.

 

 

Having debunked six common myths about real estate, I must note that if properly incorporated into your overall portfolio, real estate has a very legitimate place as a tax-preferred wealth creation mechanism. I believe the world is learning some valuable lessons right now about the consequences of overextending ourselves with oversized mortgages. But this too – along with the market fluctuations we are seeing – will pass, and hopefully we will emerge all the wiser as victors…eventually. As with so many investments, give it time.

 

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Guest's picture

Great post - I love when someone actually writes the cold, hard truth about reality.

Your second example about poor accounting is very true - most people want to feel good about their investment - even if they lost money.

One of my biggest problems with real estate investment (which isn't a myth) is the lack of diversification.

Guest's picture
Guest

If yopur neighbor has a grow op, see if you can get a photo op.

Andrea Karim's picture

Thanks so much for this post, Nora. As someone who can attest to how easy it is to lose money in a home, I have to say that this is the most level-headed assessment of the realities of real estate that I've seen in a long, long time.

Guest's picture

These are 6 great myths that will help people out tremendously when looking to invest in real estate. Even though it is a very tough market out there now, there are still plenty of investments out there for you to make some good profits today. Just make sure you do your due diligence when investing in a property

Maggie Wells's picture

You made me feel a little better... :) We are blessed with decent neighbors, a quiet street and a house that is manageable in size and mortgage payment, and it was only partly a fixer, but a good friend who is a realtor around her echos your myths! Two streets down from us nothing sells! Why? No view of the mountains and less than desirable neighbor at the end of the block.  You made me feel smarter than I am about my own house. Thanks.

 

 

Margaret Garcia-Couoh

Guest's picture
wildgift

A building is a depreciating asset. People forget that. The longer it's there, the less it's worth. The longer you own it, the more you have to fix it.

Land tends to increase in value if the population increases. If the population is decreasing, then the value of the property will decrease. It's just supply and demand.

If you accept these two facts, then, one would expect that house values increase in cities with growth, while houses decrease in value in areas without growth.

All the other fluctuations are due to other factors :-)

Guest's picture
Guest

Some good points brought up here. At this point in time I believe the days of buying and selling "fixer-uppers" are over. The reality is buying a house that needs some work is the only way some people can afford to enter the housing market.

You touched on a few real estate topics (capital gains,liquid assets, home comps, renovation costs et.) that potential homeowners need to pay attention to when looking to buy.

Guest's picture

Myth #7. Once it's paid off, you can live mortgage free. Wait, you still have insurance, maintenance and taxes. Free isn't really free unless you live out in the boonies.

-Lee from www.cheaplee.com

Guest's picture

This is good to remember when thinking about buying. I'll save this list for when the time is right.

Guest's picture

Renting is often better when considering where to personally live, but this should not be taken to exclude real estate from a well diversified portfolio. There are different types of real estate bets to make, many of which are superior to a single family residence.

When it comes to deciding whether to rent or own for yourself I defer to these two articles written on the decision:

http://www.thefreedomfactory.us/why-renting-is-better/

http://www.thefreedomfactory.us/why-renting-is-better-part-2/

When considering real estate as an investment (not place to live), apply basic discounted cash flow valuation methodologies and make sure risk-adjusted expected returns are greater than required returns for the risk level of the asset class...for real estate ~ 14% before tax RROR. Since real estate markets are illiquid and very much imefficient, there are many chances to negotiate deals that meet required return hurdle rates.

Guest's picture
Yura

Three years ago I sold my first home without any Net resources. But it was very difficult for me. I heard that some services can publish ads about my home in the Internet. Can you help me to choose between Fizber and Trulia? Do you know anything about these services? My friend said that "Fizber" better than "Trulia". But maybe he wasn't right. So I need help.